As you negotiate over fees and costs, you will surely encounter the argument that 2 percent of your capital is just a tiny amount to pay for good help. Be careful here, for it is a mistake to examine fees in relation to the amount of your capital. Rather, you should compare fees to your expected return on the capital. Thus, if your investment portfolio is expected to return 8 percent next year and they propose to take 2 percent, it would appear that they are expropriating a quarter of the return for themselves. That is more or less correct for one year. But let us not concern ourselves with one year. The numbers, and the seeming injustice, change drastically over long periods of time.
One dollar, earning a return of 8 percent over 30 years, will grow to $10.93. Reduced by costs of 2 percent, though, an after-fee return of 6 percent will be achieved. And a dollar growing at 6 percent for 30 years will become $6.02. In this example, a “mere” 2 percent fee reduces the return by almost 45 percent. When we put it that way, does it seem fair?
John Bogle gives an even more dramatic example. He looked at an investor in a tax-deferred retirement account whose return averaged 5 percent annually. Compounding year after year at that rate, $1 becomes $7.04 over 40 years, or a $100,000 input becomes $704,000. When you subtract fees and charges of 2 percent, however, the result is striking. Just like long-term gains, the bite of fees also has a compounding effect. As Bogle figures it, the projected gain from $1 to $7.04 over 40 years gets cut way down by the cost bite—down to $3.26.3
“Where did the nearly $4 difference go?” Bogle asks. “It went to the fund or to Wall Street in fees. So you the investor put up 100 percent of the capital. You take 100 percent of the risk. And you capture about 37 percent of the return. The fund or Wall Street puts up none of the capital, takes none of the risk and takes out 63 percent of the return.” In these very dramatic long-term examples, we know intuitively that the share being claimed by the industry is wildly unfair.4
Pay Only for Services That Provide You with Value
If legitimate investment services that carry excessive costs are bad, services that add no value to you are a terrible deal at any price. As mentioned before and explained in detail in a later chapter, economists can show that most stock-picking strategies perform no better than throwing darts at the Wall Street Journal. This means that a great deal of the investment advice and services being offered are actually worth nothing to you. Essentially, they seek payment for the playing out of random chance. Even if such firms spend millions of dollars on salaries, computer programs, and high-priced New York rents, their services are overpriced at a nickel.
One is reminded of the children’s story “Stone Soup.” As you recall, the hungry soldiers offered to make a delicious soup for the townsfolk out of nothing but water and stones. Slowly but surely, as they won over people’s confidence, they persuaded local folks to add meat, vegetables, milk, and spices. Eventually, the soup was delicious because the townspeople added the appetizing ingredients. The hungry soldiers’ rightful reward for their cleverness was to share the soup with everyone else. It is a heartwarming story that leaves us with a good feeling. Imagine how we might feel, however, if the soldiers demanded a high fee for the stones that were the initial soup base. The twist in the tale is that those stones are worthless—they add neither flavor nor nutrition. In fairness, nobody should be paying anything for them.
Chapter Summary
“Fair terms or no deal.”
Your idea of fair may differ from theirs.
Just because they have always done it that way does not make it fair.
Transparency is necessary to even talk about fairness.
Demand a fair share of the value being created by the deal.
Do the math on costs and fees.
Costs compound over long periods, so amounts that seem fair for one year may not be over the long term.
Don’t pay for anything that has no real value to you.
Notes
1. David Lax and James Sebenius, Manager as Negotiator: Bargaining for Cooperation and Competitive Gain (New York: The Free Press, 1986), 29.
2. John Bogle, “The Retirement Gamble,” Frontline, PBS, April 23, 2013.
3. Kerry Hannon, “The Three Surprises in 401(k)s,” Forbes, January 13, 2013.
4. Ibid.
Chapter 22
Plan the Type and Tone of Communication You Want
Communicating successfully is important in any investment situation. It is going to be critical, though, as you negotiate your working relationship with any sort of financial advisor. Because it is likely to be unfamiliar territory, you will want to control how you communicate with other parties and make sure you receive clear, valid, and complete information in return. You never want to negotiate about your investments in a state of confusion or misunderstanding.
Communication to Enhance Your Understanding
Start by promising yourself that you will not be shy or intimidated.
You need to insist on clear explanations in understandable English. Financial service providers habitually use jargon and vague terms both to obfuscate and intimidate. Persist until you have a full understanding and stand firm against any suggestion that you should be able to “read it in the prospectus.” Those documents cannot be understood by humans, or even lawyers, and you can quote me on that. Every assertion and every promise must be made in plain English that a high school student would understand.
Furthermore, be adamant that all such statements must be supplied to you in writing. While some parts of the financial industry are more slippery than others, you must insist on having everything in a complete written document in all your dealings. In this area of your life, if you don’t have it in writing, you don’t really have any deal at all.
Communication to Make Things Clear to Them
How can you let them know of your requirements, interests, and inviolate standards in the clearest way possible? You are telling them explicitly that any agreement must be better than your best alternative, meet your interests well, and be demonstrably fair. It will also have to be stated clearly in writing with all its terms verifiable. It cannot in any way “lock you in” but, rather, must give you the right to step away whenever you wish. How can you best communicate all this and more in a manner that keeps the door open for fair and honest dealing?
One suggestion is to be warm and friendly in person, yet firm and unyielding in writing. You will want to follow up all conversations with letters that summarize and confirm what was discussed. Those letters are an opportunity to make clear the firmness with which you are insisting on your needs. Be explicit in your written communications about your expectations, requirements, deal-breakers, and understandings. Choose language carefully, leaving no room for interpretation or discretion by those whose interests may differ from your own. For example, use the phrase “This is a letter of instruction” at the start of any message in which you are telling them to do something.
Create the Tone and Atmosphere You Want
Of course, being firm and unyielding is not a style that comes easily to everyone. Although some people are comfortable taking that tone, others find it nearly impossible. Even though it may be the theoretically ideal posture for dealing with a shrewd and crafty industry, it is not a viable choice for everybody. After identifying the quality of interaction that is right for you, it will be important to work hard to create that atmosphere for the negotiation process.
A truth about negotiating is that success tends to flow from being yourself. It is almost never a prudent strategy to pretend to be someone you are not. Be sure to create an atmosphere in which you are comfortable and centered. Prepare this carefully with an eye toward nonverbal cues, body language, setting, speech patterns, and physical comfort. Plan to play on your own ball field, and then make it happen.
Regardless of mood and tone, though, you will need to make clear those things on which you intend to hold firm. Being friendly, warm, and considerate is not incompatible with being determined, s
trong, and resolute. To the contrary, that is exactly what Fisher and his colleagues meant when they instructed us to be “soft on the people and hard on the problem.”1
Chapter Summary
Insist on clear and complete explanations in plain English.
Everything must be explained clearly to you in writing.
You need to let them know in writing all of your requirements.
Think about and then create the negotiating atmosphere that is best for you.
Set a tone that allows you to be yourself.
Note
1. Roger Fisher, William Ury, and Bruce Patton, Getting to Yes: Negotiating Agreement Without Giving In, 3rd ed. (New York: Penguin Books, 2011).
Chapter 23
Think about Relationship Goals
Good negotiators know that the process will benefit from an appropriate and helpful relationship between the parties. Thinking through the kind of relationship you want can help guide the interactions in the proper direction. In particular, you seek an affiliation that will best lead to fulfillment of your investment goals.
Your earliest interactions with a financial advisor are likely to set the foundations and rhythms of the working relationship that will follow. You have an excellent opportunity to craft the kind of relationship you want. You should seize it.
A Good Working Relationship Need Not Be Personal
Your interests as an investor-negotiator are best served by a professional relationship that advances your financial goals. While friendships are always nice, they are not always appropriate.
One of the messages of this book is that the investor-negotiator faces a lack of clarity about who is an adversary and who is a partner. The most frequent answer is that the people you are working with are at least a little bit of both. It is often the case that those guiding you with investments are also competing with you on the other side of the deal. As a result, you probably want to build a relationship that does not depend on trust. You don’t want to be in a position where blind faith is required in place of substantiation. Not only is it bad for you, but it also probably puts too much strain on the relationship. It is best avoided.
Along the same lines, your investment life is probably not a good place for making new friends. Friendship often leads to a slow increase in trust and gradual lowering of caution. Many of us have a strong desire to build trust in our friendships. Unfortunately, this tendency can be used against you. Television ads about financial advisors making toasts at the wedding of a client’s daughter are part of a campaign to lull you to sleep. Investment relationships require a consistent level of vigilance that may be incompatible with close and loving friendships.
That is not to say, however, that a warm, friendly attitude is not possible. A “businesslike approach” need not be cold or standoffish. Everyone around the investment table can be kind, helpful, and gracious with each other. You must remember, though, that they should not be confused with teammates, family members, dear friends, or others who are “on your side.” The conflicts-of-interest are simply too numerous and the dangers too great to permit the level of unguarded interaction that can happen with those we hold dear.
Pay Attention to Power Dynamics
While seeking to build the most appropriate working relationship, an investor-negotiator must be alert to managing the power dynamics that develop. It is typical that financial intermediaries position themselves as authority figures and expect a kind of deference. You do not want to let them seize the mantle of decision maker or wise elder.
Rather, be sure they understand you are equals. Even better, they should appreciate that they are (or potentially will be) in your employ. You need not behave like an absolute boss, but legitimate control over content and outcome lies with you. And you get the final word. Do not allow yourself to be seen as the sheep willing to follow. At the very least, display enough authority that your decision making will not be taken for granted. Make it clear that nothing happens without your explicit consent and that such consent is given only for actions that are fully explained and make complete sense to you.
Here is one way to envision the process of negotiating with those who advise you on investments. You are the CEO of your family’s investment company. The people working with you are consultants brought in to assist with your family company and to make suggestions. It should always be clear that you are the boss and that you sign all the checks. They are advisors and you are the decision maker.
Special Concerns about Financial Advisors
A strong word of caution is appropriate regarding relationships with financial advisors. Most work for companies that have long studied how to manipulate this interaction. They have concluded that there is advantage to being seen as your friend, confidant, or loyal ally. Sophisticated and powerful marketing campaigns prop up efforts to “befriend” clients. While pleasant to experience, it is one more factor encouraging clients to take their eyes off the ball.
Representatives of investment companies often seek unquestioning trust without truly earning it. Such blind trust will work tremendously to their advantage, not yours. Nor will they offer to return it in kind.1
Again, avoid overly friendly relationships with such advisors; they are simply not suitable. Former President Reagan liked to quote the Russian proverb that translates “trust but verify.” It is very good advice for the investor-negotiator.2
Chapter Summary
The people you invest with are usually part teammate and part adversary.
Friendship is probably not appropriate.
A good working relationship can be kind, helpful, and gracious.
Know your power and make it clear to everyone involved.
Blind trust is out of the question; verify everything.
Notes
1. Andrew Tobias, The Only Investment Guide You’ll Ever Need (New York: Houghton Mifflin Harcourt, 2011), 65.
2. Ronald Reagan speech at the signing of the U.S.–Soviet INF Treaty, December 8, 1987, available at www.youtube.com/watch?v=As6y5eI01XE.
Chapter 24
When to Commit—and to What
In Chapter 5, we considered how snugly or loosely we wish to be bound to the agreements, obligations, and requirements of our lives. These questions are tremendously relevant when thinking about your investments. And what of your negotiating partners? How tightly can you bind them to promises they have made? Good negotiators pay a great deal of attention to these questions and are careful to consider when such binding takes place.
In most situations, an investor-negotiator is looking to lock in the other side but preserve as much personal wiggle room as possible. At the very least, you are trying to keep an escape hatch open in the event that an investment situation turns bad.
Avoid Getting Locked In
It is very important for you to avoid situations or deals that tie you into investments for long periods. Indeed, the shorter the better. You would prefer a contract that permits you to quit without reason with five days’ notice to a contract requiring three months’ notice. A firm billing for services six months in advance locks in the client to a greater degree than does their competitor charging only after the work is completed. An agreement that can be terminated without penalty, whenever the client wishes, is superior to one that imposes an exit fee. That, in turn, is less onerous than one requiring significant notice as well as imposing a price to get out.
Many investment vehicles impose significant exit fees, which are really penalties, for trying to get your money back. For example, “back-loaded” mutual funds sometimes charge 6 percent to get your money back in the first year, 5 percent in the second year, and so on. The right to your own money without penalty will not be granted until six years after the fund was purchased. Most variable annuity products have a similar “early exit” penalty. A man recently came to our office seeking help with an “equity indexed annuity” product. To my amazement, he had been swindled into a contract that had a penalty schedule stretching 14 years
from the date of purchase.
Although there are many situations in which the investment merchant wants to lock you in but you are better off with a less binding deal, sometimes things work the other way around. A great example is a debt investment known as a “callable bond.” A typical bond pays a fixed rate of interest throughout the life of the instrument. That life is defined as ending on the “maturity date,” when the investor’s principal is paid back. A callable bond has an added feature, though; the issuer may “call” the bond by choosing to pay back the principal at certain defined times. This is wonderful for the borrowing company; if interest rates fall, they can terminate this bond and, presumably, borrow at lower rates. In such circumstances, of course, the investor would like to be able to keep the bond for the full length of time until its maturity. I refer to callable bonds as “heads they win, tails you lose.”
Who decides how much each party is to be bound? It is a negotiated matter. If you lack the power and will to impose fairness, though, or are not paying attention, there is the potential for abuse. Josh Brown came to us recently holding an investment in a private equity partnership put together and sold to him by one of the nation’s most prominent investment houses. This brand-name firm had, of course, drafted the contracts and made all the rules to maximize its advantage. The client wanted to get out of the investment, and we agreed to help him. To our amazement, the representative of the sponsoring firm explained that he “cannot get out.” Although it seems incredible, the contract and agreements specified that investors could get their money back only at such times as the general partner determined, in its sole discretion, or upon the termination of the partnership. In plain English, he would get his money back when they decided and not any sooner.
Negotiating Your Investments Page 19