Home' Island Sun : ISN 052716 Contents 39
ISLAND SUN - MAY 27, 2016
Clients receive many financial, tax and legal illustrations
when planning their estates. Financial firms will run an
analysis that plugs in variables such as assumed rates
of return, marginal tax rates, additional ongoing contributions
and withdrawals, arriving at an illustration to help a client
How many of those illustrations actually come true?
None. That's right -- not one! Allow me to explain.
When a financial illustration assumes a certain growth
rate, say that growth rate is six percent -- the computer model
will use that as an average rate. There's absolutely no chance
that any asset will increase in value at a constant rate of six percent. All of us
have seen a graph showing the ups and downs of a publicly traded company. The
graph almost always looks like a series of peaks and valleys. It may average to
six percent, but at any one point in time the real rate of return will be something
So consider if you were to take a snapshot at any particular moment in time,
and if you add money to that holding or sell all or some part of the holding, the
realized gain or loss will certainly be a different amount than that illustrated in a
That's just one example. When you think about all of the variables that must be
used in any financial computation, you realize that any such example is merely an
illustration, as opposed to a prediction.
Too often, however, clients view these charts, graphs and spreadsheets as pre-
dictions, or something that the firm believes will actually happen. It might be close,
but then again, it might be far off. Of course, most of the illustrations one finds in
financial ads or in prospectus filings are qualified with specific language. Everyone
has seen print and television ads stating "past performance does not guarantee
So what does this mean? Do we throw all of the illustrations out the window?
No. The illustrations are valuable for what they are -- a quick take of what
something might approximate given the assumptions used. Therefore, my first sug-
gestion is to closely scrutinize the assumptions themselves. Is the assumed rate of
return reasonable? Does the firm fully disclose all of the costs and expenses asso-
ciated with the investment? Is your marginal tax rate equivalent to that assumed
inside the illustration?
Examining all of the variables is tedious and takes some work. I find insurance
and annuity illustrations among the most difficult to understand. There are so
many variables associated with each product, you have to be an expert in the field
to fully evaluate whether the proposal fits within your risk tolerance and achieves
There are independent firms who will analyze insurance and annuity invest-
ments to determine if the promises made are realistic. I'm not suggesting, by the
way, that your insurance advisor is intentionally misleading you. The insurance and
annuity contracts that he sells are expansive. Often he must rely on his company
to educate him as to each product's features.
Some insurance and annuity advisors don't work on commission, rather they
charge a fixed fee for their analysis and recommendations. This way, they have no
particular "skin in the game" as to which product you buy. Anecdotally, insurance
advisors tell me that many clients won't pay the fee separately, preferring to pay a
commission. A fixed fee is an out of pocket expense that the client can feel when
writing the check as opposed to the commission that is hidden in the transaction
cost. If you're going to pay a fee anyway, why not structure it in a manner that
won't encourage the sale of the highest commissioned product?
Many clients problematically consider the purchase the end of the investigative
phase. To me, it is only the beginning. Monitoring the ongoing yield and rates of
return is just as important as the research you did before purchasing. As an exam-
ple, I ask my insurance advisor to run new illustrations on my whole life policies
nearly every year, saving the old ones for comparison. That way, I have a baseline
for comparison purposes which helps me determine if everything is still on track.
Even with insurance and annuity contracts that have steep early termination
clauses, it's important to determine if the contract you purchased lives up to your
expectations. If it doesn't, there are likely certain avenues you can further explore
to ensure success. That's why it's so important to seek a relationship with a finan-
cial advisor you trust. Even if you are a do-it-yourselfer, if you should become sick
or pass away, you want the resources of a knowledgeable professional there for
your loved ones.
Prediction Or Illustration?
by Craig R. Hersch, Florida Bar Board Certified
Wills, Trusts & Estates Attorney; CPA
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