Don't Let Your Clients Be Fooled by Wall Street Math
Let’s say your client put money into an equity investment, and they have been told they have gotten an average 7% return on interest. But you are explaining the importance of protection and mitigating losses and fees. On the surface, their average returns have been 7%, but their actual returns are less than 5%. Because once to take into account just one downturn in the investment and management fees, that drastically drop their actual return.
Average Investment Return: 7.00%
Actual Investment Return: 4.95%
YEAR
Beginning-of-Year Account Value
Earnings Rate
Interest Earnings
Misc. Fees
End-of-Year Account Value
1
$100,000.00
10%
$10,000.00
($1,650.00)
$108,350.00
2
$108,350.00
10%
$10,835.00
($1,788.00)
$117,397.00
3
$117,397.00
10%
$11,740.00
($1,937.00)
$127,200.00
4
$127,200.00
10%
$12,720.00
($2,099.00)
$137,821.00
5
$137,821.00
-20%
($27,564.00)
($1,654.00)
$108,603.00
6
$108,603.00
10%
$10,860.00
($1,792.00)
$117,671.00
7
$117,671.00
10%
$11,767.00
($1,942.00)
$127,497.00
8
$127,497.00
10%
$12,750.00
($2,104.00)
$138,143.00
9
$138,143.00
10%
$13,814.00
($2,279.00)
$149,678.00
10
$149,678.00
10%
$14,968.00
($2,470.00)
$162,176.00
TOTALS
$81,890.00
$19,714.00
$162,176.00
Oh, and don’t forget to point out that they still had to pay a management fee in the year they lost money.
But what if they were willing to take a portion of their money and put it into a safe-money product that only gave them a 70% participation rate of an index, but it protected them from a loss in a downturn. It had no fees associated with it. How would it look?
Average Investment Return: 6.30%
Actual Investment Return: 6.28%
YEAR
Beginning-of-Year Account Value
Earnings Rate
Interest Earnings
Misc. Fees
End-of-Year Account Value
1
$100,000.00
7%
$7,000.00
$ –
$107,000.00
2
$107,000.00
7%
$7,490.00
$ –
$114,490.00
3
$114,490.00
7%
$8,014.00
$ –
$122,504.00
4
$122,504.00
7%
$8,575.00
$ –
$131,080.00
5
$131,080.00
0%
$ –
$ –
$131,080.00
6
$131,080.00
7%
$9,176.00
$ –
$140,255.00
7
$140,255.00
7%
$9,818.00
$ –
$150,073.00
8
$150,073.00
7%
$10,505.00
$ –
$160,578.00
9
$160,578.00
7%
$11,240.00
$ –
$171,819.00
10
$171,879.00
7%
$12,027.00
$ –
$183,846.00
TOTALS
$83,846.00
$ –
$183,846.00
Even though they are not getting 100% participation in the upswing, they are getting 0% participation in the downturn. Oh, and they’re not paying any fees either.
When you know how to do the math, you can demonstrate that their actual return is much lower even though their average return is higher on paper. In this example, it’s the difference of a little more than $20,000! That’s where you can make the most difference as an advisor by knowing how these safe money products (in other words: annuities) work and giving them a visual reference.
As an advisor, when you have the tools to demonstrate concepts like Wall Street math to your clients, it can make all the difference to them and you.
Marty Becker is the president and owner of Atlas Financial Strategies.
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(Image: alphaspirit/Shutterstock)
