Lessons From a Former Mutual Fund Investor

by | BiggerPockets.com

I have been studying investing since my undergraduate college days where I studied Finance.  Ironically, it wasn’t for many years after college that I really started questioning the common advice being offered by mainstream financial planners.

When I did, however, I realized how wrong that common advice was and totally changed my approach.  Since then, I have been involved in the financial services industry, now concentrating on structuring Equity Indexed Universal Life Insurance policies that creates tax-free income for my clients -though I will not be limiting my posts to EIULs (boy would those be snoozers!) Instead, I will talk about all things surrounding investing and the economy.  I have been a long-time fan of real estate investing and believe that owning an EIUL is a perfect complement to real estate.

This first post I want to briefly talk about my voyage from the standard, ” mutual funds inside a 401k/IRA wrapper,” strategy for retirement income to where I am now. I’m sure many of the readers have had similar voyages.  There are some lessons to be learned from our earlier mistakes.

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Signs of Trouble

In the late 1990s I started to get a funny feeling about my retirement funds which were invested in mutual funds inside an 401K and an IRA.  There was so much emphasis on “the number” or the numeric goal you hoped to reach by retirement time that it seemed to me to simplify the process too much.  At the same time people were assuming very high average rates of return from their mutual funds, some even over 20%.  That is when I started to really look at historic stock market returns and immediately noted several huge issues.  The first was  the actual sequence of returns from the stock market was highly variable creating what is called “sequence of return risk.”

It became apparent that a large market swoon within 5 years before or after retirement was not only likely, but almost guaranteed.  The only way to avoid this was to move out of the stock market sometime earlier which of course kept your overall returns low at a critical time.  The other issue was that you never could really get a handle on how long this money was needed to last for  (or put uglier: when you were going to die.)

It became apparent that the cycles in the stock market were very long and unpredictable so it was entirely possible that you would spend a large portion of your investing life in bad stock times. Finally, it wasn’t entirely clear how best to turn your mutual fund wealth into retirement income.

To put this in technical terms there were three risks unaccounted for by mutual funds; sequence of return risk, economic risk, and length of life risk.  It was easy to see how any of these risks could create havoc even with a carefully planned retirement strategy that depended upon mutual funds no matter how they were balanced.

It also became apparent that there were opposing camps of advice that seemed to be more interested in fighting each other over client dollars than to figure out what were the best retirement strategies for folks.  The stock salesmen and the insurance salesmen spent much of their time demonstrating their opposition’s approach was dangerous instead of actually looking at the results of their advice that was streaming in.

By the way, the results of their advice was, and still is very ugly.

The other idea I found somewhat vexing was the idea of diversification.  There were many good to great investors that simply did not believe in the need for massive diversification of stocks and even the original work done on diversification was of diversified asset classes not diversification within an asset class.

Six Fundamental Ideas to Keep In Mind

So that is where I found myself with all these ideas rolling around in my head and no strategy in place to account for them.

These  ideas are important and should be kept in mind for all investors:

  1. It’s not “the number” that is important, but the income generated by the investments;
  2. Variance is an enemy of retirement income seekers;
  3. Deferring income taxes is a losers strategy because no one can predict what the income tax rates will be in the future and [here is an obvious one]our goal should be to have as much income as possible, pushing us up to higher income tax brackets in the future if we defer the tax;
  4. One really good investment is much better than 10 mediocre ones;
  5. Time is always a question mark with investing, so investments should be able to work together to account for the unknowables around how long we live, how long we can actively manage our investments, how long we have to produce money for investments, etc.; and
  6. Whenever the government and a large influential corporate cabal get together to make you a deal that seems great remember they are not doing this for your benefit but for theirs!

The Path Less Traveled

My search for answers found me focusing on three areas:

  • Real Estate;
  • Insurance products;
  • Growth stocks (including dividend producing stocks.)

It took me a while to get out of my 401k with mutual funds but after around 8 years I accomplished it.  This is all described in my blog, which I started in 2008.  During my journey I made a decision to get my insurance license and sell Equity Indexed Universal Life Insurance because I found the product so useful and the average life insurance agent so ignorant on how to use it.

It has been a strange journey to having a niche life insurance business structuring policies for maximum cash value build-up, but it has been fun.

I hope to share much of what I have learned with BiggerPockets.  Along the way if you have any questions or suggestions for posts please let me know, I can use all the help I can get 🙂

Thanks for the opportunity,

David Shafer

Photo: David Evers

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  1. I agree with you about the diversification and having mediocre investments. Warren Buffet says if we had a punch card with 20 investments opportunities that we could make in a lifetime we would do a lot more research and some critical thinking before we made a decision. The reason why so many people lose money with financial advisers is because they lack financial intelligence. Our school system is not teaching it. Most financial advisers are sales people not investors. I believe any investment can be good or bad, it’s based on the investor not the investment. Great article. Thanks for your hard work.

    • Robert, Warren is one of my favorites and invests a good amount of money for me!
      I think much of financial theory is really subsumed by the marketing needs of Wall Street.
      The fact that this blog is so successful, points out to a growing awareness for folks of that point.

  2. How does a Equity Indexed Universal Life Insurance policies compare to a whole life policy? I have had several “financial planners” tried to steer me to purchasing whole life (I know they get great commissions from this) and when I create a spreadsheet showing them how horrible of an investment this is they always back down saying maybe it’s not best for you. It’s true it’s not best for me nor is it best for about 98% of investors. I am interested in leaning a bit more on EIULs. If you could send me to a website where I could learn about these it would be appreciated.

    • Paul, to answer your question directly the Internal Rate of Return in an EIUL should be around twice what you would get in a Whole Life policy using historical data. But, the real power comes from knowing how to structure the policy for maximum performance. When structured correctly the returns are similar to what you would get with a stock mutual fund except with much less variance. You can check out my blog and website for basic information on EIULs. However, for more detailed analysis I always turn to the illustrations. Once created, they include annual expenses and IRR for my clients to see and analyze.
      I have had clients in the past create their own spreadsheets and some that don’t end up being clients! Of course, you need to identify what you are trying to accomplish with this policy first in order to see if it is the right tool for you to use.

      I hope this is OK with Bigger Pockets. My website: http://www.shaferfinancial.com

      You can contact me through the website, I would be more than happy to talk with you.

  3. Brandon Turner

    Welcome David! I have to admit – EIULs, mutual funds, stocks, etc have never been huge on my radar so we’re glad to have you on board and be able to share real estate lessons from your unique perspective! Also – great tips above. I really liked “One really good investment is much better than 10 mediocre ones.” That’s great!

  4. Jeff Brown

    Hey People — I happily stumbled upon Dave a few years ago. He’s the real deal in every way, and I endorse him personally, and as it relates to his professional expertise. Many of my clients are now his clients too, and they love it. EIULs aren’t for everyone, as Dave you tell ya, but when they’re a good fit, they work wonders in an overall Purposeful Plan.

    Use Dave as the asset he is. What a super addition to BiggerPockets.

    • Kevin, PPULs [Private Placement Universal Life Policies] are variable products. These have their own set of IRS rules. They are mostly used by corporations and the wealthy as a tax avoidance strategy and many times are placed outside the US to get $$ offshore to eliminate future taxation. They generally start around $10M [from my reading, I have not been involved in one myself] and require the policy to have 5 different assets in them. Equity indexed universal life is not a variable product but a fixed product. The differences are really important to understand. EIULs are not investments into equities but are backed by the financial strength of the insurance companies. The interest paid is tied to an index, but you are not actually invested in the index. Variable products have separate sub-accounts which can be and usually are invested in assets like mutual funds. The private placement VULs allow more choice of assets than the run-of-the-mill VULs. These have asset managers that manage the mix of assets. Of course all this means more fees. VULs have more fees than EIULs and the private placement ULs have even more fees. They also have all the market risk of those assets, hence the variable name. My belief is that those that purchase PPULs are more concerned with the tax advantages, than the overall performance. They expect the asset managers to earn their fees, but as long as the tax advantages are protected their expectations are the same as for their entire portfolio.
      Hope this helps. Pretty sophisticated folks on this blog 🙂

    • Mark, no they don’t. You are probably mixing EIULs with Variable Universal Life Insurance [VULs]. In future posts I will get into details about the strategy employed and why it is better for retirement income. Also EIULs don’t have the same limitations and penalties associated with IRAs. Finally, the total expenses are similar to what you find in mutual funds. I appreciate the question, because it will guide me as to my future posts directly on EIULs.

    • EIULs invest in a combination instruments as well European style options, meaning they don’t buy stocks or index funds directly, avoiding the systemic risk of loss. Your risk is that you won’t gain anything in a given year. Surprisingly, eliminating the risk of negative years has a very positive impact to overall growth.

      Roth IRAs have many limitations including limits on how much you can contribute which get severe as you make more money. EIULs have no limit on how much money you can contribute. Roth IRAs also lock away your money with onerous requirements in the event you want to “borrow” money. EIULs let you borrow from them and pay them back at relatively low cost. I have a Roth IRA where I hold just a few stocks (no mutual funds), but due to income I have made in the past three years, I can’t add any more to it for the time being. Kind of sucks.

      It’s true that EIULs are expensive in the beginning, but after 10 years, the costs drop off dramatically, meaning if you hold it for 20+ years, the costs eventually become cheaper than just about anything else out there.

      The concepts are simple, but actually setting one up best for you requires the right kind of expert agent (like Dave Shafer). Most life insurance agents don’t know how to set them in your favor vs. in their own favor.

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