The Myth of Investment Bargains

Originally published 3/8/2010 at FPA's All Things Financial Planning Blog

We all know there are deals to be found in the shopping world. But do we ever consider the value we receive for the price we pay?

William Poundstone’s book, Priceless: The Myth of Fair Value (and How to Take Advantage of It) points out most of us are really suckers when it comes to shopping. (Poundstone has written more than dozen books, his first, published in 1983, was titled Big Secrets: The Uncensored Truth About All Sorts of Stuff You Are Never Supposed To Know.)

We overwhelmingly lack the information we believe we possess to be ‘price’ experts. The result, Poundstone argues, is we’re often taken advantage of, and prone to paying just about any price (and sometimes more today than we would have yesterday).

In this video, Poundstone gives another example of the ways price can be misleading by demonstrating how one can leverage psychology in their Internet sales to increase the price of a product on eBay.

In the investment world, it can be even more difficult to consider cost and value. And it’s understandable why that is when product prospectuses are longer (and more dull) than a textbook. Often, investors will rely only on hypothetical or recent returns equate to value, and costs — and by this I mean the total costs of a strategy — are never considered.

A few of my biggest concerns are with products that investors believe “guarantee” growth in “retirement income,” or products that shed sound, investment principles to employ strategies that you would like to have owned yesterday, but have no promises for tomorrow. (I wrote more about that topic in a blog post on what I call the “Barnyard Rules of Investing.”)

Total costs include more than just a percentage of your investment dollars paid in annual management fees (when annual management fees for a product go above 1.5%, alarm bells go off for me.)

Total cost of a product may include:

  • Reduced growth or cash flow compared to traditional investment strategies;
  • High back-end penalties for leaving. My personal rule of thumb is to be wary of any back-end charges;
  • Fees that are low initially to attract dollars, only to rise when you are trapped in the product (the classic “bait-and-switch” tactic).

Whenever you review an investment proposal, consider your thoughts on the proposal before jumping in:

  1. If you have the feeling that you are getting a real “deal”, or bargain — STOP! There are no “deals” in the investment world. Investing is not shopping.
  2. If you sense that you are being pushed to make a decision today, or in the next week, stop and ask why. I hear stories from clients being told a product will no longer be offered over the next few months, so they need to invest now. Would you consider buying a car that is being discontinued? How about if your grocer told you a product is being recalled… buy now? Clearly you need to stop, and don’t walk, but run from this offer.
  3. If you haven’t taken the time that’s necessary to analyze and compare the costs and benefits of an investment comprehensively by comparing it against low-cost strategies, stop and perform this exercise.
  4. If you don’t have a clear understanding of how this product fits into your plan, stop and ask why you are not discussing how this product meets your future cash flow needs specifically. The product should be about a fit for your plan, not about exotic features that sound exciting.

If you don’t understand a product or strategy, don’t invest. It is sad to say, but most people who have been burned by products have not done their homework, and simply trust in an expert. They accept the sales pitch that they will receive “more” that is well worth paying hefty fees.

Clearly, it can be a tough job to compare products based on value. Because of that, I am a strong advocate of getting help explaining value by a second professional opinion before settling on a strategy. You would get a second opinion before major surgery, or even before buying a major household appliance. Your long-term financial security is far too important to squander on investments that drain, rather than provide, value.

Find qualified advisors for a second opinion with FPA’s PlannerSearch.


About the author

Robert Schmansky, CFP®

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