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A CLOSE FRIEND’S LONG career in the motion picture business recently came to an end when the studio eliminated her job. Even before the pandemic, the industry was changing, so she wasn’t surprised or, for that matter, especially sad about getting laid off. She was lucky to receive a good severance package and is now ready to do something different. But finding the right job will likely take time, so carefully managing her cash through the transition period is crucial.
That’s why alarm bells sounded when she asked me for advice about a product she’d been pitched by a wealth management vice president at her bank. “You have all this cash sitting in savings earning little,” he said. “Why not invest it with us? I designed something for you that’s liquid, conservative and pays monthly tax-exempt income.”
Wow, specially designed just for my friend. How nice.
Did the VP ask about her cash needs in the months ahead? Did she share her risk tolerance before he pitched this? “Nope,” she told me. “I just said I’d like to earn more on my savings.”
“What if you put your cash in this investment—and it disappears when you need it most?” I asked.
I wouldn’t have been so worried if the product really was low risk and liquid, with a return better than a savings account or certificate of deposit. But I couldn’t think of any investment like that today, so I was curious to read the VP’s proposal.
What was this thing that he had “designed”? It turned out to be a portfolio of individual bonds and a bond fund actively managed by an outside investment advisor. The money would be held in a separately managed account, with a big chunk of the portfolio in municipal junk bonds. Thanks to its 1.5% per year account fee, it regularly returned less than its benchmark index. For comparison, Vanguard Total Bond Market ETF charges 0.035%. That’s the difference between $1,500 and $35 in costs each year on a $100,000 investment. And that isn’t the worst part.
Would this account be insured by the FDIC like my friend’s savings account? Of course, not. Has the pitched investment ever lost money before? Yes, in three of the last 10 years, including a 20% drop a year ago in March. As I see it, bonds shouldn’t be viewed as the same as cash investments. Both can be a good diversifier for stocks—and bonds are often the better choice—but cash investments are the place for money you’ll need to spend soon.
If my friend were back working and earning a steady income, taking on a bit more risk to keep up with inflation would make sense. But this product seemed like a great way to enhance the bank’s wealth, not hers, especially if her unemployment lasts longer than she hopes.
All this brought to mind Morgan Housel’s excellent book, The Psychology of Money. Housel writes, “There are a million ways to get wealthy, and plenty of books on how to do so. But there’s only one way to stay wealthy: some combination of frugality and paranoia.”
Housel summarizes money success in a single word: “survival.” To me, survival starts with having both the patience and sufficient cash to weather the worst situation you can imagine. I suggested to my friend that, in her case, patience meant not putting her money at risk of permanent loss by reaching for yield during this period when she doesn’t have a paycheck.
Housel is a fan of building a margin of safety into our financial plans. This boosts our chances of success. To achieve our goals, we don’t need everything to turn out exactly right. Instead, we’re prepared for a range of possible outcomes, all of which would leave us reasonably happy.
In Rational Expectations, the wise William Bernstein cuts through all of Wall Street’s nonsense around investment risk and what you need for financial survival with this simple clarity: “There are risky assets, there are riskless assets, and there is an exchange rate between them. When times are good, that exchange rate is low, and when blood flows in the streets, it is high.”
He adds, “Make absolutely sure you have enough riskless assets to tide you over during the bad times…. You must have patience, cash, and courage—and in that order.”
Today, it strikes me that patience is in short supply, leading some to jump into highflying investments and others to reach for yield. Fear of missing out on imagined gains—or the greed to get rich quick—drive many to “pay too much for the whistle,” as Ben Franklin would say.
What about my friend? In the end, she decided patience and FDIC-insured cash was the sensible way to stay wealthy until she resumes collecting a steady paycheck.
David Powell has spent his career writing software and leading engineering teams. During his 40 years working in tech, he has come to respect the limits of human imagination in any planning. Like the rest of us, David looks forward to a post-COVID world with lots of travel, shaking hands and dining in restaurants. Follow David on Twitter @AmpedToGo and check out his earlier articles.
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Great post, David – the need for sufficient “sleep money” to withstand the ups and downs of the market must be paramount for folks approaching or already in retirement. Any “advisor” who does not first prepare a current HH cash flow analysis (and do a robust risk tolerance assessment) for a prospective investor should be avoided like the plague. Both are 101 fundamentals of reputable advising practice, long before a product’s suitability and asset allocation / diversification strategies are discussed. Tell your friend to RUN (don’t walk) from any huckster who doesn’t start with these two exercises as their first items on the agenda.
1.5% annual account fee? “Conservative” muni. junk bonds? Egads, run for the hills!
David, you did your friend a great service by wisely steering her away from that “custom designed” plan.