(You Say It’s Your) Birthday
The Second World War ended In 1945 and members of the Baby Boom generation began arriving in significant numbers soon thereafter. Boomers changed the country’s economy in many ways including providing new markets for baby books (remember Dr. Spock?) and denim fabric. Colleges were enlarged, even established, to accommodate them. Boomer’s aging has also affected the country in several ways from increased sales of reading glasses and hearing aids to requiring colleges to advertise “lifelong learning,” since the straight from high school student population has waned.
The generation embraced a smaller change too-a replacement for the traditional “Happy Birthday to You” which had been the standard since the early 1900′s. The Lennon/McCartney song which provides the title of this article was released In 1968 and quickly became the song of choice for many Boomers. I mention this because the US Census Bureau estimates that an average of 7,671 Americans turned 65 every day of 2011. Those approaching that fateful threshold have some pretty important decisions to make related to Medicare and Social Security. Since both are government programs, it may not be surprising that they are a bit complicated.
Potential Medicare recipients must sign up prior to turning 65 or face mandated delays in receiving coverage. Typically, we suggest that individuals review their options around eight weeks prior to their birthday so they can make application about a month before. There’s a lot to think about these days with four different programs available. Parts A (physician) and B (hospital) cover everyone 65 and over and there is a premium for Part B. The Bush-era addition of Part D provides drug coverage and this year there are more than 1,000 different stand-alone drug plans available. There’s been lots of griping about the “doughnut hole” (gap in coverage) but I’ve heard very few expressions of thanks for the more than $2000 per year which is now provided to help cover drug expenses. Those who truly cannot afford their Part D premiums are eligible for further assistance. Medigap policies are offered to provide supplementary coverage, capping out-of-pocket expenses in exchange for a periodic premium. Part C (known as Medicare Advantage) integrates Parts A, B & D under a single policy, with most plans providing at least some dental, vision and hearing coverage which original Medicare does not.
There are hundreds of Medicare supplement and Part C plans available and choosing the right one has become easier with the release of Medicare’s on-line tool. It allows you to enter personal information, including the medicines you take, then view a sortable list of the various plans available in your area. Medicare has been rating providers since 2007 and that data is part of the report. The process is tedious but not terribly difficult. Anyone who completes their own FAFSA forms should have no trouble doing it but it is a service that some clients prefer that we handle.
Social Security is another blessing for retirees. It was established in 1935 during the Great Depression to help alleviate poverty among the elderly. The first recipient was Ida May Fuller, who famously worked only three years under the system before collecting benefits until her death at age 100. Of course, there have been changes to the rules over the years and individuals must now work at least ten years to qualify and, for Boomers, full retirement age has been moved back to sixty-six. Benefits are calculated actuarially based on the thirty-five highest earning (not most recent) years of employment and an anticipated life expectancy of about 80. From the government’s perspective, it doesn’t matter whether you receive a smaller payment over a longer period or vice-versa.
Although it doesn’t matter to the government, the timing of Social Security benefits is very important to each individual. SS income is generally taxable so anyone who is still working should probably delay, especially since she or he would still be paying into both SS and Medicare. On the other hand, someone with reason to expect a shorter than average life span might want to begin receiving benefits sooner. There are also issues regarding coordination of spousal benefits. The lower-earning spouse is generally entitled to the greater of his or her own benefit or half of the spouse’s. This has gotten so complicated that we now use specialized software to help guide our clients through the decision-making process.
From time to time we hear concerns expressed about the solvency of the SS system. As a matter of fact, Boomers having to wait a year longer to begin receiving their full benefit is a step towards ensuring its continued viability. This is a topic I keep a close eye on but I don’t expect any major changes-the issue is just too politically sensitive with the most reliable voting bloc-retirees. Warren Buffet and others have suggested that those who are better-off should pay more or receive less. It might be worth your time to read this article from Allan Sloan to see if this is already happening.
Having opened this article with a Beatles lyric I’d like to close with one from another Boomer icon. In 1974, Bob Dylan wrote: “May you grow up to be righteous … and may you stay forever young.” That’s an impossible dream, of course, but we’d say that thoughtful planning tends to increase the likelihood of at least feeling forever young and enjoying those birthdays as they roll around.
The Great Muppet Caper
The artistry of the late Jim Henson made the Muppets an enduring American institution and it’s from his 1991 movie that I borrow the title of today’s article. His characters are on my mind because of the comments of Greg Smith, the London-based derivatives salesman who recently resigned quite publicly from investment bank Goldman Sachs. Among other things, he reported that customers were derogatorily referred to as “Muppets.”
Smith’s letter of resignation was published as an op-ed piece by the New York Times. To quote a couple of sentences “… the interests of the client continue to be sidelined in the way the firm operates and thinks about making money. … The firm has veered so far from the place I joined right out of college that I can no longer in good conscience say that I identify with what it stands for.” Not surprisingly, Goldman takes issue with Mr. Smith’s comments, saying: “The assertions made by [Greg Smith] do not reflect our values, our culture and how the vast majority of people at Goldman Sachs think about the firm and the work it does on behalf of our clients.”
Goldman Sachs was founded in 1869 and is an extremely significant player in global markets. On one hand, its alumni list reads like a Who’s Who in the world of finance, including past US Treasury Secretaries Robert Rubin and Henry Paulson, governor of the Bank of Canada Mark Carney, along with CNBC personality Jim Cramer. On the other hand, negative comments about the firm’s values and culture are nothing new. It was sued by regulators and investors in 1970 related to bonds it underwrote for the Penn Central railroad and, in a post 2008 market crash Rolling Stone article, was described as a “vampire squid.” Goldman was one of the firms which current Treasury Secretary Geithner decided to bail out after the market crash. Soon thereafter it paid $550 million to settle a Securities and Exchange Commission complaint regarding its role in that crash. Although that’s the largest settlement in the SEC’s history, it hardly caused a ripple in a firm which earned nearly $4.5 billion in 2011, a firm which continues to calculate its bonuses just as it did before the settlement.
The SEC was established in 1934 during the Great Depression to regulate all securities activities in the United States. It is responsible for administering the various laws which govern the securities industry including the Investment Advisors Act of 1940. That Act defines the difference between those who primarily offer financial advice and those whose advice is solely incidental to their primary work. That’s an important distinction in Mr. Smith’s case because it also defines in whose best interests he must act. Since his job as an employee of Goldman Sachs was the sale of securities, he had to act in Goldman’s best interests, not his customers’. Only if Mr. Smith had been an Investment Advisor as defined under the Act of 1940, would he have instead owed that fiduciary duty of care to those whom he advised.
Benjamin Graham’s 1949 book The Intelligent Investor is one of the classics in the field and has great relevance here. One quote: “A great deal is at stake in the innocent-appearing question whether “customers” or “clients” is the more appropriate name. A business has customers; a professional person or organization has clients. The Wall Street brokerage fraternity has probably the highest ethical standards of any business, but it is still feeling its way toward the standards and standing of a true profession.”
Those who do business with a brokerage firm (like Goldman) are called customers for a reason, as was noted by some of those who responded to Mr. Smith’s letter. Financial blogger Matt Levine (also a Goldman alum) said: “That’s, like, your job as a salesman: to think about how to build trades that will get your clients to do them and give you lots of money.”
In the movie, Muppet reporters are assigned to travel to London, the last city in which Mr. Smith worked for Goldman. According to his resignation letter, he had served as an advisor to “two of the largest hedge funds on the planet, five of the largest asset managers in the United States, and three of the most prominent sovereign wealth funds in the Middle East and Asia.” Although our clients are nowhere near that size, their investments are important to them so we treat them seriously too. The difference? From our perspective, investments are just one aspect of their entire lives. And, as Registered Investment Advisors, we place our clients’ interests ahead of our own; it’s just the right thing to do.
YOU Are the Product
The retail brokerage industry began in New York City in 1792 with the signing of the Buttonwood Agreement. It established the organization now known as the New York Stock Exchange and fixed commissions for customers at one quarter of one percent. One hundred eighty-three years later, the discount brokerage industry began with the deregulation of stock commissions through the Securities Acts Amendments of 1975.
I’m offering this history lesson to make the point that just because you can’t see the costs associated with a purchase, it doesn’t mean they’re not there. As Robert Heinlein famously said in his 1966 science fiction novel The Moon is a Harsh Mistress: “there ain’t no such thing as a free lunch,” noting that bars which serve a free lunch also charge more for drinks.
The New Scientist recently reported on Purdue student Abhinav Pathak’s research into the battery usage of free games for mobile phones. He found that the Angry Birds uses about 20% of the total power it consumes on the game itself and the remainder on determining where the user is, downloading location-appropriate ads and keeping the wireless connection open. In a more candid approach, I recently downloaded free Avery software to create custom note cards. It makes the design process much easier and it’s obvious what Avery gets out of providing the software - increased sales of their extensive line of blank card stock.
“Rollover your 401(k) and get a year of free trades.” Does this advertisement sound familiar? Variations on that theme are legal because of the deregulation of commissions but, from a business perspective, how is it possible? How can the brokerage firm give away something that has had cost associated with it for well over two hundred years?
Since brokerage firms are retail businesses, it’s possible that we’re seeing an example of a loss leader, a deeply discounted deal advertised in hopes of bringing you into a business. Once there, the retailer anticipates that you’ll spend money on more appropriately priced items. In this case, perhaps if you accept their offer, you’ll also transfer your non-retirement account and the brokerage firm will be able to charge its normal commissions. After a year, the free trade period is up but the firm hopes the friction which is part of any transfer process will keep the account with them instead of the customer chasing after another offer.
In addition to commissions, there are less obvious ways that a brokerage firm can make money. During the housing bubble, new mortgages were replacing old ones at a previously unheard of rate and Merrill-Lynch stockbrokers were paid for referring their customers to another M-L division for new mortgages. Even in more normal times, brokerage firms have additional sources of income. It’s easy to enter an order to purchase a stock on-line and see that the commission was added as expected but do you pay attention to the firm’s role in the transaction? Did they act as your agent, buying in the open market or as principal, selling shares from the brokerage firm’s own inventory? If principal, do you have any idea what the firm might have paid for the security you bought? It was almost certainly sold at a profit. Likewise, buried in the contract you signed when you opened the account is language describing what’s called “payment for order flow,” a concept originated by the investor’s good friend Bernie Madoff. These are fees paid to brokerage firms by market makers for routing orders through them instead of the NYSE.
Both of these factors make it difficult to determine whether you really got a good deal or not. Although “best execution” is broadly required on the aggregate of all trades made for all customers, it’s pretty hard to tell how a small investor who is unable to demand the best prices did on any particular transaction.
If you purchase Microsoft Word each role is clear. You are the customer and the transaction is complete when you pay for the software. If you use the free Google Docs instead, the transaction isn’t complete until an advertiser buys an ad. Of course, every time you log back onto the website, you see another ad, so in some ways, the transaction may never be complete. Many people have embraced Facebook as a way to connect with family and friends. It seems to be free but if you stop to think about it for a moment, users are not Facebook’s customers: advertisers are. As has been said in several places, including Jim Calloway’s law blog (in a post about Google’s new privacy policy): “If you are not paying for the product, you are the product.”
