3 Financial Planning Urban Legends

Alien crop circles, Bigfoot sightings and even Mr. Rogers’ secret life as a Navy SEAL. 

We’ve all heard of the popular urban legends, and while we know they’re myths, we still find them oddly compelling. A similar dynamic exists in the wealth management industry, where persistent misconceptions can hinder good advice, according to David Hultstrom, CIO at Financial Architects. What sounds right in the heads and hearts of clients and their advisors, might not make much sense in practice.

 “I’ve started keeping an informal little list, and the working title of that list was ‘Stuff brokers are wrong about,’” he said at the National Association of Personal Financial Advisors symposium in New York City last week.

Believe it or Not

Most urban legends stick around because they sound emotionally or intuitively right, even when they’re outdated or just plain wrong, and it’s no different in financial planning. One of the most enduring myths is the bucket strategy, which divides investments into separate boxes of cash, bonds and stocks. The popular version suggests holding five years of spending in cash or near-cash assets so clients can avoid selling stocks in a downturn. But Hultstrom says that’s a form of market timing. “There’s no case where when the market goes down, you’re selling stocks,” he said. “When the market goes down, you’re buying stocks.”

An additional taboo strategy is income investing — generating cash flow through dividends and interest, without touching the principal investment or selling securities. “People love income investing because they have this weird ‘Don’t spend your principal rule’ as a spending control, but it’s not relevant to anything, and it leads to bad portfolio decisions,” he said. Instead, he recommended advisors focus on total return investing, which draws returns from dividends, interest, and capital gains.

A Matter of Life and Death. Another myth centers around longevity assumptions. Clients occasionally cite family history as a reason to avoid long-term planning. “When a client tells me about longevity in their family, I listen very politely and then ignore it completely,” he said. His firm plans for clients to live to at least 100, noting that individual longevity is more about lifestyle and access to healthcare than genetics. Hultstrom also pointed out commonly misused financial terms:

• Mean Reversion is often confused with serial correlation, the idea that asset prices are likely to reverse to their previous values when they reach significant highs or lows.
• International investing technically includes the US, but is often incorrectly used to mean “foreign investing,” which excludes the US.
• Liquidity is occasionally misunderstood as being exclusive to cash or near-cash assets. Stocks are perfectly liquid, Hultstrom emphasized.

“[These urban legends] are perennial, but never seem to get straightened out,” Hultstrom said.