Outspoken, controversial independent advisor Ric Edelman has written an exposé on everything employees always wanted to know about 401(k)s and IRAs — but were too naïve to ask. Workers need answers, insists the unabashed consumer advocate and ubiquitous marketer.
In “The Truth about Retirement Plans and IRAs” (Simon & Schuster Paperbacks), the CEO-chairman of Edelman Financial Services enlightens readers on such “secrets” as hidden 401(k) fees and demystifies plans’ hazy undersides. Mainly, though, he shows employees how to quit sabotaging their future retirement by providing them with practical strategies for investing and generating income during the hoped-for golden years.
Long a candid critic of the financial services industry — taking to task brokerages, product providers and advisors alike — Edelman, 55, has created a jumbo national practice starting with one office he opened two months after the 1987 crash that has grown to 35 today, with more than 100 advisors and a total of 425 employees. Helping the mass affluent market, EFS manages $12 billion in assets for more than 23,000 clients.
Serving up personal finance know-how is how Edelman, thrice named by Barron’s the nation’s No. 1 independent financial advisor, built his business from the get-go.
Extroverted, forthright and provocative — charging, for example, that “deceptive business practices [are] pervasive in the retail mutual fund industry” — and unconventional in the way he has structured his vast practice, Edelman is a financial advisor other financial advisors love to, um, pick on.
With his long-running radio program, television shows, appearances on “Oprah” and New York Times bestsellers, it’s safe to say some advisors are downright jealous.
Born in Philadelphia, bred in Cherry Hill, N.J., Edelman began as a journalist writing for a variety of trade publications; eventually, he focused on finance. Betting he could earn much more working in the industry than reporting on it, he reinvented himself as a financial advisor.
Following a brief stint with a small broker-dealer in 1986, he and wife Jean — who’d been picking up back-office procedure at PaineWebber — along with a partner opened their own firm. Four years later the partner left, and Edelman Financial Services was born.
In a move to expand nationally, in 2005 the entrepreneur sold a majority stake to the publicly traded wealth management firm, Sanders Morris Harris Group, chaired by George Ball, former E.F. Hutton president and Prudential-Bache chairman-CEO.
Seven years after that acquisition came a management buyout wherein Lee Equity Partners bought a majority interest in what had become the Edelman Financial Group. Edelman is CEO and second-largest owner; Ball continues as chair.
Nowadays, Edelman spends more time running the firm than advising clients, though he still works with a batch of folks who have been with him for about 25 years and occasionally takes on new accounts.
ThinkAdvisor recently interviewed Edelman, who spoke from EFS headquarters in Fairfax, Va. On the phone, his dry humor jibed with a New Yorker magazine cartoon tucked into his new book. Husband (working with laptop) to wife: “If we take a late retirement and an early death, we’ll just squeak by.”
ThinkAdvisor: What do you do for a living?
Ric Edelman: Consumers think I’m in the service business, but I’m in the product business. The service I provide is giving good advice about the product. Because I’m in the product business, Wall Street is in the manufacturing business. Like any other manufacturer, it will manufacture a product that it knows people are willing to buy, which has nothing to do with whether or not people ought to buy it.
How else does the system work?
Wall Street makes a lot of money manufacturing the product, and then they pay very high levels of compensation through the distribution system to get people to sell the product. Whether or not the product actually delivers on its promises isn’t Wall Street’s concern at all.
That’s too bad.
It’s very much too bad! But the problem begins with the consumer. When they say they want a product with a high return, for example, they don’t realize they’re setting themselves up for disappointment by chasing last year’s high return. We all know that past performance doesn’t guarantee the future. But when consumers tell Wall Street what they want, Wall Street is happy to oblige.
What’s the upshot?
Just because they get what they want doesn’t mean they’re getting what they need.
You write that “the financial services industry is the most profitable in the world.” What makes that possible?
Leverage. Unlike other industries, we’re not trading hours for dollars. We’re being paid on the size and duration of the assets. If you invest $1 million with me and if that money is invested with me next year, I earn the same money even though I might not be doing as much work. When a shoe salesman sells you shoes this year and next year sells you another pair, he’s not making money on two pairs of shoes. But in our industry, we make money on both pairs. No other business on the planet operates that way.
Many people don’t trust financial advisors and therefore won’t use them. What’s your take on that?
The overwhelming majority of advisors are trustworthy. So it’s not so much that investors are going to get ripped off by crooks or that advisors are incompetent. But most people don’t believe they’ll have a good experience with an advisor and refuse to hire one, or they feel they don’t have enough money to attract their attention. The biggest issue is that, because they don’t have an advisor, they aren’t maximizing their potential.
What’s problematic for consumers concerning their 401(k) plans?
Employees aren’t contributing early enough or aren’t contributing enough money. The average American worker has about $65,000 saved in a retirement plan. This is a crisis for the country!
Do advisors pay enough attention to 401(k)s and IRAs in working with clients?
They pay a huge amount of attention — but all with the expectation of eventually capturing the rollovers. This is a major source of new assets for the advisor, and that’s why the entire financial services industry actively targets the rollover marketplace.
The title of your book implies deception about 401(k)s. Are employees being lied to?
The biggest lie is the borrowing provision. The very word, “borrow,” is the inherent lie. Employees aren’t borrowing — they’re withdrawing. The money is actually removed from their account. So it’s no longer there, growing in value. A great percentage of workers have taken out “loans” and don’t understand the impact to their account. They think it’s harmless; but it’s devastating. And what about the tax picture?
They don’t realize that they’ll end up incurring double taxation: When they repay the loan, they’re repaying it with after-tax dollars; when they withdraw the money in retirement, they have to pay taxes all over again.
What else are consumers in the dark about when it comes to retirement plans?
The cost of the investments are largely hidden from them. Two-thirds of consumers believe that their 401(k) is free. But the vast majority of 401(k)s use retail mutual funds, which have an annual expense ratio of about 1-1/2%. Since most workers have no idea what their plans cost, they don’t understand the importance of keeping costs low.
What’s another stumbling block?
Employees’ lack of understanding about how to properly choose investments for their plan. The fundamental elements of investment management are unknown to most of them. They don’t know how to select the investments or create an asset allocation model. They don’t understand the principle of compound growth.
Can’t they get help?
Advisors are generally not allowed to provide advice. And the people who often do provide the advice are selling the product that’s in the plan, which might be expensive annuities and limited mutual fund choices.
But can’t advisors give behind-the-scenes advice?
Very often. We do that, to the degree we’re allowed under the law. But that’s very different from having a formal program with unrestricted access on a one-on-one basis. And because advisors aren’t compensated for giving advice, many fear the liability of doing so. So the rules hinder us.
Very. I know more about my clients than anyone else, often even their spouse or physician. But I’m not allowed to give advice about their retirement plan at work! That’s silly. And considering that the majority of people have most of their money in retirement plans, it’s an unfortunate aspect of the regulatory environment [imposed by the Department of Labor].
Anything being done to try to change this?
[The Employee Benefits Security Administration] is working hard to improve the rules so that consumers have greater access to independent advice. But, of course, the industry is opposing it: plan providers don’t want independent advisors commenting to plan participants about the investments because that could threaten their business.
What misconceptions do workers have about IRAs?
They don’t understand the beneficiary designation or the required minimum distribution (RMD) rules or the rollover rules.
What mistakes do advisors make with clients regarding IRAs?
They invest IRAs in municipal bonds. That’s horrific. It’s flat-out incompetent: you’re converting tax-free income into taxable income when it’s withdrawn. The second thing, nearly as egregious, is placing an IRA into an annuity. Again, the IRA is already tax-deferred, so you’re not gaining tax-deferral benefit from the annuity itself, which is typically a very expensive investment. In a few rare cases, an annuity may be justified because it offers guarantees, like living benefits or a death benefit.
Why do advisors recommend annuities for IRAs?
Overwhelmingly, they’re doing so because of the commission these products pay, not because of the product’s inherent benefit to the client. Why do you oppose mutual funds?
What I oppose is how the mutual fund industry exploits Morningstar ratings in an effort to market their products. When [companies] advertise that their fund has five stars, they’re implying that you should buy it. Consumers assume that five stars means this is a product that’s going to perform. But everybody in the financial industry knows that past performance doesn’t guarantee the future.
You advocate diversifying broadly and having a long-term perspective. That’s pretty conventional. What’s the subtext here?
I say that because Wall Street loves to churn money since they tend to make money mostly on transaction expenses. It’s the movement of money that makes Wall Street the most profits. They love to have you get out of what you have and get into whatever they’re currently selling — like the fashion industry. That has trained consumers into a short-term focus, and it’s completely contradictory to what’s in their best interest.
You warn against emotional investing. That’s a challenge. Some TV shows even encourage this by getting viewers all stirred up about the market.
Very much so. When they talk about the moment-by-moment activity, it’s always about fear or greed — something bad or something good has just happened. That gets you motivated to either buy or sell, neither of which is in your best interest when you’re dealing with retirement planning, which is a 10-, 20-, or 30-year conversation.
To what extent do you still personally work with clients?
Not as much as I used to. I’m not taking on new ones except if their situation is really, really rich or really, really intellectually interesting — an unusual case, often a very difficult or sad circumstance. It could just as easily be a pro bono case.
Why haven’t more independent advisors expanded in the way that you have?
They’re not inclined to build an organization as large as mine. It’s not that they can’t. Frankly, I think they just don’t want to.
Are you trying to help advisors outside your own firm by teaching them practice management techniques?
Actually, we’ll be presenting a series of training programs around the country later this year to help them improve the way they operate. I’m convinced that many can benefit from the experience we’ve had in growing our practice.
You position yourself as the Starbucks and McDonalds of financial planning, and not wanting clients to be dependent on one particular advisor. Please explain.
Wirehouses have 15,000 brokers doing 15,000 different things: selling stocks, selling mutual funds, trading options, doing managed money. There’s no consistency within each firm. I didn’t want that because consumers are coming to my organization because of their exposure to me: they’ve heard my radio show, seen my TV shows, read my books. They understand my methodology and want to know that my advisors are going to espouse that.
How are your advisors’ practices structured?
We make sure they’re all operating identically and that the underlying philosophies are the same. We’re not cookie-cutter, by any means: they have great flexibility to provide individual advice. But they’re doing it within a framework of investment management that’s highly consistent and highly systematized.
However, relationship-building has been the industry trend for about 20 years now. How can that occur with your approach?
Clients have very close relationships with our advisors. That isn’t the same thing as saying, “My advisor is the only one in the firm that’s able to help me.” When you call us, any one of the advisors can immediately provide assistance because we all have complete information about your circumstances. In that way, you’re not dependent on any one individual.
But what’s wrong with putting trust in just one advisor?
With our system, you don’t have to worry about the whims of a single individual or that they’ll wake up in a bad mood and decide to sell everything in your account because they’re panicked over something they saw on TV. Instead, you have the collective experience and mind of all of us working as a team. There’s a tremendous degree of support. We have three dedicated support staff for every advisor.
How are your advisors compensated?
They earn a share of the fee that the firm collects from each client.
What else is different, if not unique, about working at your firm?
Our advisors do no paperwork at all and no marketing of any kind. In fact, they’re not allowed to look for clients. Instead, all they do is interface with the clients that the firm provides. As a result, they’re able to give clients far greater levels of service than typical advisors because they aren’t distracted.
Do you intend to hire any new advisors this year?
We’re working very hard at that right now. We’re planning to add 30 to 50 advisors this year and are looking for them in a wide number of cities across the country. I’m more interested in the advisor than their book. If they have one, great. But I really don’t care.
What’s your firm’s account minimum?
Only $5000. The fact that many consumers don’t have an advisor because they don’t have enough money is one of the most outrageous conceits of our industry. It’s horrific. Firms feel they can’t make money serving smaller accounts. That’s an awful commentary on our industry and helps explain the terrible reputation it has. We need to help Americans become rich, not merely help rich Americans stay that way.
Over the years, you’ve grown through being acquired. Why did you go that route?
In 2003 we had one office, and I wanted to [expand]. But I realized I had no experience growing multiple locations and that it would take a lot of money. I didn’t want to take that risk myself. I needed capital and someone with experience. We chose Sanders Morris Harris.
Then what happened?
With their backing, financial and otherwise, we began to grow on a national basis. We started by opening six offices simultaneously in the New York Metro area in 2009. The financial crisis helped us because consumers were in deep need of advice. To what do you primarily attribute your overall success?
Building our firm on the basis of consumer education. In the ‘80s, when I started, an incredible amount of abuses were occurring in the industry. Wall Street was earning an amazing amount of money with ridiculous products they were pushing on hapless consumers. The only place to get education was from the guy selling you whatever product he was pushing.
In your book, you recommend ignoring the advice of popular money gurus. But aren’t you a popular money guru?
I never offer predictions. I tell you how things work. That’s different from telling you what’s going to happen next. [The others] are contributing to the hype.
What really bugs you?
Pretty much everything! [laughs] Which is why I work so hard. I’m convinced that no one else is doing it as well as I am. So I have no choice but to step in and do it.
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