Crooks are getting more creative with how to part you from your money. One of the biggest growing areas is in “affinity fraud”. Learn what it is and how to avoid it.

Also, Victor discusses top 401k mistakes, including introducing one investment option that might interest people looking for tax-free growth and tax-free distributions.

Make It Last with Victor Medina is hosted by Victor J. Medina, an estate planning and elder law attorney and Certified Financial Planner™. Through his law firm and independent registered investment advisory company, Victor provides 360º Wealth Protection Strategies for individuals in or nearing retirement.

For more information, visit Medina Law Group or Private Client Capital Group.

Click below to read the full transcript…

Announcer:  Welcome to “Make It Last.” Helping you keep your little ducks in a row, and your nest eggs secure. With your host, Victor Medina, an estate planning and elder law attorney, and certified financial planner.

Victor J. Medina:  Everybody, welcome back to Make It Last. I am your host, Victor Medina. Jeez, that music always gets me excited to talk to you. I am just thrilled.

This is the fall season. The fall season is my favorite season. If you’re listening to this in a podcast way, way later, it’s like November. It is a nice cool crisp November. I love this season. I love getting ready for Thanksgiving, and I love to host Thanksgiving.

One of my favorite things to do is to cook about five, six of the dishes. Here’s the one dish I don’t cook, which is the turkey. I’m no good at the turkey. I leave the turkey to somebody else, but all the side dishes I’m pretty good at, and I like cooking though.

I’m in negotiations now with my wife to try to figure out if we’re going to host or if we’re going to go to somebody else’s house. But I hope we get to host because I love staying home, I love watching the parade, I love cooking for most of the day, I love having family over and then last, but not least, I like watching football. Anyway, it’s a good season for me.

This is going to be a good show for you. I’ve got two topics I want to cover. One is a concept called affinity fraud and a lot of people are familiar with identity fraud but this is affinity fraud and we’re going to cover that today. The other thing I want to talk to you about is top 401(k) mistakes.

More and more people are making mistakes when it comes to their 401(k) ‑‑ how much they invest, when they invest, what they invest in, when they come out of it, why they might come out of it. I’m going to introduce a novel concept about why your retirement vehicles may want to include things beyond your 401(k).

We’re going to through that and talk about some taxes, so put on your thinking caps and stay with me as we go over that.

The first segment I want to go over with you is affinity fraud. Affinity fraud, if you look up the definition, it’s basically referring to investment scams that prey upon members of identifiable groups. You could be part of a religious or an ethnic community, you could be part of the elderly, that’s part of the affinity fraud or the kinds of professional groups.

The people who perpetrate this often are members of the groups. It’s one of the ways to get in with them and get all the confidence that you need in order to scam people out of stuff.

I remember the first time I was exposed to this, I was pretty young. I was in the middle of law school and I was a teaching assistant to new law school students. It was probably my second or third year, and I was meeting with one of the members of my team that I was teaching.

Obviously, they would have a professor and they would have these teaching assistants and they would break out, and we would tear up their writing. We would teach them how to think and how to write.

In any event, I was meeting with this gentleman. He was actually proficient in sign language. In addition to that, he spent some time being an advocate for deaf people. It started when he was in college. I think he was dating a deaf woman.

One of the things he taught me though is that the deaf community, deaf people, are often very suspicious about people who are good at sign language because the culture is such that that’s how they get preyed upon. They’re relying on people who can sign to speak for them.

A person who is vision impaired can still hold a conversation even though they can’t see you and they know that what is being said to them, if it’s in their native language, is exactly what they can understand. When someone is serving as a translator, the deaf community doesn’t know if what they’re translating to them is correct or not and so they have trust issues around that.

Fast forward about 15 years, a little bit longer than that, and I have a set of deaf clients. They always meet with their daughter. They’ve grown to trust me, but in the beginning of it they only trusted their daughter to have conversations with me and interpret what our advice is.

Since then, they have taken to just meeting with me one‑on‑one. They’ve grown to understand what I’m saying. We don’t often meet with the daughter, but we do every once in a while. The point was that I saw that reinforced, the lesson that I got very early with the student that I was mentoring.

I’ve always been keen to the idea that people who perpetrate frauds like this are often coming in as members of the community as though they were the most trustworthy of folks. Now, the scam levels actually vary. There were some things that are just out and out scams that are like pyramid or Ponzi schemes.

There was a special on HBO that went over the devastating effects of multilevel marketing, [inaudible 5:15] . One of the things that they were highlighting is that most of the people that are being scammed by one of the ones that deals with like herbal supplements is the Hispanic community. It’s done by people who can speak Spanish.

They go down and sometimes they’re just scams, pure scams. But there are slightly less ‑‑ what’s the word I’m thinking of ‑‑ obvious scams that are going on and those ones are the ones that I want to raise to your attention. I’m not saying everyone can avoid the scam stuff, I don’t know how to prevent that except to surround yourself with people that you know and are trustworthy, and things like that.

I have that top level that I’m worried about. The one that I get, mostly, concerned about that isn’t as obvious is the affinity scams that have to do with investments. One of the things I want to raise for you is this idea that people are creating investments around affinities and they’re probably not the best thing to be latching onto.

One of them that I saw had to do with a new investment fund, and there are different ones, you got mutual funds, you have these things called ETFs, and they’re Electronic Transfer Funds. They’re a form of mutual funds. But most people think of ETFs as being following an index, so you can get an S&P ETF.

One of the ones that I saw recently was actually, something that was related to Biblically Responsible Investing, so BRI. An ETF was, essentially, just trying to get you to invest in this ETF, put your money there because, I don’t know, you latched on to the idea that Biblically Responsible Investing was the good thing to do.

I can’t really figure it out, except to say that they are preying upon your desire, your affinity with wanting to be good, a good religious citizen, that’s what it is. They promised the world it’s an ETF that talks about how they’re going to invest morally and still not lose any of the performance potential and they’re not going to invest in immoral and anti‑biblical activities.

The point is this. This is where I get a little…what I want to talk to you about is that following your feeling and emotion about an investment is never a good decision, just not.

Investing requires cold calculation and no emotion whatsoever. You don’t go by feeling and you don’t chase the good feeling that comes from being with a, whatever they’re calling it, the Biblically Responsible Investing Fund. You just don’t. That’s not the way that you invest.

You can have moral objections to certain kinds of investments and some of the funds that we offer might fall under the area of socially responsible investing. That’s, maybe, a little bit easier, but we do talk about how it will sacrifice performance because you aren’t including some things that will just, by their very nature, follow the trends.

In this case, this Biblically Responsible Investing is doing nothing other than preying on someone’s belief that what you invest in should match your conscience. On top of that, parking the money with them without any more due diligence off of it. Sometimes, advisors can help you avoid this kind of stuff.

I haven’t had too many clients coming and saying this is what they want to do. But I have seen this come across the radar more and more in, whether is in affinity with a particular culture, and an affinity with religious beliefs or something other.

We got to stay vigilant on this stuff and make sure that we leave emotion out of the investment that we’re doing. Would you look at that, I went long on this segment. We’re going to go a little short on the next two.

When we come back, we’re going to talk about top 401(k) mistakes. I want you to pay attention to that. Listen to the commercial, but also grab yourself a piece of paper and a pen. We’ll return with Make It Last, where we’re going to cover top 401(k) mistakes. Be right back.

 

Victor:  Welcome back to Make It Last. This is going to be two segments. Or these are going to be two segments. We’re going to talk about top 401(k) mistakes. I’m going to cover four mistakes in segment two.

Let me give you a brand new idea in segment three, and probably one that you haven’t heard from other advisors. I’m going to need your thinking caps for that one in segment three. Let’s go over the first ones when we talk about the top mistakes for existing 401(k)s.

The number one mistake that I see in the 401(k) is treating it like a play fund to do your investing and to follow trends. You might put this under the category of trading too much. That’s the top number one mistake that I see.

I always love when I get to use family members as examples on the show. The family member here is my delightful mother‑in‑law. My delightful mother‑in‑law had her 401(k), and she had things that she chose to invest in.

What she would do at the end of the month is she would check which funds were doing well, and then she would move her money into those funds. She was the definition of track record investing and chasing that performance.

She was shocked that her account value didn’t grow at all. Since we took it over, her account value did what the market said it was going to do and went up, because that’s what’s going up now. The point was that it didn’t lose any momentum because of the trading that went on.

It’s all kinds of research that has been done time and time and time and time again. The trading in and out of securities is a bad idea. First of all, you will never be able to time the market correctly. You will incur unnecessary trading fees going in and out.

If I wanted to be efficacious about it, the time that you spend trading your 401(k), you probably would have made more money if you had trained to be a better employee and gotten another bonus. The first 20 parts of your career, getting promoted and getting paid is where the real money is at.

You want to avoid investing in stuff just because it’s a track record. Don’t invest too much. The other flip side of that coin though is you don’t want to be overbalanced.

When you create a diversified portfolio…Let’s go to mistake number two. Mistake number two is lack of diversification. This is sometimes part of trading too much. People will chase after certain performance, and what they will have is an unbalanced portfolio.

Any particular segment is doing well at a time. We don’t know how long that’s going to last. The one that’s not doing well almost never gets the attention and time that they need, with money that’s been invested in there, and percentages and things like that.

The truth of the matter is that, if you have a diversified portfolio, what I say to people is, it’s always having to apologize for something. [laughs] There’s something in there that you have to apologize for, because it’s not doing well.

It also means that you’re never doing as well as your neighbor down the street, because they’re invested totally in the thing that is doing great. The lack of diversification is best thought of as pistons in an engine. At no time are all eight pistons firing at the same time.

The engine doesn’t move forward. The car doesn’t move forward when you do that. The reason why we have multiple asset categories is so that things that go down will eventually come up, and things that go up will eventually come down.

We want to own all of the asset classes that we can. There are some models that you can follow to make sure that you are represented in each one of those asset classes correctly, depending on your risk tolerance.

You’re going to own some of this, and some of that, and some of the other. That’s diversification. We see as an error that there’s a lack of diversification often. People will own a target date fund, which is by its definition, diversified with some goal about when it’s going to mature.

Then they’ll also buy other funds. Typically the ones that are doing well, because they’re track record investing and chasing that money. That ends up throwing their investments off‑balance. I’m not telling you that you ought to own a target date fund solely.

Many of them are not properly constituted. Many of them are not represented in certain asset classes. There’s nothing that we can say about them universally. If we have a diversified portfolio, we want to stay diversified.

Part of the first mistake ‑‑ we talked about trading too much ‑‑ there are times where you are going to want to rebalance. Rebalancing is essentially selling the thing that is high to buy more of the thing that is low, so that you get back into the ratios that you want to.

If you had put down, “Well, I want 20, 30, 10, 10, 10 at certain funds.” When those 20s and 30s go up to 30 and 40, you want to sell some of that off so you get back to the 20, 30, 10, 10, 10. The reason why you want to do that is, first, you’re committed to a long‑term investment, and diversification is the right thing to do.

The second reason you want to do that is those things that are 10, that are low, that you’re buying cheap, are eventually going to come up. You want to buy them cheap so that you can ride that roller coaster up, and that’s one of the reasons why we’re going to keep that in balance.

You don’t want to be doing that too often. There’s all kinds of mathematical theories behind tolerance levels. Stocks are going to vary up and down, up and down, up and down. They’re going to vary widely. Just because it’s up today doesn’t mean necessarily that we’re going to sell it.

We’ve got to have tolerances that we will withstand before we are out of tolerance and need to sell something. The idea generally is that you want to stay diversified. Become diversified, stay diversified with your investments.

The third mistake is investing in expensive or active funds. Usually they’re married together, that active funds are expensive. Sometimes we just have expensive funds because we have expensive funds. We have expensive funds because they pay the advisor an extra fee that you don’t know about.

All kinds of reasons where you can have expense ratios. One of the things that we do, if you’re interested in our services, is we will assess your portfolio and do it like an MRI, so that you can see what your fund expense ratios are, and whether or not you’re diversified.

We’ve got a software tool that does that. It pulls all the expense ratios from these published documents with the SEC. We’re able to very clearly say, “This is how much you’re paying for your investments.”

One of the reasons you want to avoid doing that is that expensive investments create enormous drag on your money. I’m going to use an example. Stick with me, because I know it can get confusing when I use numbers over the radio and you’re not seeing what’s going on.

If you have an investment that’s, say, $10,000 and it’s going to grow for seven percent a year over 10 years. Let’s just say that those are the averages. If you are paying 1.44 percent for your investments, which, by the way, is an average that has been concluded by DALBAR, which is a subjective research.

If you’re paying 1.44 for your investments, at the end of 10 years, you keep 76 percent of your money. I get this talk a lot, I got the numbers mixed up. Anyway, 76 percent of your money, and 23 percent of it went to fees. A quarter of it went to fees, generally.

If you have an expense ratio which is closer to a third of a percent, 0.33, which, by the way, is the most expensive balanced portfolio that we implement. If you have that, then you keep 93 percent of your money, and only 7 percent goes to fees over the course of the 10 years.

There’s a 20 percent swing on that. That is enormous. That’s only over a 10‑year period. If you extrapolate that out to 20 or 30 years, then the amount of money that you’re able to keep by not having this boat anchor around your investments with all of these expensive fee options, you really catapult your retirement.

You want to look up the expense ratios. One of the services that we perform for our clients is seen as sometimes we’re managing their money directly. Many times there is still participants in a 401(k). Being participants of a 401(k), they’re essentially captive.

They can’t move that money out at all. We will, in fact, give them a portfolio that’s probably the least offensive thing that we can put together, and we’ll do that routinely. What I find is that often 401(k) options just stink.

They’re not great investments. We have to really engineer a decent portfolio, and then try to get that stuff out as soon as possible. Only have some tricks that we can do to move them out for a married couple. It’s a little more sophisticated planning.

Some people want it. We get to a point where we said, “Look, this portfolio is no good. Do we want to do something different with it? We’re going to have do some legal and financial magic to make that happen, but we can move it out of the 401(k) and get it invested properly.”

Many clients choose to do that. The last one also has to do with a drag on your investments. The last mistake is borrowing from your 401(k). The reason why this is a mistake is…I can understand that people are hard up for some money.

It can look like that that 401(k) is a bank that you can borrow from, assuming that you don’t incur penalties for doing so. The real thing that I want you to avoid is the lost time of growth during the period in which you’ve made the loan or taken that loan out from the 401(k).

This is a strategy. Investing in a 401(k) is a strategy that you are implementing for tax‑deferred growth, so that you have a nest egg that is available to you when you retire. Your company is likely matching some portion of it, which is great.

We want to make sure that we’re getting our matching. It is helping you grow you money faster than you could grow it alone. Part of the magic in making that money grow is to leave it alone.

If you borrow from it for any length of time ‑‑ because nobody knows when the top days or bottom days of the investment market are going to be in the new period ‑‑ you are going to lose out on the growth that that money could have made, which when extrapolated out over time, will severely impact your investments.

There are all kinds of reports. Just look up online. Missing the top 10 days, just the top 10 days of the last 30 years. If you miss out on the top 10 days, what you own at the end is a fraction of what you would have been, if you had actually owned it at those times.

We don’t want to borrow from our 401(k). We’ve got to figure out another way to meet that expense. This is a strategy that will serve you in retirement, and no one’s going to let you borrow money to retire. This is your nest‑egg.

Victor:  We need to act like adults, big boys and girls. We need to leave that money alone. All right. When we come back, I’m going to cover one secret strategy that may appeal to you.

I’m going to try to make the case for why you should consider it, especially if you’re concerned about income taxes in the end. Stick with us. When we come back on Make It Last, I’ll give you the last final mistake, and the most original idea that we have for retirement, and 401(k)s.

We’ll do that when we come back.

 

Victor:  Welcome back to Make It Last. I’m just not being a very good radio show host, because I went long on both of those segments. [laughs] We have left a very little bit of the time from those original idea that I have with respect to 401(k), and how to avoid mistakes.

I’m going to try to go through this as quickly as I can. It is a rather sophisticated idea. Stick with me as we go through it. If you need more information, don’t hesitate to contact us, and we can see if we can send you some different illustrations on what we’re talking about.

Here’s the thing, 401(k)s, basically, are a way for you to make contributions to your retirement that are tax deductible when you make them, and the growth is tax‑deferred. They come with one compromise with the Federal Government, which is that when you take that money out, it is taxable.

You get all this tax‑deferred growth and you avoided paying taxes on that money on the return, but when you take it out, it’s all taxable. Here’s the thing, that money that you’re putting aside is not money you need to live on.

You are actually paying taxes on the all the money that you need to live on, because those are your wages, that by definition, they are the things that you didn’t save or deduct. You’re at one tax bracket.

For most people when they retire, they are going to remain at a very similar tax bracket. The reason for that is that Social Security is not going to make up the bulk of what they need to live on. They’re going to need to take money out of their 401(k) to make up the difference.

If they’re going to receive $30,000, $40,000 worth of Social Security benefits, they’re probably going to have to take out another $80,000 or $90,000 a year to continue to live on, to maintain a similar quality of life, especially in the beginning parts of their retirement.

That money that’s taxable when it comes out is going to pay taxes at about the same rate as the taxes when they came in. There’s a tremendous benefit to a 401(k) in which you get a match because you get free money. That is fantastic.

When you contribute to your 401(k), regardless of the tax deductibility of your contributions, getting free money from your employer is definitely something that you want to do. Many people would benefit from controlling their income taxes in retirement.

If you look at an investment like a Roth Account. Roth Account are not made tax deductible contributions, but the tax growth is tax‑deferred, and the distributions are tax‑free. By the way, there’s limitations on when you can contribute to a Roth.

Most people are limited to $5,500 a year, if they’re even eligible. If you can’t make contributions to a Roth, what are you left with? Something that will give you at least two out of the three benefits that I’ve been talking about ‑‑ tax deductible contributions, tax‑deferred growth and tax‑free distributions. We want a couple of those.

One of the things that you can do is invest in indexed universal life insurance policy. Before you shut off in your listening, life insurance, in and of itself is not a dirty word. In fact, life insurance is pretty much things that people get all of the time. They exist.

You have a group insurance policy. You have a life insurance policy that might be part of a death benefit when you have a pension. Why couldn’t we use this in order to help us with retirement?

It might be more beneficial to plow some money into an indexed universal life insurance program because it gives us two out of the three benefits with none of the limitations of the Roth.

The two benefits that it gives you is that the growth is tax‑deferred and the distributions are tax‑free, whether you take those distributions during your lifetime or your leave them as a life insurance death benefit.

Unlike a Roth, you can contribute money into an indexed universal life insurance policy with no limitations. The one trade‑off, of course, is that you pay taxes on that money. This is after‑tax contributions, but if you contribute that money in, all of the growth is tax‑deferred.

If you left it in a investment account, you would pay taxes on that later. There is a good benefits to investing in one of these things. To illustrate that, with only a few seconds left in today’s show, I’m just going to have you think about this.

Consider a farmer in one state being told that there’s a 10 percent tax on the value of the seed that they’re planting. Another farmer in a neighboring state is taxed 10 percent on the value of all the harvested grain.

If you were a farmer, which state would you rather live in? The seed money is the money that you’re putting in the indexed universal life insurance policy now, and it is taxed. The harvest at retirement may be able to be taken tax‑free.

On the other hand, the 401(k), or other qualified plan, may not be taxed now before the assets grow, but all of that money at retirement is taxed at ordinary income rates. It may be more beneficial to think about doing that.

I’m out of time for the show today. If you’re interested in learning more about this, don’t hesitate to contact our office, and we can help you illustrate the benefits to contributing to a 401(k), over and above the power that gives you a match, or thinking about this as an option as well.

We can talk about both of those things. The time went by very, very quickly. I want to thank you for joining us here on Make It Last, where we help you keep you legal ducks in a row and your financial nest egg secure.

We will be back next Saturday with something new and interesting just well.

Victor:  You keep working on those pots, and that Thanksgiving stuff. If we’ve got an extra seat at the table, maybe you’ll join us. Have a great week and we will catch you next week. Bye‑bye now.

Announcer:  The foregoing content reflects the opinions of Medina Law Group, LLC and Private Client Capital Group, LLC, and is subject to change at any time without notice.

Content provided herein is for informational purposes only, and should not be used or construed as investment or legal advice, or a recommendation regarding the purchase or sale of any security, or to follow any legal strategy.

There is no guarantee that the strategies, statements, opinions or forecast provided herein will prove to be correct. Past performance is not guarantee of future results.

Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses, which would reduce returns.

All investing involves risk, including the potential for loss of principal. There’s no guarantee that any investment plan or strategy will be successful. We recommend that you consult with a professional dedicated to your needs.

 

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