The potential client was sitting across from me as I reviewed his investment account history. “John” was in his upper 40s and employed as a mid-level manager at a real estate company. He had left a larger real estate company years before and had rolled his 401(k) retirement assets into an IRA account.
There had been a somewhat consistent pattern of his broker redeeming a mutual fund once or twice per year and then purchasing a similar fund in another fund family. Going outside the fund family from which the first fund was redeemed caused John to be charged a commission. This is a process known as “switching” and benefits the broker at the expense of the client. This practice had impacted the returns on the account.
I explained to John what was happening in his account and showing him the specific transactions. The amount was usually $10,000 to $15,000, enough to hit him with a commission between $500 and $750. I was not ready for his response.
“Well, Ken, maybe things will turn around.”
He didn’t seem too upset. I dropped the gloves and told him the broker was using the account as an ATM.
“You live and you learn, Ken. Win some, lose some.”
His response was opposite of what I expected. I couldn’t figure out why the excess commission wasn’t hitting his buttons. I tried another button.
“John, if this broker did the same thing that he did to you to your daughter or son, what would you do?”
His attitude changed on a dime. He leaned forward.
“Somebody taking advantage of my kid? The SOB would have to deal with me!”
I found the right button.
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My father taught me to go from first to third on a single to right field and how to gap and change the spark plug in my motorcycle, among other things. He did try to teach me about the opposite sex but I was too shy and embarrassed to have that conversation with him.
My father did not teach me about the workings of the investment markets, the impact of management fees on portfolio returns, or the importance of dividend yield. He didn’t teach me about maintaining liquidity or the proper way to structure portfolios for growth or for yield.
The reason why my father didn’t teach me these things was because they weren’t known to him. They weren’t close to being on his radar. My father was a laborer for a public utility company. He was too beat at the end of a work day to worry about the gyrations of the stock and bond markets. His idea of retirement planning was to keep working and keep paying into the Social Security system. He was also hoping the physical labor didn’t cause him to make an early exit and miss the small monthly pension payments promised to him.
When the division of the gas company my father worked for was sold, the company paid the pension in lump sum distributions to the employees. My father did the only thing he knew to do with his money. He bought a bank Certificate of Deposit. The irony here is that my father’s father lived through the Depression and was witness to bank closures and bank failures. He was afraid of banks. His son was afraid of everything else.
Of all the things parents must teach their children, it’s time to add another item to the list. While parents don’t need to convey the meaning of the Sharpe Ratio or how to trade options, they do need to provide some financial and investment education to their children. Those children will one day be asked to enroll and invest in 401(k) plans and make contributions to IRAs. They may also inherit assets. They need to understand what they are investing in, why, and the mechanics of those investments.
Beyond making prudent investment decisions and protecting themselves from “John’s broker,” there are other important financial concepts parents should teach. These include the proper use of credit, “impulse control,” and basic negotiating skills.
Credit card companies have long been marketing to college students right on their campuses. That first piece of plastic, if misused, could get a young person off to the wrong start with credit—especially if that young person already has college loans. Most of my friends and I did a foolish thing the moment we could afford a new car—we bought one. The social status of having a new ride didn’t last as long as the payments we had to make for a vehicle whose value went below that of the loan amount a year or two after we started driving it.
Impulse control is the concept of not buying something just because you see it and like it. If children can keep their money—and that credit card—in their pocket when the bells and whistles go off, they’ll be better off financially. Teach your children that our brains are wired for instant gratification. By sharing this concept, they will have better control over the impulse to buy that shiny object. Share with them that they should wait three days to purchase an impulse item. In that waiting period they may realize that the item doesn’t have the same value to them as it did the moment they saw it.
People who negotiate a few times per year are at a major disadvantage to a person who negotiates every day. Your children won’t buy a car or rent an apartment every month. But they will be sitting across the table from people who negotiate on a regular basis and may have been negotiating for years. Teach your children never to negotiate when they don’t have control of their impulses, to separate the invalid and irrelevant aspects of the negotiation from the valid and relevant aspects and to realize that their counterparty is attempting to get more value than they are giving.
Proper investment allocation, prudent use of credit, impulse control and basic negotiation skills. Things that parents should add to the list of what they teach their children.
Of course, many parents, like John, may need to learn these things first.