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Chad is the Managing Director of Creveling & Creveling Private Wealth Advisory. His experience in institutional research, corporate advisory, and private wealth advisory has given him a firm grasp of the financial issues and challenges facing his international clients, as well as the... More
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  • Looking Past The Sales Pitch: Analyzing An Insurance-Linked Investment Scheme

    If you're an expat who has been abroad for any length of time, you're no doubt familiar with the various types of insurance-linked investment schemes (or unit-linked life assurance plans) peddled relentlessly in the offshore markets. We've been analyzing these products for years and have previously written about their pitfalls. The products have evolved over time, however, and unfortunately expats continue to get caught up in their aggressive marketing.

    For an update on what's currently being pushed at expats, we recently looked at one insurance-linked investment scheme that touts an "award-winning" range of investment and insurance products, with the following benefits:

    • Access to 90% of your premium from the start
    • Opportunity to earn a loyalty bonus
    • No initial sales charge-100% of each premium is invested
    • No bid/offer spread
    • Wide range of funds managed by investment specialists
    • Potential for tax-free investing
    • Free fund switching
    • Choice of plan currency
    • Ability to add to your plan at any time
    • Life assurance with 101% death benefit

    The scheme is even regulated in one of the major offshore financial centers to "provide an exceptionally high degree of regulation and security."

    That all sounds pretty impressive. With such a lineup of benefits, who wouldn't be enticed? Still, things are not always as they seem. Let's take a closer look at the supposed benefits of this product.

    #1: No Initial Sales Charge

    Technically, it's true that there is no initial sales charge. But there is something called an "establishment charge," which is equal to 1.6% of the premium each year for a period of five years. In other words, 8% of your initial premium is deducted over a period of five years. The charge is taken quarterly from the underlying investments prior to stating their net asset values (NYSE:NAV), so clients rarely notice.

    Each new investment or "premium" is subject to the same 8% charge. This charge covers the fee the product provider pays to the financial advisor. If you want to surrender your scheme early, then any unpaid establishment charges are brought forward as a surrender charge.

    #2: No Bid/Offer Spread

    There is no bid/offer spread because there is now something called an "establishment charge." The financial advisor or salesperson has to be paid somehow. Previously, this was more or less hidden in the bid/offer spreads. The establishment charge makes this cost more transparent.

    #3: Access to Your Capital

    The scheme allows you to withdraw up to 90% of your premium/investment, subject to certain restrictions. It's unclear why this is a benefit. If you invested in a stock or mutual fund, you could withdraw 100% of the value at any time. The scheme does not offer any special protection. If the underlying investment in the scheme falls below your initial investment, you are not going to be able to withdraw your initial premium/investment.

    #4: Additional Contributions

    The scheme allows you to make additional contributions whenever you like. Again, it's difficult to see why this is a benefit.

    #5: Tax-Free Investing

    Advisors often sell these insurance-linked investment products based on their tax advantages. In many cases, however, non-American expats are not taxed on their offshore investments in the first place. For example, most countries do not tax nonresident citizens on assets held outside their home countries. Many expats also work in countries, particularly in Asia, that do not tax assets held offshore. If they did, these products would offer no protection. These products do not confer any real tax benefits, beyond what most expats naturally receive simply by working and holding their assets outside their home countries.

    For Americans taxed on worldwide income and assets, offshore insurance wrappers are unlikely to qualify for U.S. tax-deferral benefits from the IRS. Worse, the investments they house will likely also be considered passive foreign investment companies (PFICs). Unlike U.S.-incorporated mutual funds, where capital gains are deferred until realized and which are subject to preferential long-term capital gains rates, PFICs are subject to a particularly punitive taxation regime. Annualized tax rates on PFICs can total 50% or more.

    #6: Access to a Range of Investment Specialists

    In this case, the scheme offers mirror funds linked to 200 external mutual funds from 35 different fund houses. A mirror fund is set up by the scheme provider and is designed to "mirror" the fund of an external manager. It does this by investing mirror fund assets net of fees in the external fund. Due to fees and other factors, the mirror fund will not necessarily track the performance of the external fund. The mirror funds can be accessed only through the scheme provider.

    But how notable are the scheme's investment options in reality? For comparison, consider that one global discount broker affords direct market access to thousands of stocks, options, futures, forex, bonds, ETFs and CFDs in 100 markets across 23 countries.

    #7: Death Benefit

    The scheme has a death benefit that pays 101% of the plan's surrender value (after deduction of all sales-related establishment charges). This is like a bank offering you life insurance tied to the value of your deposits. The amount your beneficiaries receive on your death is the value of your deposits (not the death benefit and your deposits). There is virtually no insurance value here-it's all self-funded. These products are designed as investments and meet only the barest minimum of requirements to be classified as an insurance product.

    #8: Fees

    The scheme comes with several layers of fees:

    • Administrative charge: 1.2%
    • Establishment charge: 0.4% each quarter (1.6% per year) of the premium for five years
    • Underlying fund fees: Up to 3.35% (with an average of 1.5% to 2%) some funds may include performance fees

    Essentially, each contribution/premium is subject to an 8% commission (although it is spread out over five years), which covers fees to the advisor/salesman. There is also an ongoing annual fee of between 2.7% and 3.2%. These fees are collected from the underlying funds prior to posting the fund NAVs, so they are rarely recognized by the investor.

    To be fair, the sales brochure lays the fees out pretty clearly, particularly in comparison to earlier products. Contrast that with a globally diversified portfolio that can be constructed with low-cost exchange-traded funds (ETFs) through a global discount broker for about 0.25% annually.

    #9: Security

    According to the marketing material, the scheme's location in one of the major offshore financial centers means it is protected by comprehensive legislation, which provides "an exceptionally high degree of regulation and security." Tell that to LM Investment Management (LMIM) investors, who lost millions when the fund collapsed in 2013.

    The fine print states that investors should be aware that specific investor protection and compensation schemes that may exist in relation to collective investments and deposit accounts are unlikely to apply in event of failure of such an investment held within insurance contracts.

    Additionally, the company offering the scheme/product clearly states on its website that it does not provide advice or sell products direct to the customer, and for further information on services and products, the customer should contact their financial advisor. Of course, the financial advisor is not an employee of the firm offering the product. Nor is the advisor typically regulated by the offshore regulator that oversees the product provider.

    The scheme provider is therefore not liable for any advice, selling or misselling by an advisor/salesman to a client. This is why an advisor needs to be regulated in the jurisdiction in which the advice or selling is being provided.

    The fact that the scheme itself is regulated in a major offshore jurisdiction affords little real protection or recourse for investors from the misselling and fraud that sometimes occurs in the offshore markets.

    Consider Your Options

    It's possible that there was a time when these insurance-linked products were pretty much the only way for an expat to invest outside their home countries. Times have changed, however, with product innovation and the rise of global online discount brokers. The next time you are pitched one of these insurance-linked schemes, make sure you do your homework and consider your options.

    Additional Resources

    Five Things to Consider Before Buying Offshore Investment Schemes
    Low-Cost Investing for Asia's Non-U.S. Expats
    Five Questions Expats Should Ask Before Choosing an Offshore Custodian
    American Expats: Don't Get Caught by U.S. Tax Rules on Foreign Investments
    Investment-linked insurance schemes a trap for unwary investors (South China Morning Post)
    When an investment fund goes bad (South China Morning Post)

    Find more articles by Chad Creveling, CFA, on Google+

    About Creveling & Creveling Private Wealth Advisory

    Creveling & Creveling is a private wealth advisory firm specializing in helping expatriates living in Thailand and throughout Southeast Asia build and preserve their wealth. Through a unique, integrated consulting approach, Creveling & Creveling is dedicated to helping clients cut through the financial intricacies of expat life, make better decisions with their money, and take the steps necessary to provide a more secure future. For more information visit crevelingandcreveling.com.

    Aug 14 8:25 PM | Link | Comment!
  • Expat Financial Advice: Successful Investing For An Overseas Retirement

    How much will you need to retire overseas, and how should you invest to achieve that goal? For many of us, a retirement portfolio worth the equivalent of USD 1 million might seem to be more than enough-almost like winning the lottery. Unfortunately, USD 1 million doesn't go as far as it used to. Depending on your overseas lifestyle, this amount may provide only a reasonable, not generous, retirement, especially if that retirement lasts 30 years or more. In this article, we'll explain how to judge if the equivalent of USD 1 million will be enough for you in retirement, as well as how best to invest to ensure you don't run out of money or have to curtail your lifestyle.

    USD 1 Million Can Buy a Reasonable-Not Affluent-Retirement

    One rule of thumb is that you should be able to withdraw an inflation-adjusted 4% per year from your retirement savings with a low chance of running out of money over a 30-year retirement. But even if you have saved USD 1 million, 4% is only USD 40,000-less than the median income in the U.S., and less than some expat families spend on travel and entertainment in a year. This amount doesn't quite purchase the type of lifestyle that you might expect for a millionaire.

    Even then, depending on how you invest, there is a substantial risk of outliving your money.

    If you just put your USD 1 million under a mattress and divided it by 30, you would have about USD 33,000 per year. But this doesn't take into account inflation. Thirty years of inflation at 3% per year reduces purchasing power by 59%. At an average inflation rate of 5% per year (not unheard of if you live in a country with an emerging economy), purchasing power is diminished by 77%. This means that USD 1,000 today would buy you only USD 412 worth of goods in 30 years with 3% inflation and just USD 231 with 5% inflation.

    For your USD 1,000 to be worth USD 1,000 in the future, it's going to have to keep up with inflation. The annual inflation rate in the United States has averaged 4.21% per year from 1972 to 2013.

    To Beat Inflation, Invest in a Diversified Portfolio

    Unfortunately, investing in a cash deposit or money market account won't get you much more of a return than putting your money under your mattress. An all fixed-income (bond) portfolio is better, but not good enough. The examples below show what happens to 1,000 potential 30-year return sequences for a USD 1 million cash or bond portfolio, subject to the long-term average inflation rate of 4.21% per year while withdrawing an inflation-adjusted, after-tax amount of USD 40,000 each year. Portfolio earnings are assumed to be subject to a 15% tax rate.

    Is USD 1 Million in Cash or Bonds Enough for 30-Year Retirement at 4% Withdrawal Rate?

    All-Cash Portfolio

    All-Bond Portfolio

    all cash

    all bond

    98% chance of running out of money before 30 years at 4% withdrawal rate

    49% chance of running out of money before 30 years at 4% withdrawal rate

    Note: Monte Carlo analysis, 1,000 iterations using different pathways of random actual returns

    As shown above, the cash portfolio does not last for 30 years, and the bond portfolio succeeds only in about half the cases. If inflation is higher than average, the chances of either portfolio lasting for a 30-year retirement would be even lower.

    Contrast the above results with the same analysis of a portfolio diversified across various fixed-income, equity, and alternative asset classes, with a split between equity-type risk and fixed-income risk of 60%/40%.

    USD 1 Million in a Diversified Portfolio: A Better Chance for 30-Year Retirement

    60/40 Diversified Portfolio

    diverse portfolio

    22% chance of running out of money before 30 years at 4% withdrawal rate

    Note: Monte Carlo analysis, 1,000 iterations using different pathways of random actual returns

    As shown above, the diversified portfolio gives you the best chance of success. Of course, to achieve this success rate, you have to put up with the additional day-to-day and year-to-year volatility that comes from including equity in the portfolio. For more on choosing an investment strategy, see our article "Choosing an Expat Investment Strategy: Your Time Horizon Matters."

    Order of Investment Returns Matters

    Short-term volatility is common for investors, as is the general rise of portfolios over the long run. Part of what determines if a portfolio will last for 30 years in retirement are the up and down periods encountered over that time, the order of investment returns, and when funds are withdrawn.

    For example, having positive investment returns early in retirement and one negative year out of five in the last year can leave you with the same five-year average if the return percentages are reversed.

    However, you'll end up with less money by withdrawing funds for retirement if the negative return year happens in the first year of the five-year average. Why? Poor returns at the beginning of a retirement period combined with withdrawals quickly depletes the value of the portfolio and overwhelms its ability to recover, even when there are better returns later in the retirement period. For more details on this, see our article "Expat Investing: In Retirement, the Sequence of Returns Matters."

    Diversify and Save More

    A diversified portfolio is the best way to ensure your money lasts throughout retirement. You should also test your plan against actual returns during different historic and economic periods. Look at return sequences where the poor returns occur up front. Use Monte Carlo testing to generate thousands of potential return sequences and see how your plan stands up. If you are a retiree in an emerging market, remember that emerging market equity and currency add another layer of volatility to expat portfolios. Plan accordingly.

    Other things to do: Save more. Start early. Know your numbers, which means creating a financial plan that encompasses your unique situation and updating it frequently. Learn what successful long-term investing is all about. Learn to deal with market volatility. Create a lifestyle you can afford. Get help if you need it.

    Additional Resources

    Seven Things Expats Need to Know About Investing
    Expat Investing: In Retirement, the Sequence of Returns Matters
    Choosing an Expat Investment Strategy: Your Time Horizon Matters

    Find more articles by Chad Creveling, CFA, on Google+

    About Creveling & Creveling Private Wealth Advisory

    Creveling & Creveling is a private wealth advisory firm specializing in helping expatriates living in Thailand and throughout Southeast Asia build and preserve their wealth. Through a unique, integrated consulting approach, Creveling & Creveling is dedicated to helping clients cut through the financial intricacies of expat life, make better decisions with their money, and take the steps necessary to provide a more secure future. For more information visit crevelingandcreveling.com.

    Jul 10 9:30 PM | Link | Comment!
  • Vanguard Study Shows How Advisors Can Add 3% Or More To Your Annual Investment Return

    Expat investors often want to know the best way to assess the value of financial and investment advice. Without a clear answer, many fall back on seemingly tangible but misleading and unattainable metrics such as "beating the market" or achieving some arbitrary short-term portfolio return.

    The desire for a single, tangible measure of value is entirely understandable, particularly as many of the benefits of working with a financial advisor are more easily described than quantified. The problem is that focusing on beating the market or other arbitrary and misleading short-term measures does not result in long-term wealth creation. Instead, it encourages a narrow focus and such wealth-destroying behaviors as emotional decision-making and performance chasing. The traditional sales-driven financial service industry, which is based on transactions, product sales, and short-term metrics, further discourages the behaviors that truly create long-term wealth.

    Quantifying the value of a holistic, advisory-based approach to financial and investment advice is challenging. Over the past decade, Vanguard, a global investment management company with approximately $2 trillion in assets, has developed a framework that shows how an advisor can add value by focusing on the long-run drivers of wealth creation.

    Vanguard Study: Potential 3% Advisor Value Add

    In a recent study, "Putting a Value on Your Value: Quantifying Vanguard Advisor's Alpha, "Vanguard found that a coherent, disciplined advisory approach that focused holistically on long-term outcomes had the potential to add up to 3% in additional returns for the average investor.

    The 3% value add was relative to a sales-oriented, transactional approach that attempts to capture short-term pricing movements or the situation where a do-it-yourself investor takes a less-than-disciplined approach to managing their financial affairs.

    Some value-creating strategies such as eliminating excess product fees or reducing portfolio tax add value annually. Others, such as helping clients maintain a disciplined investment strategy in difficult markets, add value intermittently but create significant wealth over time.

    Even More Potential to Add Value in the Expat Markets

    Vanguard's findings are based on a study of U.S. investors. The typical expat in Southeast Asia, however, has a far more complex financial life, including multiple tax regimes, currency issues, higher product fees, less investor protection, and a loosely regulated financial service industry that is heavily focused on product sales.

    Given the greater complexity and scope, we estimate that a holistic, long-term, goal-oriented approach to wealth advisory can add 4% or more to an expat's net return over the long run.

    Where's the Value?

    Some aspects of financial advisory services are easier to quantify than others. As an example, the value of convincing a client not to bail out on their investment plan during a financial downturn is hard to quantify, but perhaps would add the most value over all.

    The chart below outlines Vanguard's estimates for how advisors can create value for clients by adhering to a holistic, client-focused approach to wealth advisory. We've provided our own estimates for the expat offshore markets.

    Source: Vanguard and Creveling & Creveling Estimates

    Asset allocation: Asset allocation and diversification are the most powerful ways an advisor can help a client manage risk and achieve their financial goals. Numerous studies have shown that an investor's asset allocation is the biggest factor in determining long-run portfolio performance and volatility. The Vanguard study found that the value added by the asset allocation was perhaps the most significant, but too unique to quantify for the average investor.

    Behavioral coaching/disciplined approach: Investors often succumb to media-driven, greed-fear decision-making and the corresponding temptations to time the market and chase performance. Yet these are behaviors that have been shown in numerous studies to destroy portfolio value over the long run. Vanguard estimates that helping clients focus on the long term and maintain a disciplined approach to investing throughout all market conditions can add up to 1.5% per year.

    Cost-effective implementation: Vanguard estimated that using lower-cost funds and ETFs to implement an investment strategy had the potential to add up to 0.45% annually. Given the significantly higher product fees in the offshore markets, we estimate the average expat investor can save up to 1.5% or more by using lower-cost funds to implement an investment strategy.

    Tax management: The proper allocation of assets between taxable and tax-advantaged accounts can add up to 0.75% per year. The highest value will accrue to those with assets split relatively evenly between taxable and tax-advantaged accounts and who are in the higher marginal tax brackets. This may not be a value add for some expats, but for Americans or Americans who have a nonresident alien (NRA) spouse, the benefits may even exceed Vanguard's estimated 0.75%.

    Disciplined rebalancing: Vanguard estimates that disciplined rebalancing back to a client's strategic long-run asset allocation can add up to 0.35%. This sounds easy to do, but requires tracking and rebalancing assets across all accounts in the portfolio. In our experience, clients typically don't have the time or software to track and implement this strategy across all the accounts in their investment portfolio on their own.

    Of Great Value, But Harder to Quantify

    The strategies outlined above are some of those that apply to nearly all investors and are the most easily quantified. The Vanguard study also looked at retirement withdrawal strategies and total return vs. income investing. Each had the potential to add significant value, but that value was unique to a specific client.

    Below are some additional ways an advisor focused on a holistic, long-run approach can add value, but which are either difficult to quantify or where the specific value added is unique to a particular client:

    • Maximizing employee benefits
    • Better financial decision-making
    • Goal-oriented financial planning and investing
    • Mitigating risk
    • Client education
    • Peace of mind

    Understand How Your Advisor Adds Value

    Vanguard's work shows that a good advisor with a client-focused approach can add significant value over the traditional sales-oriented or DIY approach. Not all value is easily quantified or accrues annually, but a disciplined approach and a focus on the long-term drivers of value can result in significant wealth creation over time. Don't be fooled by arbitrary or misleading short-term metrics. Make sure you understand how your advisor's approach helps you create and preserve your wealth over the long run.

    Additional Resources
    Seven Things Expats Need to Know About Investing
    Expat Investing: In Retirement, the Sequence of Returns Matters
    Expat Investment Advice: Don't Chase Returns, Diversify Instead
    Low-Cost Investing for Asia's Non-U.S. Expats
    Expat Investing: Three Quick Ways to Boost Investment Returns
    Non-Deductible IRA: A Backdoor Roth for US Expat High Income Earners

    Find more articles by Chad Creveling, CFA, on Google+

    About Creveling & Creveling Private Wealth Advisory

    Creveling & Creveling is a private wealth advisory firm specializing in helping expatriates living in Thailand and throughout Southeast Asia build and preserve their wealth. Through a unique, integrated consulting approach, Creveling & Creveling is dedicated to helping clients cut through the financial intricacies of expat life, make better decisions with their money, and take the steps necessary to provide a more secure future. For more information visit crevelingandcreveling.com.

    Jun 19 8:04 PM | Link | Comment!
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