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An Open Letter to Mr. Jason Zweig about I-Bonds and AUM Fees

An Open Letter to Mr. Jason Zweig about I-Bonds and AUM Fees

I read a lot, mostly about the same topic - finance.  And while I consider myself somewhat widely-read, I do have a cache of authors whose content I frequently consume.  Nearly all of what I read is well-prepared, most of it is insightful, and sometimes I'm provoked into some sort of action.  To be fair, I don't always agree with the conclusions - that is just the nature of things.  Almost never - in fact this is a first - the content of an article strikes a chord and necessitates a BLOG post...here it is by way of an open letter.

On May 28, 2021, Mr. Jason Zweig published an article entitled "The Safe, High Return Trade Hiding in Plain Sight" - you can read it here.  Before getting into it, I will openly say I admire Mr. Zweig.  He is a highly-respected, widely-read Journalist of the highest caliber.  I have been a Wall Street Journal subscriber for a number of years and read almost every article he publishes.  Moreover, I read his updated version of the revered Intelligent Investor by Ben Graham as well.  While I did not personally think the book needed updating, for as much as my opinion means anything, I thought he did a commendable job. All of this said, I take umbrage at some of the statements and conclusions Mr. Zweig recently published about my profession - Financial Planning.

The Investment Hiding in Plain Sight

I-Bonds (the 'I' stands for Inflation) were created in 1998 and offer a very simple way to provide some inflation-protection for US Government issued securities.  These instruments offer both a fixed and inflation-adjusted investment return.  The fixed-part is determined upon purchase and remains the same throughout the life of the bond, which is limited to 30 years.  Conversely, the Inflation-Adjusted part resets every 6 months according to the Consumer Price Index.  As of May 2021, the fixed-rate is 0.0% (yes, you read that right - ZERO) and the Inflation-Adjusted portion is 3.54%.  Note, the 3.54% is actually the annualized 1.77% rate (1.77% x 2 = 3.54%), which will reset again in November of this year...more on this fluctuating part in a moment.  I-Bonds are limited in the following ways:

  • You must own them for 1-year before you can cash them in
  • If you sell them before a 5-year holding period, you forfeit 3-months of interest
  • Buying is restricted to $10,000 per Social Security Number per year, though there are exceptions to this rule I'll ignore here
  • Any income is subject to taxation, which is applied upon redemption, though you can choose to pay annually if you like
  • These investments are not eligible for Roth IRA Accounts, though they can reside in a Traditional IRA

Clearly, I-Bonds have unique characteristics worthy of consideration for Investor portfolios.  Like every other investment candidate for a Client portfolio, inclusion depends upon the Client's risk tolerance, needs, goals, and of course, suitability.  NO INVESTMENT EVER RECEIVES A BLANKET 'YES' FOR EVERY INVESTOR...more on this in a minute.

I-Bond Performance

In Mr. Zweig's article, he quotes the current Inflation Component credited to I-Bonds as 3.54%.  While that number is irrefutably true on a 6-month annualized basis, that is only today's Inflation Component of an I-Bond's return and needs context.  First off, this is not an investment return.  Rather, it is a component used to compute an I-Bond's value.  Moreover, this component adjusts every 6 months.  Below is this component's historical value copied from the Treasury Direct Website from inception:

What counts with ANY investment is theAfter-Tax Rate of Return....that applies to cryptocurrencies, stocks, bonds, baseball cards, or whatever other instrument into which one chooses to invest.  For context, let's see what returns an Investor would have enjoyed over the trailing 1, 5, 10, and 15 Years with I-Bonds.  Using the Treasury Direct website, you can calculate the value of any I-Bond.  Here are the source values I used for the charts that follow...please verify the amounts yourself if you don't trust these numbers:

To make the comparisons a bit easier to present, I have multiplied the values in the above chart by 10, which also corresponds to the maximum amount one person can buy in I-Bonds per year, $10,000.  Here are the valuations an Investor would have enjoyed over the aforementioned holding periods:

I have included the after-tax values for these instruments as they are ineligible for the tax-free treatment one would receive in a Roth IRA - a significant factor in choosing these assets as a component of an overall portfolio.  The percentages correspond to the first 5 Income Tax Brackets presently in use in our tax code.  I have omitted those brackets above this (35% and 37% as of this writing) to simplify the presentation.

As I stated before, quoting the current 6-Month CPI-Adjusted Inflation component is only part of the story.  What counts is what the investment returns on an after-tax basis.  Therefore, to further illustrate an I-Bond's choosing, it is constructive to look at their after-tax rate of return, which were as follows for the above holding periods:

As the last piece of the puzzle, let's look at how these investments would have compared to a different fixed-income selection.  For Clients of Resilient Asset Management, the Baird Core Plus Institutional Bond Fund (Symbol BCOIX) serves as the core component of the Fixed-Income portfolio allocation.  This fund is not hard for any Investor - professional or otherwise - to stumble upon.  It is frequently listed as one of the better managed and better performing funds in popular literature, both professional and retail.  There are many other strong candidates with similar performance.  Nevertheless, let's see how I-Bonds stacked-up against this fund.  Here are the numbers (BCOIX Returns are taken from Morningstar):

The Baird Core Plus Bond Fund out-performed I-Bonds in each period.  Moreover, since the Baird Fund is eligible for inclusion in a Roth IRA, this makes their selection over I-Bonds even more compelling.  I've illustrated the performance advantage over the 10% bracket...the advantage for an Investor in the higher brackets would be more pronounced as more I-Bond returns would have been eaten by taxation.  

While there are many factors involved with this outperformance, I think it is very clear that while I-Bonds do provide some insulation against inflation, we should perhaps hold-off on their enshrinement in the Investing Hall of Fame for the time being.  In fact, looking at the above returns, I can paraphrase Samuel Johnson: "A Bond indexed to Inflation is a remarkable bond, not a remarkable investment".

One cold rightfully argue that I-Bonds should not make up ALL of one's fixed-income investments.  I agree and add that the same can be said of a Core Plus Bond Fund constituting an entire fixed-income allocation.  Continuing that thought - given that fixed-income investments make-up a relatively (to stocks) small part of a typical investor's portfolio, choosing I-Bonds for a "piece of the small piece" of the portfolio dictates I-Bond performance, or lack thereof, will concomitantly diminish its impact on portfolio performance. 

For example, if Bonds constitute 40% of one's portfolio and I-Bonds are chosen for 10% of the Bond Portfolio, I-Bonds will only comprise 4% of the overall portfolio.  On a $1 Million portfolio, taking the return on 4% of the portfolio from 1% to 5% only changes the portfolio's return by 0.16%....$400 for every 1% of added return for a $1 Million portfolio. 

More simply put, buy I-Bonds or whatever you like - CDs, Money Markets, Short-Term Bond Funds - for the stable value portion of your portfolio.  Whatever you choose, a properly allocated portfolio will result in whatever you select being inconsequential to your overall performance.

And as you can see, you could have simplified your life - and number of passwords - by side-stepping Treasury Direct and just adding the Baird Core Plus Bond Fund to your portfolio.  Of course, past performance guarantees nothing about the future.  However, I seriously doubt I-Bonds will turn night into day for any Investor, regardless of Income Tax bracket.

AUM Fees

AUM here refers to "Assets Under Management", which is the total amount of assets a Financial Professional directly manages for Clients - I am simplifying the definition somewhat here.  An "AUM Fee" refers to the percentage of AUM a Financial Professional charges to a Client.  For example, a 1% fee on $1 Million is $10,000, which is typically billed "quarterly in arrears".  Like a batting average in baseball, an AUM Fee is painfully simple to compute, and like the bathroom scale (or Khakis for my Sailors out there), an AUM Fee doesn't lie.

Mr. Zweig is a frequent critic of this fee structure, perhaps rightly so.  You can read one such article here...there is a good bit of other material.  To be fair, I have my reservations about this fee structure myself, though I do have a solitary Client for whom I employ it.

One jab in Mr. Zweig's I-Bond article was a zinger directed at Financial Professionals, which read as follows:

"...financial advisers have no incentive to sell I bonds, which don’t pay commissions or charge expenses and are available exclusively from the U.S. government (see TreasuryDirect.gov). If four family members each put $10,000 into I bonds, that’s $40,000 on which a financial adviser can’t assess a management fee. At a typical 1% charge, that’s $400 a year the adviser won’t earn."

I could write several articles refuting many aspects of this criticism.  However, let's simply start with defining the Investor Space.  Here are a few data points from a CNBC Survey completed in November, 2019 :

  • 75% of people are their own Financial Planner - they self-prescribe with no outside input
  • 15% of people rely on their spouse or partner for financial advice
  • 4% of people rely on their parents for financial advice
  • 1% of people rely on a Financial Planner

Admittedly, much has happened since November, 2019; however, I seriously doubt the percentage of Americans relying on Financial Planners has changed much.  If it's moved at all, I would guess it is still far less than 5%.  Given how thorough Mr. Zweig's research usually is - he did edit the Intelligent Investor mind you - I'm vexed how he can infer ANY causality between I-Bond proliferation and Financial Planners.  The statement is made even more vapid for Financial Planners who are not compensated by AUM.  Whatever the Fee Structure, there simply are not enough Investors seeking professional advice to hang ANY Investment's exclusion from portfolios on Financial Professionals, period...only 1% of Investors even have one.

Additionally, given the evidence (see above) of superior alternatives to I-Bonds, perhaps one would question why a Financial Planner would include them in a Client's Portfolio at all.  And recall, generally speaking, higher-earning people seek professional financial advice.  And for this subset of the population, I-Bonds make less sense than for their lower-earning counterparts due to both the Income Tax burdens (Not Roth Eligible) and the associated purchasing limitations ($10,000 per year).  Mr. Zweig made this point in his article as follows:

"Ironically, the less you earn and have to invest, the more powerful a tool I bonds are." 

Another quote in Mr. Zweig's I-Bond Article was from Mr. Marvin Vinluan, a software developer who said the following: 

“So all the advisers, all the brokerage firms—all the places people go to for investing advice—aren’t going to say a word about I bonds.”

To me, "all" implies everyone.  Well, I am a Financial Planner and I frequently discuss inflation-protected securities, including I-Bonds, with both Colleagues and Clients.  I'm not sure if that constitutes counter-evidence...I'm a minnow in the Pacific Ocean of Financial Professionals.  Bottom Line:  I seriously doubt AUM considerations has anything to do with their use in Client Portfolios across the country. 

A few more words for Mr. Vinluan:  I-Bonds have many competitors in the Fixed-Income space.  I can't speak for other Financial Planners, though I can say that my Clients have enjoyed far more satisfactory performance than they otherwise would have with an I-Bond only fixed-income portfolio.  Of course, I-Bonds may be suitable going forward, though they are no panacea.  For most people, bonds provide ballast for a portfolio, they are not the foundation upon which wealth is built....stocks do that.  If you would like to discuss this, please call me at (559) 817-9279.

Other Fee Models

Any Financial Professional's Fee Model is subject to criticism.  Very simply put, when fees are Involved, there is no such thing as "conflict-free" advice.  That said, Mr. Zweig appears to presuppose that ALL Financial Planners use the AUM model...we don't.  Like any other industry, Financial Planning has evolved its free structures. 

In today's marketplace, any individual can pay hourly fees, subscription fees, percentage of Income, percentage of Net Worth, or combinations or permutations of each.  Just as an Individual can choose amongst a wide-offering of restaurant tastes, so too can the same Individual choose amongst Financial Planning fee schedules that make sense and work for individual needs. 

For any conspiracy theorists out there, Financial Professionals are required to publicly disclose exactly what their fees are and how they are calculated...it's an absolute open book.  You can simply Google "BrokerCheck" and enter either a Firm or a Financial Planner's name and read all about it.  Try it, my Firm is "Resilient Asset Management" and my name is "Christopher Flis".  Or even easier, some Financial Planners post their fee schedule on their website - here is mine.

Among other things, alternatives to the AUM model increase the population of individuals who can receive financial advice.  And there is a tremendous need for it in my United States.  I say that not to cast blame...individuals outsource all kinds of things via experts all the time - and Financial Expertise is no different.

And if either Mr. Zweig or Mr. Vinluan think a wide swath of Financial Planners are crafting ways to inflate AUM at the expense of their Clients, perhaps there are some, though I would suggest their numbers are dwindling - fast.  As counter-evidence to AUM inflation, here are some highlights of recommendations I've made in my own practice, all of which decrease AUM:

  • Not to cash-out a Company-Provided Pension so Annuity payments remain in-place for life.
  • Transferring money into the Thrift Savings Plan (TSP) to facilitate Roth IRA Contributions
  • Paying off a Home Equity Line of Credit (HELOC) with invested assets
  • Securing a Shared-Care Long-Term Care Policy for a couple in lieu of investing the premium funds
  • Not to claim Social Security to invest the payouts, thus enjoying delayed credits
  • Delaying Social Security to earn delayed credits and using invested assets for living expenses
  • Suspending Social Security payments at Full Retirement Age to earn delayed credits and use invested assets to replace the income
  • Using assets in Taxable Accounts to pay the Income Taxes on Roth Conversions
  • Making Qualified Charitable Distributions (QCDs) from Traditional IRAs
  • Facilitating nearly $300,000 dollars in charitable donations to Donor Advised Funds upon which I charge ZERO Fees

The list is a great bit longer, though I hope both Messrs. Zweig and Vinluan get the point - NOT ALL FINANCIAL PROFESSIONALS TRY TO SQUEEZE EVERY LAST CENT OF FEES FROM THEIR CLIENTS.  Financial Planning is a helping profession and help we do.

I can't speak for others - however, I can say that I have no financial need to work and I take a great deal of personal liability risk being a professional Financial Planner.  For me, it's all worth it when I assist my Clients' in achieving their financial goals.  It was most fulfilling when I orchestrated an Estate Plan for a single mother with a minor child.  I know for a fact that I am not alone in this mindset...of anything I have written, of that you can be absolutely certain.

A few words for Mr. Zweig:  The cause for financial literacy and responsibility is crippled - not helped - by railing on Financial Professionals.  Any profession - Law, Medicine, Journalism - has its bad actors...that's unavoidable.  Charging a 1% AUM Fee doesn't make a financial professional illegitimate.  Moreover, you should consider that Holistic Financial Advice - encompassing not just investments, but EVERY aspect of Client Finances - is the wave of the future...and perhaps the present.  You're a brilliant journalist...I encourage you to champion this shift to Holistic Advice and publish articles describing it in detail.  Also, I encourage you to suggest that your readers seek financial advice when it's needed...it very frequently is.