Spotting Ads That Prey on Fear

Beware your motives for investing: Pitchmen guess them and take advantage. A radio commercial running recently in my area, for example, trumpets non-traded real estate investment trusts (REITs) and, like many hawking financial products these days, the sponsors use fear to sell investment products.

The spot opens with an employee of the financial firm, David Lerner Associates, discussing how he understands the pain and uncertainty so many experiences. I add that pain and uncertainty sometimes stems from this type of financial-advice commercial, along with an endless negative pitter-pat of financial news.

The employee then asks what he knows many potential clients wonder: “Will the stock market continue to go up or will it have a sharp decline like has happened 16 times since 1929?”

Is he implying that the stock market didn’t advance during this period because of 16 “sharp” declines? If that’s his meaning, he’s wrong.

The Lerner firm ran into trouble in the past with the Financial Industry Regulatory Authority (FINRA), which fined it $2.3 million and ordered $12 million in restitution to clients – all for unfair sales practices and excessive markups. But the firm did log a win last year when a judge tossed out a class-action suit against it. Lerner has labeled charges against it “baseless.”

The market regularly declines more than 20% in a year but yearly cumulative advances more than offset the declines through time. The stock market averaged approximately 10% returns for the past 50 years. Remain committed to these companies through enviable “sharp declines” and you capture these returns.

The radio spot hammers on, asking, “What will happen with interest rates?” Since no one knows for sure, this question only causes you to doubt your investing judgment or, worse, gives you reason to stall your financial planning. Or, of course, you can buy the products the sponsor peddles.

That’s non-traded REITs, among other investments. Regular REITs sell like a stock on the major exchanges and invest in real estate directly. A non-traded REIT does not trade on a securities exchange and so is illiquid for long periods (you cannot convert illiquid investments to cash immediately without losing a significant amount of true value.)

Front-end fees at the time you buy non-traded REITs can hit 15%, much higher than for a traded REIT, due to the limited secondary market. The Financial Industry Regulatory Authority (FINRA) announced a potential rule change in February that takes into consideration the various fees and commissions to brokers and dealer managers and that reduce the share price on each customer account purchasing shares in a non-traded REIT.

“For example, if the prospectus for an offering with a $10 offering price per share disclosed the selling commissions totaling 10% of the offering proceeds, and organizational and offering expenses of 2%, the amount available for investment would be 88%, or $8.80 per share,” according to the FINRA rule proposal on the regulator’s website.

For years, brokers who sold non-traded REITs used this illiquid feature to give the illusion of a stable investment, as the price did not reflect the changing real estate market.

So what do you do about “uncertain” times highlighted in the radio spot? First, understand that we live in a world of uncertainty and plan your finances accordingly.

Our firm, for instance, always conducts a fire drill to prepare clients for “sharp declines” and discusses actions we will take before and during these events. We do this with the added advantage of maintaining liquidity at a reduced cost.

The best preparation for these declines is to understand they are common and to keep cash available in the short term during these downturns in case it is needed. Then when declines occur, your cash allows you to re-balance your portfolio to purchase additional shares at “sharply” reduced prices while maintaining additional cash to await a recovery.

Your best course? Work with a true financial coach, not a salesman peddling bad products.

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Dan Crimmins is the co-founder of Crimmins Wealth Management LLC in Woodcliff Lake, N.J. His blog is Roots of Wealth.

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