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Stuart Arakelian: Wealth Acceleration

We're talking wealth acceleration with Stuart Arakelian. Stuart has created two courses for us here at WealthFit. To say that he knows a thing or two about the whole wealth management, acceleration protection, transfer picture would be a little bit of an understatement.

In this particular show, we talk about a lot of different things. The focus is wealth acceleration. However, we go into his 30 years of being in the business of financial education, of financial stewardship from people that are getting started, young families in life all the way up to incredibly wealthy individuals.

No matter where you are on the spectrum, you are going to benefit big time from this show. I thought some things that you should look for in this particular show are different strategies for different folks. You've heard that before, but in this particular show, we talk about the big lessons learned from 2008. What was the big crash of 2008? What are some of the big takeaways that we all can benefit from? Maybe some of us don't remember that time. Maybe some of us are trying to forget it. You're going to see that in this particular show.

We also talk about what the advantages are of getting advice in paying fees, which is an interesting conversation because fees are a heated topic. If you don't do it right or if you don't think through it, you can erode a lot of savings because it compounds each and every year. We talk about the whole fee compensation and structure.

In addition, we talk about how to properly go out and vet somebody. If you're looking for someone to give you advice and maybe you're looking for a planner or somebody with a financial background, what are some of the markers? What are some of the key things that you should be looking for? That also includes a conversation about the big-name institutions that provide advice, are they in our corner or not? What are the pros and cons of each? Going for an institution to get advice, a big name that you would know that you see on TV or someone that's in your own town. Someone that is local that has the picture that is not necessarily tied to it. We talk about the pros and cons of that and then it gets creative at the end with wealth transferred. I know some of us aren't thinking about it, but I find it fascinating that there are creative strategies here in a lot of the things that we do. Are you bringing that level of creativity? It is an in-depth show.

Dustin
This is Stuart Arakelian, Founder of Arakelian Wealth Management, Principal and Financial Advisor.
It's September 2008. On the media, on the TV, everywhere, we see the Lehman Brothers collapse. The powers that be, the guys that should have the solution, should have the answer, they all fly to Washington if they're not there already. We're talking big-name people, the President. They're all flying to figure out, “How do we get out of this mess?” You're watching this unfold on TV. You see the look in their eyes that this has never occurred before at this level of any magnitude. There's this panic. They don't know the answer. You make a radical decision at that moment. Stuart, I want you to take us back to what it was like in 2008, how you saw it and then talk to us about this radical decision you made.
Stuart
Even one step before that, there was an economic slowdown that was occurring. Housing had started to slow. Interest rates had begun to run up a bit. Housing prices had begun to drop. People weren't saving any money. They had enormous levels of debt and these were all indicators to me that these were bad signs for the economy. As I was talking to many investment representatives, companies that represented mutual fund companies and exchange-traded funds, whenever I would bring this up to them, they would all tell me the same thing. They would say, “It's alright. It's all okay. It's all in your head. You're imagining these things. You're not focusing on the important factors of the economy.” What rung to make clear was these people didn't have the client's interest necessarily at heart or the financial advisor's interests at heart. All they wanted to make sure was that all of the clients stayed fully invested and kept all their money in the stock market. If outflows began happening, then the markets would even drop more and their revenues and incomes would drop.
Fast forward to the event that at the end of September 2008, Lehman Brothers, one of the most unblemished blue-blood firms with hundreds of years of history in the United States goes bankrupt. It was questionable. The federal government decided not to bail them out. That was a questionable decision, but it happened. As that happened, we were in the midst of a presidential election. The future President Obama was running against Senator McCain. George W. Bush was President at the time. Secretary of the Treasury was Paulson and the Federal Reserve Chairman was Bernanke. It was such a pressing time. It's such a scary time because we had never seen anything like this since the Great Depression, which would have been many years prior. They met as a show of unification to put together a plan on what steps they were going to take to solidify the economy. I diligently watched that. I had my eyes peeled because I wanted to see and hear what they had to say. As I looked at their faces in the room and the fear that appeared to be in their eyes, that none of them had a solution to what was going on and they were looking into the abyss. I made a unilateral decision at the time, a Draconian move to sell all of my clients out of the stock market.
It was a time where I felt that I needed to think differently. That's a part of our business mantra all the time, is that we need to be thinking differently than other financial advisors. The old school of thought that is buy and hold, the markets are always going to go up over time. I do fundamentally believe that. The problem is that if they drop 50% or 60% like they did in 2008 and 2009, I can mitigate that and only have them drop 20%, 25%. The road to recovery is a lot easier and a lot fewer sleepless nights. That was a point in time where it was a difficult time. It was a stressful time. I joke to my clients that I didn't sleep for two years. I didn't get comfortable until around 2010 with the recovery.
Dustin
What was it like telling your clients? I'm curious what your clients thought of pulling out of the stock market and then also maybe what your peers were telling you when you decided to make that decision. What was that like?
Stuart
Our clients pay us for our advice. They trust us. They listen to us. The decision we made at that time, it's important to understand is we sent out correspondence to our clients telling them what we were going to do. We asked them to reach out to us if they didn't agree with it. We had to make the decision and we had to move and make the move quickly. We told them that if they disagreed, we would buy him back into the market at our cost. It was that important to us that we did this for our clients. Our peers thought we were crazy. 90% of financial advisors all think alike, “Buy and hold.” You can't time the market. I don't disagree with that. There is a time and that holds true 75% to 100% of the time. There's a point in time where you need the risk. There's a point in time where you need to say, “It's time to go to the sideline. That was a time.” I got funny looks, I got skepticism. They weren't skeptical when my clients had all their money back in two years and it took their client about five to six years to get their money back.
Dustin
You've been doing this for quite some time. You've seen cycles. What did you learn about the big crash? What would you do differently? What did you discover about yourself and your thoughts? I know that there are a lot of questions coming at you, but basically what were the big takeaways that you're walking away with now that your clients benefit from into the future? What are some of those big things that you discovered?
Stuart
Always be listening to respective financial institutions. They're smart. They have enormous research budgets. They have deep pockets. They have the smartest financial minds in the world but listen to them with a skeptical ear. I don't want to name any particular firm, but every investment company, every household name mutual fund company. I did not have one fund company at the end of 2007, in the middle of 2007 come and say, “We see a real slow down and you ought to go away from equities,” because they did not have the interest to do so. I learned that. Listen to them, but listen to them with a little skepticism. Two, it reinforced to me that the markets always come back. That is scary as things look and as terrible as things were, that the market's rebound and they rebound quickly.
Dustin
I want to jump in here and I want you to keep continuing the takeaways, but I want to make it clear for people because your other colleagues didn't get out of the markets. How does somebody, a do-it-yourselfer, maybe someone that's not your client yet take this somewhat conflicting ideology of, “The market's going to bounce back, let it ride,” versus what you did smartly and you got them out? How do you weigh that?
Stuart
You have to weigh it and say, “Is this a correction? Is this a reasonable adjustment in the market?” It’s like what we're going through right now. We're not making big moves in the market with all the volatility that's going on and a slowing economy and rising interest rates and all. We're not making radical changes in our portfolio. We're reducing equities, stocks a little bit. We've had a wonderful nine-year run-up in the stock market. Our clients have made a lot of money. This is the natural contraction in the market and it's inevitable. We've been waiting for this for a few years for this to occur. It might not happen now, but we're going to have a recession in the next few years. That's natural. I would not make huge moves in that situation. It was different in 2008. Banks were not lending to one another. What that means is that when banks are lending money, in order to do so, banks lend money to one another. Wells Fargo lends to JPMorgan Chase, and Chase lends to another bank and so on and so forth. They rely on that lending, but they also rely on getting paid back. Wells Fargo was worried to lend money to Washington Mutual because they were afraid they weren't going to get any money back. They were right. It was such a scary time that banks were going out of business. It was awful. We were going into a depression.
General Motors was on the verge of bankruptcy. Ford was on the verge of bankruptcy, on and on. If it is that bad and you get to the point where you say, “There are no signs of anything good.” That's when you make a radical decision to do that. For the most part, the way you mitigate this is simple, asset allocation and diversification. You don't put all your money in stocks. You put some money in stocks, some money in bonds and some money in alternative investments. In good years, you do pretty well. In bad years, you don't lose as much. Over time, you're going to do well. That will work 90% of the time.
Dustin
I want to get into it. I want to give you a chance to share with us any other big takeaways from 2008. Number one, you talked about listening to the institutions for their research with a grain of salt essentially. Number two is that markets do bounce back. Any other big takeaways you learned?
Stuart
Number three is don't be afraid because markets do bounce back. Be a leader and ahead of the curve in getting back into the markets. They do come back quickly and you're never going to time getting back in at the exact right time, but it's better to be a little too early than a little too late when it comes back.
Dustin
The theme of this episode is wealth acceleration. It's important to talk about a foundation. Before we accelerate anything, we’ve got to make sure our house is in order. I know you're a big guy on setting the foundation. Can you talk a little bit about what does a solid foundation financially look for most people?
Stuart
It's basic. The purpose of a solid financial foundation is simply to make sure that if you have an unexpected event, your family or your business doesn't go backward. That's logical. How do you ensure that you don't go backward? What you do is you have a liquid savings reserve account. You have proper insurances, whether it's health insurance because if you have an unexpected health event and you don't have health insurance, you're going to go bankrupt. There's a statistic that says the number one cause of bankruptcy in the United States is healthcare. They can't pay medical bills. They didn't have proper insurance. They were uninsurable, whatever the factor might be. Proper life insurance is critical.
People don't talk about life insurance. Most financial advisors don't talk about life insurance. That's another sad but true fact, but life insurance is a foundational item that needs to be at least talked about. Not everybody needs to do it, but as a financial advisor, we need to be talking about, “Do you have three to six months savings in the bank? Do you have health insurance? Do you have life insurance?” You need your property and casualty insurance. You need home owner’s insurance, fire insurance, car insurance. These are foundational items. They're not sexy. They're not something you talk about at cocktail parties and that's why people don't like to talk about life insurance or, “I’ve got a great whole life policy,” but they want to talk about that they own Apple stock. They want to talk about Amazon and Google and what penny stock they bought that's up 350%. My job is to make sure that every step of the way is covered in the most prudent and responsible manner. It’s understanding there's no get-rich-quick way to get to your goals. It's one brick at a time, one foot in front of the other.
Dustin
“Stuart, I see all these ads online that say I can be an overnight millionaire.”
Stuart
That's who it's playing to, but I'm a boring guy and our clients understand that there are certain ways to build a nice nest egg and a nice comfortable retirement. Our way is a proven way to do that.
Dustin
I want to ask you about disability insurance. Life insurance, if you die your family's protected. Health insurance, if you get sick or whatever. What about disability? If you're a surgeon and you can't use your hands anymore, is that part of your foundation disability?
Stuart
It is. It's something that we should be talking about. The reality is that it's a difficult sell. It's an expensive proposition, but one of the greatest analogies I’ve ever heard. I’ve been doing this for many years. The question you posed to a client is this, “If you had a money printing machine in your garage that printed $10,000, $15,000, or $20,000 a month, how much would you pay to ensure that the machine didn't break down?” That's all disability insurance is. Would you pay $4,000 a year to make sure that $150,000 machine didn't break down? Part of the problem is, and I don't want to discourage people, it's not the easiest thing to underwrite. There are a lot of steps, both health and income-related, job classification, several carriers have gotten out of the business of selling disability insurance but something definitely worthwhile.
Dustin
Lengthier of a process than life insurance would you say?
Stuart
There are additional factors that make it riskier to an insurance company. There's more risk in morbidity than mortality. What I mean by that is, as crude as this sounds, they don't care if you pass away. They don't want you to have a stroke. They don't want you to have a heart attack. They don't want you to get in a car accident. They don't want you to get in a hiking accident and you slip and fall. Those morbidity claims where you can live another 20, 30, 40 years and be on claim is risky to them. It makes it a little harder to qualify.
Dustin
Everyone wants to talk about wealth acceleration. Everyone wants to talk Apple stock. Even I included, there are things that I was missing in my foundation because I was focused on the growth. Does it change at all depending if you're a young person versus someone later in life? Does the foundation change if you're getting started in the income generation side versus somebody that's ultra-wealthy already? Is a foundation a foundation?
Stuart
I would argue that risk moves as you get older. What I mean by that is when you're 30 years old, 35 years old, 40 years old, you have a mortgage. You have young kids. You have college to worry about. You have income replacement to worry about. You have some debt. You have all of these factors that require you to need life insurance. You have life insurance risk. You have the risk that you need money if something were to happen to you. If you're a middle-class person and you get older. You get to 55 to 60 years old and the mortgage is paid for or almost paid for. The kids are gone and you've saved a little bit of money. You're almost Social Security and you have no more educational cost. You don't need as much life insurance per se. You still might need life insurance, but you don't need as much probably.
What you need is long-term care insurance. Long-term care insurance costs are outrageous. The risk of decimating a family's financial situation is enormous. That's why financial planning is a fluid process. It's dependent on having a strong financial advisory relationship and partnering with somebody. I would say you still need savings. You still need property casualty. You still need all of that but the life insurance gets replaced with long-term care insurance. When you've accumulated a lot of net worth and you've become extremely successful, you no longer need life insurance to protect your family from debt. You need life insurance to protect your family and your business from estate taxes and those types of things. You need advanced planning and by far the best solution for that is life insurance to resolve those solutions. I know I'm talking a lot about life insurance, but that's a foundational issue before we get into the accumulation stage.
Dustin
I definitely want to get back to the tax savings side of life insurance. I want to invest some time on the long-term care. This is something I am not versed in. I want to invest some time because a lot of people may share that as well. Long-term care, in the working world you got health insurance. If you're working a job, the company hopefully helps you there. You're talking about long-term care is after you've retired
Stuart
If you get in a motorcycle accident and you're not working, you need home healthcare. You need somebody to come and do all this stuff for you that you can't do for yourself.
Dustin
What does that look like? Is that something that you want to invest in before you stopped working or before you get into an accident?
Stuart
You generally want to start planning. In my opinion, a good time to start planning for long-term care is when you're around 55 years old. You're still probably healthy. Rates are competitive, relatively low. That's a good time to do that. When you start getting into your 60s and 70s, the costs go way up and the risk of insurability goes down. There's a lot of misinformation. Health insurance doesn't cover your long-term care costs. If you need to go to a facility, if you need to go to an assisted living facility, the nursing home, health insurance doesn't cover that. Your Medicare covers the first 60 days of care. After 60 days, you're on your own. This is why a lot of people wipe out their entire estate and then have to go onto Medi-Cal to cover their long-term care costs.
People are living for a long time now. There are statistics that say that if you're healthy at 65, a husband and wife, one of them is going to live into their early to mid-90s. There's a 70% chance that one of the husband and wife is going to need long-term care. It could be argued that it's probably going to be the wife because the wife is going to outlive the husband. The wife is going to take care of the husband until the husband is gone, and then there's nobody for the wife. She goes into the facility. We think that this is an extremely important area. The good news is that they have these attractive products. A lot of companies have gotten out of the long-term care insurance business, but the ones that have stayed in and gotten creative have come up with some flexible type of plans.
Dustin
What does it look like? Let's say you’ve got to put myself in a home when I get to be that age or somebody in my family. Are we paying $1,000 a month to get $5,000 potentially in services? Break it down.
Stuart
I'm making it up numbers and I'm assuming that this podcast is going across a broad piece of the country. It varies by state. Here in California if you go into a pretty nice assisted living facility, you're looking at $4,000 to $5,000 a month. If you have memory care, it's $10,000 a month. That's if you have Alzheimer's, dementia and that is accelerating. You've worked your whole life and you've saved $500,000 to $1 million. You’ve got to still live, but then you're spending $75,000 a year on long-term care. How long is that? That's why long-term care is important. That's why foundational protection to make sure you don't go back is important. The only people who don't need long-term care are people who are poor or rich. If you're poor, you go on to Medi-Cal. If you're rich, you can pay for it out of pocket. If you're a middle person, and I classify middle anybody that has a couple million dollars in liquid savings. Anybody that's got $250,000 to $2.5 million, $3 million should be talking about long-term care insurance.
Dustin
Let's get into wealth acceleration. Everyone is interested and excited about wealth acceleration. I'm curious as to do you have any favorite or preferred vehicle? Once your foundation is good, you've got some money to place. Do you have any favorite vehicles that you use? Is it going to be dependent on every situation, every person and every family?
Stuart
I have my beliefs but it does depend on age to a point. I do believe that cost is an issue. The cost of the investments you’re using, the fees you're paying the advisor and the tax efficiency of the investment you're using. All of those are costs. The cost of the investment, are you using mutual funds? Mutual funds are fine. How much are you paying for that mutual fund? How much are you paying your financial advisor? Are you paying them 1.25%? Are you paying them half 0.50%? Are the mutual funds you're using tax efficient or are they tax inefficient? That's a huge drag for overall performance. At the end of the day, if you're overpaying by 1% to 2% on your investment, that is a hard bogey to overcome. I like a lot of things. I like mutual funds. I like exchange-traded funds. All an exchange-traded fund is it's like an index. It's inexpensive, it's tax efficient and it's going to beat 80% to 90% of most mutual funds’ performance. We understand that there are 10% to 20% of mutual funds and those are the ones we use that are going to consistently beat the indexes. We like mutual funds. We like exchange-traded funds. We are not embarrassed to say that if a client wants guarantees and they want guaranteed income because they're looking at this market right now. They don't like turning on the TV and seeing the stock market dropped 3.50%. Maybe putting some guarantees in an annuity makes sense.
Are annuities more expensive? A little bit more expensive. Are you getting something for that additional cost? You're getting guarantees. We like individual stocks and we like alternative investments, which would be things like real estate and business loan type private funds, and managed futures and hedge funds because it's proven in 2018. I'm going to say one more thing is that 2018 is an anomaly year. This is why it's been an extremely frustrating 2018. US stocks are barely up in percentage return. The S&P 500 I'm referencing. It might be up 2% for the year. Small cap stocks are down, small company stocks are down. Mid company size company stocks are down. Large-cap value stocks like dividend-paying stocks, they're down. Bonds are down in value. Real estate is down in value. International stocks are down in value. 2018 is a year where it's been almost impossible to find any returns.
The only place you could have gotten those returns to offset because they do what they're supposed to do is the alternative investments. Our alternative investments in 2018, while everything else is down a little bit, not down huge. International is down 10% or so, but anywhere from 0% to minus 2%, 3%. Our alternatives are up 5% to 8% for the year. It offsets the risk. It's a diversifier. It lowers the volatility of the portfolio. I like a lot of things. What makes us different is thinking differently. If you go to most financial advisors, they’re going to talk to you about stocks and bonds, a two-legged stool.
Dustin
What we're doing at WealthFit and especially on the show here, we've interviewed a lot of financial experts that advocate do it yourself. You’ve got the stock guy on and saying, “Do this system.” We had the gold and silver expert. We believe that you shouldn't just do one, you should diversify. A lot of these folks that are these experts in do it yourself and you should learn these things and manage it yourself. They’re a big knock on planners or fees and you even knocked it. You understand it. What's your commentary on the whole fee situation? What's the proper mindset that people should have around fees? Is this negotiable? Can I go to my planner and say, “This 2% fee if you want my business, you're only getting 0.50%?” Is it that cut and dry? What's your advice there?
Stuart
I would argue adamantly that the people who are saying do it yourself are the people who are selling something. Whenever you see a television personality saying, “Those financial advisors are awful. They're selling, they're conflicted. There's a percent that is. There's a percentage of every profession that is not as ethical as they should be. The vast majority of financial advisors that I know are partnering and care about their clients. The people that you're talking about who are doing podcasts, I'm assuming they're selling something. I could be wrong. They're saying, “Don't go to a financial advisor. Use my system.”
Dustin
It's their argument, like you. You're in the business of marketing or selling products and services. It's not that they're knocking. I'm not saying that they're knocking financial advice. Their argument is that there are fees and over time those compound.
Stuart
They do, there's no doubt. The question and we pose this to our clients, is I don't think that the fee structure that a firm might have is overly negotiable. They've priced that. The challenge with working with the big firms, the big national household firms that we've heard of for years is that they're a lot more expensive. They have a lot more layers. They have fancy buildings. The fancy cities with the fancy art collections in their lobby and the marbled in trees and the vice presidents, the senior vice presidents, the president and the shareholders all have to get paid. That comes out of somebody's pocket. A lot of it comes out of the financial advisor’s pocket because they get what's called a lower payout from the firm.
What do they have to do to offset that lower payout? They have to raise your fee. My experience is that those large firms need to be a significant percentage. Whereas independent financial advisors, people like myself who have their own registered investment advisory firm. People that own their own business are independent contractors and are partnering with their clients do have a lot more flexibility, leeway, and economies of scale to be able to be more competitive on their fees. I’ll put our fees against anybody. For example, we've been fortunate in the growth of our business and our fee levels are competitive.
Don't get caught up in that the fee only is to manage your money. The fee is to help you with your long-term care. The fee is to give you tax advice. The fee is to give you income and distribution planning advice. The fee is to make sure you have a lifetime for the rest of your income. The fee is to cover life insurance and make sure your family's taken care of. The fee is to create a budget for you. The fee is to help make sure your kids go to college. There's more than just, “He's charging 1%. He's charging me $10,000 to manage $1 million.” I would argue, “He's doing that, but that's how he's getting paid to do all of the other things that he or she does.” The question is and this is critical, “Are they doing those other things?” We do them.
Dustin
Not all financial planners do. There are stocks and bonds types of planners.
Stuart
They're painted into a box. They have a nice little comfortable business that they have built up. They’re comfortable. You could say they're fat and happy, and they have relationships with the clients that they have. They've painted themselves into the box. The other thing that's important is the average financial advisor is somewhere around in their mid to late 50s in the industry. They've been doing it for many years. They have their same old mindset on how they're going to do things. They're not going to change. There are not a lot of young people coming into our industry so it's important that you deal with a firm and an organization that does think differently. That does have generations of advisors that are thinking and creating in different ways. I stress fees are important but don't get focused on that the financial advisor is managing money for the fee. He or she is doing a lot of other things.
Dustin
You've given us some markers on what to look for, but I want to give people a little rapid fire. Let's say I'm enjoying the conversation. I don't want to pay for artwork. I don't want to pay any more fees than I should have to. Going with a boutique, is that the proper way to say it or going with a not national, not institutional independent broker?
Stuart
Independent broker deal that’s self-employed, he's an independent contractor. He or she runs his own business. They get to charge the fees they want to charge. They get to work with the clients they want to work with. They run the business in the way they want to run it.
Dustin
What are some other markers? As soon as I don't go with a big institutional name, it's not that we lose trust. It's that when you see a big name on TV or wherever there's a sense of trust. However, if you go to the mom and pop guy or someone in your local marketplace that's independent, what are the good markers so that I know that I'm not going to the stock and bond pusher? I want someone like you that's going to prescribe the whole thing. What are the markers that I need to look for? You said RIA, registered investment advisory firm, what else?
Stuart
What the definition of an independent firm is do they have their own products and do they do their own investment banking and issue their own stocks and bonds? If you have your own proprietary products, you issue your own stocks and bonds, you have your own mutual funds and you have your own annuities. My argument would be that you are much more likely, not because you're a bad person, not because you're unethical, but because of allegiance and loyalty to rationalize that those products are as good as any other product. I'm going to represent those rather than saying, “I'm going to find the absolute best product,” and that's a challenge. When you look at some of these big clearing firms, Schwab and Fidelity, for example, they have their own exchange-traded funds, their own mutual funds, their own annuity products.
For example, whenever I get a statement from a client that uses those companies, all their products. I brought a new client on from Newport Beach and he brought in his portfolio. I said, “What's the common theme here?” There are about 12,000 mutual funds out there. What's the likelihood that every one of these funds is best in its category?” That's the challenge. That's one. That's the value of being with a good independent broker-dealer and independent financial advisor. I would argue a lot of people say you need to be with a CFP, a credentialed financial advisor. I would argue because I'm not a CFP, but I have CFPs that work for me. It's more important than having a CFP designation that the advisor has a lot of experience working with clients. I tell my prospective clients that ask me if I'm a CFP, I say, “No, but I have 12,000 appointments under my belt. I’ve seen a lot more situations. I'm a lot more educated hands-on and I have CFPs that work for me if they need to do some technical analysis, but I can do that too.” CHFC is a good designation. Those are good. To make sure when I'm interviewing an advisor, I would ask them, “Tell me how you responded in 2008 and 2009? What did you do? What was your philosophy in 2008 and 2009?”
The challenge is they can make up any number. We kept statements from our clients because we wanted to be able to show our clients that this is how they did. They lost anywhere from 18% to 27% depending on if they got out and what their portfolio was. Those are some pretty good questions. I would also think that it's important that the advisor has a network of other professionals on their team that they work closely with like CPA, estate planning, mortgage brokers, all of those types of people. Real estate brokers and all of those who are ready to advise and work with clients at a fair fee and that is very good.
Dustin
Is that like birds of a feather flock together? If they have a strong team, a strong network, that's a sign of who they are as a person as well. Is that part of your thinking?
Stuart
There are a lot of people, a lot of financial advisors and I keep looping back to this because I'm proud of what we've been able to build it at Arakelian Wealth Management. There are few advisors that do comprehensive wealth management. The analogy I use is most financial advisors use a microscope to do your planning. We use a telescope. We believe that there's so much going on and the world is dynamic. If you get tunnel vision and all you're doing is stocks and bonds and managing a portfolio, you're missing many other opportunities and value-add for your clients.
I’ll give you an example. I have a client of mine who said, “Stuart, my daughter moved to Tucson, Arizona and she loves it there. I like it there too. I'm thinking about buying a house there and I'm thinking about buying a house there for her. It would be a second home for me and she'll pay me rent.” I said, “Give it six months. Make sure she likes it. Go slow. The market's not going anywhere, it’s probably even going to slow down in the next few months a bit,” one. Two is I said, “If I were me, you own your home outright. I would do cash-out refi out of your house and I would pay for the Tucson place with that, lower rate, tax deductible on a first home, etc. I’ve got a guy for you. I'm not an expert in this area, but I’ve got two people that I think highly of you who will give you a 25% discount because they're affiliated with Arakelian Wealth Management.” That's an example where we introduced the concept and then transitioned it over.
When you go and see the financial advisor you're interviewing, ask him if he asks you to bring in your tax returns. The tax returns are critical in determining how he can save in taxes on the investments they're holding. Where there's an opportunity to improve their tax situation, to look at their income, to look at their needs, to have a discussion about that. Having CPAs you work closely with to refer. In our business, living trusts and estate planning is critical.
Dustin
Let's talk about preservation and protection. That's a big part of the equation that people in our audience, especially if they're on the backside of their careers. This is something that's important to them. What are some things that people need to consider or be thinking about now when it comes to the preservation and the protection of the wealth strategy?
Stuart
It depends on their financial circumstance and their net worth that varies. I would think that every client is different and that's why you can't pigeonhole any client into any point of view. It's not my job as a financial advisor to tell somebody how they're supposed to feel emotionally. Some clients say, “I don't want to leave a dime to my kids.” We've heard this, “I want the check to the mortuary to bounce.” I have other clients who say, “Stuart, I want to make sure I set my kids up.” Either way, it works. “Stuart, I have total faith that over time the markets are going to perform. I don't want any guarantees in my portfolio. I don't care. I'm good.” I have other clients who think the world's going to come to an end. I was meeting with people in 2010, 2012 who thought the United States was going to go away and they were buying bunkers up in the mountains. I was like, “Crazy stuff,” but every situation is different. Every person is different.
There are multiple types of protection. That would be, “How would you feel that if your portfolio drops from $2 million down to $1.5 million? You had to take a big pay cut. Would that bother you? Would you rather get a 6% income guaranteed for the rest of your life? What's better for you? Even if your kids on the back end got a little bit less, but you knew that you were going to go to that mailbox every month and you are going to get a 6% payday.” Some clients would say, “I’ll take that all day long.” Some clients would say, “I don't care.” There's the protection of income. There's protection against long-term care. Third, there's protection against death if you have a situation and a need, especially if you have a high net worth for estate tax purposes.
Dustin
Let's talk about asset protection or clarify it.
Stuart
Before I dive in, I want to talk about the value of life insurance not only as a death benefit tool but also as an accumulation tool. There are two components to life insurance. I don't want to oversell life insurance. There's a saying as, “Don't sell life insurance. Sell what life insurance does.” Talk about all the features that it does and people will be drawn to it because people don't understand it. They don't want to talk about it. There's a lot of misinformation on the news and in periodicals about life insurance. In essence, life insurance is the only tool. It is the only investment vehicle other than a Roth IRA where you can put money in with after-tax dollars. Every dollar grows tax-free and every dollar comes out tax-free. Unlike a Roth IRA, you can touch the cash value prior to 60 years old without penalty. I can put money in. If God willing if you're in the position, you're not limited to $5,000 or $6,000 a contribution. You can put in $20,000 a year. I have clients putting in $500,000 a year into this. It is the only place that high net worth people can get tax-free growth and tax-free long-term income and then protect their families and businesses at the same time. I would pose this to any person and it's not for everybody. If I were to come to a client and I was to say, “I can get you 4% to 6% or 7% safe investment return overtime on a tax-free basis and protect my family and have accessibility to the money,” would you say that was a pretty attractive vehicle?
That's the concept, but you turn on the news or you turn on the TV and I was on a website and it said, “If anybody tells you to buy a permanent insurance policy, they're crooks. Run away from them. They're only trying to sell you something.” That's the challenge. The challenge is that I understand when I manage the amount of money that I manage. How difficult it is to get a 5% or 6% tax-free income. I do not discount the value that life insurance creates. I understand the value of term insurance, which is what the opponents of permanent insurance say. They're all about term insurance, but term insurance is actuarially mathematically calculated and not being enforced when you die. That's why it's cheap. 99% of all term insurance has no claim attached to it. Yet the people say, “The only reason they want to sell the permanent policy is that of commission.” The permanent insurance is going to be enforced for your entire life. That's why it's called permanent insurance.
I’ve never had anybody tell me in my many years in the business, I wish I would have bought less permanent insurance. I’ve had a lot of people say because they become uninsurable. The rates went way up. They couldn't afford to buy it and so on and so forth. It's a powerful tool. It’s not for everybody. If you're dealing with a financial advisor who doesn't know anything about life insurance and doesn't believe in life insurance. Who can't intelligently have a conversation about life insurance and doesn't have leverage with insurance companies in underwriting situations like we do in questionable underwriting situations. Then you need an advisor who can talk about these things. This is thinking differently, talking about all these areas. Not doing all of them necessarily, but having an open conversation and open lines of communication with your advisor.
Dustin
I want to jump in here and ask you the question about in life insurance. I want to talk a little bit about wealth transfer. It's passing it on to your kids. My understanding of life insurance and another benefit too is you can change the beneficiary on life insurance so that potentially you have the ability to leave that to your kids. I don't want to say tax-free, but I want to say at a tax advantage versus someone's 401(k) or IRA is going to get destroyed when they die because the government's going to take a piece of it. Is that true? Am I speaking correctly that there is an advantage with life insurance policies, a tax advantage?
Stuart
The answer is yes. It's a little complicated, but I assume you're talking about a wealthier person with an estate planning problem. Let's start there and then we can go to somebody that's successful and has done well. Life insurance death benefits are income tax-free 100% of the time. That's a win. Over your lifetime theoretically, you pay in $200,000 in premium. You get $1 million in death benefit, maybe $1.5 million. That $200,000 in premium you paid grew to $1.5 million over time. You had access to the cash on a tax-free basis for the kids' education, maybe to buy a piece of property, whatever it might be. Your family was protected the entire time. You've got a policy paid for free and clear. You’ve got $1.5 million death benefit. That's a mom and pop straightforward deal. You're talking about an estate planning issue and it's important to understand what estate taxes are.
In the tax plan that passed at the end of 2017, the congress opts what's called the unified credit. The unified credit says that any individual with an estate of $11 million or a couple that has $22 million, there are no estate taxes. Many years ago, that was $600,000 each, then it went to $1 million. It went up a little bit more and then under President Bush, he repealed the estate tax altogether. President Obama got into office and he raised it to $5 million each, a couple that had $10 million. I could make an argument that if you did some planning, you could probably have an estate in the $15 million range and you would pay no estate taxes. President Trump and the Congress, they raised it to about $11 million each so it's $22 million. Theoretically, if you have an estate of $22 million, you’d pay no estate taxes, so very few people. Don't be misled when you hear it called because there's a political party that is an anti-estate tax that calls it the death tax. They effectively have framed it. If you go to people, there's a statistic that says 75% of all people believe that they're going to be susceptible to an estate tax when they die when it's less than 1%. These are the people.
It's not a death tax, it's an estate tax. It is for rich people who have not paid tax on their assets. That's an important point too. Dad buys a piece of property for $100,000 many years ago. It's now worth $5 million. He paid property taxes all along. He paid income taxes all along on any income generated off of that property, and then he passes away and mom passes away. How much income tax do you pay on that $4.9 million? It’s $0 because you get a step up in basis on your income taxes. The kids inherit that $5 million and will never pay any tax. When that $5 million piece of property grows to $20 million and their kids inherit it, they'll never pay any income tax on it. The purpose of an estate tax is to pay taxes that will never be paid because wealthy people can pass money from generation to generation.
With that said, life insurance is the best way to pay estate taxes because it's income tax-free. If you put it into a trust, it's considered outside of the estate for estate tax purposes. You can put it in what's called an irrevocable life insurance trust, an ILIT. That trust is outside the estate, so you don't have to sell properties or assets at may be an inopportune time to be able to cover future estate taxes. With regards to an IRA, if you're a wealthy person and you've accumulated $3 million, $5 million IRA in your estate and you have estate taxes and the kids inherit that. They're going to pay 75% in taxes.
Here's the good news. It is includable for estate tax purposes, but you can roll that into what's called a beneficiary IRA. Not pay the income tax and take income on it for the rest of your life. That's the way around that, but you would pay estate tax on it. These are concepts that you want to know when the guy says, “Why do you pay 0.50%?” It’s because of these strategies that these people don't have much of a clue about, or you donate the IRA to a charity, you get a deduction for the donation so it's not taxable to you. The charity pays you a higher income for the rest of your life and you get a deduction for the donation. The income you're generating is higher than it ordinarily would have been, plus a portion of it is tax-deductible because it's a donation.
You get a higher income stream. You do a nice thing for charity. What we do then in some cases is with the increased earnings and the tax savings. We then buy a life insurance policy to replace the asset to the next generation. When I talk about the value that competent financial advisors deliver, we do a lot of things. This is a little different in the way I think versus other people. There's a debate about fee-only financial advisors versus what is called hybrid advisors. Fee-based advisors only charge a fee to manage your money. They charge 1%. They charge 1.75% depending on how much money you manage. They make no commissions. They cannot do anything that generates a commission or pays them in any way than an advisory fee under their RIA. That's fine. That's the way they've chosen to build their business. There are many successful advisors who have built their model that way. The challenge is that life insurance only pays a commission. Long-term care insurance only pays a commission. Most variable annuity-type products that have the guarantees only pay a commission. A lot of these alternative products that are special, they only pay a commission.
If I'm a comprehensive wealth manager and I'm having a full discussion with my clients, how can I do a competent job if I’ve got one hand tied behind my back and I can only do fee-based? There are respected people out there whom I listen to that say, “Only deal with a fee-based advisor.” I fundamentally disagree. The analogy that I use on this is would you ever go to a doctor that told you, “I only prescribe drugs that are from Eli Lilly?” The answer is no. You'd run out of that doctor's office. You want to go to a doctor that represents every solution, every medical option to deliver the most value. Whereas an RIA only does one thing, they manage your money for a fee and as long as the investment vehicles that they use do not pay a commission. 10% to 20% of my clients want guarantees. They do. There is nobody or few people that can talk intelligently about life insurance and estate planning as well as I can. Why am I going to refer that business out to somebody else and lose control of the client in the process?
Dustin
I'm excited that you're creating courses for us here at WealthFit. If folks want to keep tabs with you and seek you out, how can they best do that?
Stuart
You can go to our website www.AWMFS.com, Arakelian Wealth Management and Financial Services. Our phone number is 925-866-8600. You can always shoot me an email at Stuart@AWMFS.com. Dustin, thank you for the opportunity. I’ve enjoyed it.
Dustin
Thanks for being on the show. Thanks again.
Stuart
Thank you.

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