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Can You Give Investment Advice (Without Being a Registered Investment Adviser)?

One question that I am often asked is under what circumstances a person can give investment advice, without needing to be a registered investment adviser (RIA). I want to be clear that what follows is only a high level summary of that topic. If this is more than just a curiosity for you, I would encourage you to consult with an attorney with relevant expertise.

Where to Find the Rules

The actual relevant legislation consists primarily of:

And then there are of course various other relevant sources such as regulations, court cases, etc.

What’s an Investment Adviser (“ABCs Test”)

The Investment Advisers Act of 1940 defines an investment adviser as: “any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities.”

The Uniform Securities Act includes a definition that is nearly identical to the above.

People often use the mnemonic device “ABCs” to remember this test. That is, an investment adviser is somebody who is 1) in the business of 2) giving advice 3) about securities 4) for compensation. (Advice, Business, Compensation, Securities.)

And the idea is that you have to meet all of those requirements before you’d need to register as an investment adviser.

So, for example, if you’re a nurse and your daughter comes to you asking how she should invest in the 401(k) at her new job, you are perfectly allowed to give her advice. And there’s no need for a “this is not investment advice” disclaimer. It is advice about securities, but you’re not receiving any compensation, nor does your daughter have any reason to think that you’re “in the business” of providing investment advice for compensation. You don’t meet the ABCs test and thus don’t have to register as an investment adviser.

One important point here is that the SEC and state regulators tend to interpret the above tests as broadly as possible (i.e., to include as many people under the definition as possible). So, for example, any economic benefit received in exchange for the advice would be probably considered “compensation.”


The 1940 Act and Uniform Securities Act also provide exclusions. That is, there are certain people who do meet the above requirements (i.e., they satisfy the ABCs test) but who are nonetheless explicitly excluded from the definition of investment adviser — and thus don’t have to register as investment advisers.

Some of those exclusions include:

  • Any lawyer, accountant, engineer, or teacher whose performance of such services is solely incidental to the practice of his/her profession.
  • Any broker or dealer whose performance of such services is solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation for the investment advice.
  • The publisher of any bona fide newspaper, news magazine or business or financial publication of general and regular circulation.
  • A bank or savings institution.
  • Any person whose advice, analyses, or reports relate to no securities other than securities which are direct obligations of or obligations guaranteed as to principal or interest by the United States.

This is why, for example, somebody can write a blog that discusses all sorts of investment topics, without having to register as an investment adviser. It’s also why somebody can teach a personal finance class — and provide investment advice in that class — without having to register as an investment adviser.

I will note that, as somebody who is a practicing CPA, the exception for accountants is somewhat challenging to apply in real life.

Firstly, what specifically is meant by “the practice of my profession”? That is, what services are considered included in my profession as an accountant, so that we can then try to figure out what would be “incidental” to that profession? At least here in Missouri, public accounting is defined as “services involving the use of accounting or auditing skills, or one or more management advisory or consulting services, or the preparation of tax returns or the furnishing of advice on tax matters.” So basically, accounting includes tax preparation, tax advice, management advisory or consulting services, and “services involving the use of accounting skills” — a pretty circular definition.

And what would be “solely incidental” to that practice? That wording is clearly intended to be vague (i.e., determined on a case-by-case basis, depending on the facts and circumstances). So it’s no surprise that different accountants will draw the line in different places, as far as what degree of investment-related advice they feel comfortable giving.

So, in short, if you meet the “ABCs test” (i.e., you’re in the business of giving advice about securities, in exchange for compensation) when that test is interpreted as broadly as possible (i.e., to include as many people as possible), and you do not fall under one of the explicit exclusions, you probably need to register as an investment adviser. But again, if you’re even remotely unsure about whether something you’re doing (or considering doing) would require you to register as an investment adviser, I’d encourage you to consult with an attorney.

Should I Sell Bonds to Prepay My Mortgage?

A reader writes in, asking:

“We bought a home recently, when rates were high though not as high as they are now. Without having any idea of whether home prices and interest rates will decline or continue to rise, how does one determine whether it’s a worthwhile tradeoff to sell some or all of our bond funds to payoff, or pay down, our mortgage?”

Changes in the Home’s Value Don’t Matter (For This Decision)

Firstly, the decision of whether to prepay the mortgage has nothing to do with the price of the home.

Example: Bob borrowed $400,000 to purchase a $500,000 home (i.e., making a 20% down payment of $100,000). If the home goes up in value by $50,000, Bob’s balance sheet will now include a $550,000 home. And that’s true regardless of whether he prepaid his mortgage or not. Similarly, if the home declines in value by $50,000, it’s now a $450,000 home, regardless of whether he prepaid the mortgage.

If you bought a home, you now own that home. You will experience 100% of the home value fluctuations, even if you only have, for example, 20% equity in the home. Point being, the amount by which the home goes up or down in value is unaffected by the decisions you make about the mortgage. And in turn, the decisions you make about prepaying the mortgage should be unaffected by your expectations for how the home’s value will change over time.

Yield on Bonds vs. Mortgage Interest Rate

The comparison to make is the interest rate of the bonds you would be selling as compared to the interest rate of the mortgage. Specifically:

  • For bond funds, we want to look at the SEC yield.
  • For individual bonds, we’d look at the yield-to-maturity.
  • If the bonds are in a taxable account (as opposed to a retirement account such as a 401(k) or IRA), we need to calculate their after-tax yield.
  • Similarly, for the mortgage, we’re concerned with the after-tax interest rate (i.e., after accounting for any tax savings you get as a result of the itemized deduction for home mortgage interest).

As of this writing, Vanguard Total Bond Market ETF (BND) has an SEC yield of 4.82%. If you owned that ETF in a taxable account, we’d have to multiply by [1 minus your marginal tax rate] in order to find the after tax yield (e.g., 4.82% x 0.75 if you have a 25% marginal tax rate).

If your mortgage is from several years ago and has a 3% interest rate (which is likely less than 3% after accounting for the itemized deduction for mortgage interest), selling bonds that yield 4.82% in order to pay down a 3% mortgage doesn’t seem all that appealing, from a purely financial point of view. (Some people may still choose to do it, because eliminating the mortgage gives them psychological benefits.)

On the other hand, if your mortgage is newer, with a 6% or 7% interest rate, selling those 4.82% bonds does look pretty attractive.

A complicating factor is that interest rates change over time. If for some reason you are convinced that interest rates are about to fall or rise, that would have an impact on whether or not you should sell your bonds at this time. (Bond prices move in the opposite direction of interest rates. So if you are convinced that your bond values are about to rise or fall in the near future, that would be either a point in favor or against selling right now.)

Personally, I have not seen any evidence that interest rate movements are easier to predict than short-term stock market movements. So rather than making guesses, I prefer to make decisions based on today’s rates.

Other Tax Considerations

Another important factor is: what type of account is it that you would ultimately be drawing these assets from, in order to prepay the mortgage?

If you would be using assets from a taxable brokerage account, we want to account for the capital gains tax (if any) that you would have to pay as a result of selling the holdings in question.

If you would be using dollars from a traditional IRA, what tax rate (including 10% penalty, if applicable) would you be paying on the distribution? And how does that compare to the tax rate you expect to face in the future (i.e., whenever these dollars would come out of the account later, if you don’t take them out now)? The higher the current tax rate that you would pay is, relative to the future tax rate that you anticipate, the less desirable it is to tap this account for any reason, including prepaying a mortgage.

If you would be using Roth IRA dollars, would you be paying tax (or penalty) on any of the distribution?

Risk Considerations

One point that trips many people up is the idea that by selling bonds to prepay the mortgage, they’ll be increasing their financial risk (because the portfolio will now have a higher percentage allocated to stock). In most cases, that’s not true. In most cases, it will not be a significant change in risk.

When you buy the home, you increase your risk. In our example above (Bob uses $100,000 of cash and a $400,000 mortgage to buy a $500,000 home), he now has $500,000 additional dollars of exposure to real estate (risky). He has a new $400,000 liability (risky). And he has $100,000 less cash (also an increase in risk). He has increased his economic risk in three different ways.

But once he has bought the home, those things have already happened. He has already taken on all of that additional risk.

Selling bonds to prepay a mortgage doesn’t affect how much exposure you have to real estate volatility (see the beginning of this article). Nor does it affect how many dollars you have exposed to stock market volatility. What it does do is:

  • Reduce your liabilities (thereby reducing your risk), and
  • Reduce your safe assets (thereby increasing your risk).

Net change in risk: roughly zero.

People often latch on to the percentage change in the asset allocation. But that’s a distraction. In our example above, imagine that after buying the home, Bob’s portfolio is $1,000,000, of which 60% is stocks and 40% is bonds (i.e., $600,000 in stocks, $400,000 in bonds).

If Bob were to use all $400,000 of his bonds to pay off the mortgage, he’d go from a 60%-stock portfolio to a 100%-stock portfolio. If we just look at the percentage, that’s a huge increase in risk. But in reality, he still has exactly $600,000 exposed to stock market risk. He didn’t increase his allocation to stocks at all. We just have a smaller denominator in our fraction ($600,000 total portfolio rather than $1,000,000).

Selling bonds to pay down a mortgage does not typically change the household risk level by very much. It is, mostly, just a decision of interest rates (after accounting for the various tax considerations).

My Experience with Check Fraud – And What You Can Learn From It

As many of you know, I’m currently serving as the Secretary for The John C. Bogle Center for Financial Literacy. A few months ago, there was a form I needed to file with the Texas Secretary of State on behalf of the Center.

The form in question requires a $5 filing fee. For just $5, I decided it was simpler to pay the fee myself, rather than bothering Ben Holland (Treasurer for the Center) to have the Center pay the fee. So I wrote a personal check, included it in the envelope with the form, and dropped the envelope in the blue USPS mailbox down the block.

Below is the check I wrote. (Please forgive the messy handwriting. I was not expecting to show this check to thousands of people. The address is an old address, but I rarely write personal checks anymore, so I had never bothered to have new checks made.)

And below is what the check looked like, when it was cashed/deposited. (If the images are not coming through in your email/browser, here’s the original check and here’s what it looked like after alteration.)

Apparently somebody intercepted the check, chemically “washed” it to remove the ink on specific portions of the check, and wrote in a new payee, amount, and (partial) memo.

In the months since this occurred, I’ve seen a handful of articles about the topic and heard from many people who have had a similar experience, as it’s apparently nothing short of a fraud epidemic at the moment.

Per the police detective who was in charge of the case, they’re getting ~30 of these reports per day. And that’s just in our patrol district (i.e., a few neighborhoods in St. Louis).

We did eventually get our money back. But, in total, resolving the situation took more than 3 months and required 14 phone calls (including I have no idea how much time spent on hold), 2 visits to local Bank of America branches, and 2 visits to the police station.

If I had not scanned the original check before mailing it, the process likely would have taken longer.

And we had to close our checking account, open a new one, and switch over everything that automatically charged to the old account.

In short, even if you get your money back, I assure you that it’s an experience you’d like to avoid, if possible.

As far as how to avoid being on the receiving end of check fraud, the most important and easiest thing you can do is just to avoid mailing checks. Pay electronically whenever you can. (I know that’s my own preference regardless of this mess.)

If you do have to mail a check, if possible have it sent via your bank (i.e., using a “bill pay” feature) rather than writing it by hand.

If that’s not possible, write the check in sharpie, as apparently that ink is the hardest to remove.

And if you do have to mail a check, do not put it in your mailbox or a blue mailbox on the corner, as those locations have a higher likelihood of being physically intercepted. Instead, drop it off directly at the post office. (Though I have heard from people who have been victims of check washing fraud despite mailing the check at the post office, which suggests there’s some degree of an “inside job” going on here. So again, best to not mail checks at all, if possible.)

The Problem with Socially Responsible Mutual Funds

I’m often asked what I think about socially responsible mutual funds (or socially responsible investing in general).

To explain, let me introduce you to Jim.

  • Jim is an accountant. He has never had a super high income, but he has been consistently employed since finishing college 30-something years ago.
  • Jim has saved diligently throughout his career, and his index-fund portfolio is now sufficiently large that he expects to be able to retire within the next few years, despite having no pension.
  • In other words, Jim has accumulated a significant sum of money.
  • Every so often, Jim experiences some misgivings about having that much money. He recently read that his seven-figure net worth means he has more wealth than 99% of other people in the world.
  • Jim also has some misgivings about several of the companies that are owned by his index funds.
  • Jim’s annual budget does include a non-trivial amount of charitable giving each year, but the reality is that in order to meet his goals, he has to keep most of his money.
  • Jim wants to feel better about having a lot of money. That is, he wants to continue to have a lot of money. But he doesn’t want to feel bad about it.

Jim has a need.

There are a lot of Jims.

What does the financial services industry do when it sees a lot of people with a given need/desire? It creates a product.

Socially responsible mutual funds are that product. Socially responsible mutual funds exist to let you feel better about having money (i.e., not giving it away). The fund industry usually doesn’t want you to give your money away. If you do, they don’t get to collect a percentage (in most cases).

This isn’t to say that socially responsible funds are a bad thing. From a “doing good in the world” standpoint, a socially responsible fund might have a beneficial effect in that it might exercise its voting rights more frequently — or more frequently in line with your views — than typical index funds.

Conversely, if the fund’s way of being socially responsible is simply to exclude certain stocks/industries from the fund, it is giving up its power to vote to change the behaviors of those companies/industries. That is, as a shareholder, a fund has influence. If it chooses not to own those companies, it gives up any potential influence it might have. You may see where I’m going with this. As a socially responsible investor, I would like a fund that owns all firms (i.e., an index fund) and which votes to make the changes I want to see. I do not want a fund that goes out of its way to give up its influence over the companies I would most like to influence.

Unfortunately, whether or not socially responsible funds actually have a positive societal effect is not generally super important from the perspective of the fund company (or, in most cases, from the perspective of an advisor recommending the fund). As long as you feel better about owning this fund as opposed to another one, mission-accomplished.

It is normal to have some misgivings about having far more wealth than almost everybody else in the world.

And it is clear that the most effective way to alleviate those misgivings is to give away more money — either directly to people who need it more than we do, or to charitable organizations that fight against the thing(s) we find unethical.

But, unfortunately, there’s a limit to how much we can give while still reaching our goals. With our current retirement system (in which few people have pensions and Social Security doesn’t cover everything), if you want to retire someday with a middle class level of spending or higher, you must accumulate a pile of money — and keep it for yourself.

It is also normal to have misgivings about owning shares of companies that do things you find unethical.

Yet owning those shares and using your vote as a shareholder is precisely how you can attempt to influence those companies. Unfortunately, as mutual fund investors, it is the fund managers that must vote on our behalf, and we have limited information as to how fund managers vote their shares. And the “socially responsible” funds (i.e., the funds with a stated mission of working for positive change) go out of their way to give up their right to vote on such issues, because doing so allows people to feel better about owning the funds (i.e., it makes them more marketable).

How to Change Somebody’s Mind About Investing

A reader writes in, asking:

“How do you convince somebody that they are making a bad investment decision? A member of my family often brags about his latest money move. Apparently he is always getting in or out of a stock at just the right time or making an options bet that paid off. I’m sure we are not hearing about all the bets that DONT pay off. But none of this seems like actual prudent investing…not even remotely.”

I usually don’t even try. If somebody is telling me about their investments, I just listen, unless they explicitly request my opinion. And even then, my standard reply is just, “I don’t follow or invest in [individual stocks/Bitcoin/gold/options/whatever] at all. I’m just a boring index fund investor.” That is, I am open about what I do with my own money, but I don’t try to convince them that they’re making a mistake.

That’s not to say that I haven’t tried. I used to. Given my line of work, it’s pretty common for friends/family/acquaintances to ask my opinion about a particular investment decision they’ve made. But what I found over the years is that in most cases, the other party’s only goal for the conversation is to be congratulated on having made a smart decision. They don’t actually want or care about my opinion, unless that opinion is, “great job!”

There have been occasions on which the other party was in fact seeking to have a conversation about the pros and cons of a particular investment strategy — and in such cases I’m happy to have that conversation of course — but that’s not the most common outcome.

And really, that’s just human nature. When was the last time that you had a conversation with somebody, in which they convinced you that a decision you were making was unwise and you decided to make a different decision going forward? It happens, sure. But not very often.

Personally, I find that when I change my mind about a topic, it’s usually because of something I have read rather than something somebody said. There’s something about sitting down to read a book (or a piece of research) that puts me in a mindset where I’m ready/willing to question and change my current views on the matter. I am certainly not in that same mindset when somebody starts providing unsolicited opinions about my life decisions.

So, if you’re looking to change somebody’s mind about investing, my best suggestion is to:

  1. Lend them your copy of a book (e.g., A Random Walk Down Wall Street or The Four Pillars of Investing — or Bogle’s Little Book of Common Sense Investing if you suspect that the person would not read a longer book), and
  2. Pitch the book in a subtle manner (e.g., “I was thinking about this book recently. It’s one of my favorites. And it occurred to me that you might really enjoy it as well, given your interest in investing.”) so that the other party does not feel defensive.

But even then, you have to be prepared for a scenario in which the attempt is entirely unsuccessful. It’s hard to change somebody’s mind.

Re-evaluating Betterment After Their Price and Service Change

Most readers of this blog are passive investors of some form or another, whether via Target Retirement/LifeStrategy funds, robo-advisors, or just simple index-fund/ETF portfolios.

A few readers have asked for my thoughts on the changes that robo-advisor Betterment recently made to their fees and offerings.

Previously, Betterment’s cost was 0.35% pear year for accounts up to $10,000, 0.25% for accounts from $10,000-$100,000, and 0.15% per year for portfolios of at least $100,000. And for that price, the customer received automated portfolio management, including tax-loss harvesting for taxable accounts.

Now, they will be offering three different levels of service, two of which include ongoing human advice along with the portfolio management:

  • For 0.25% per year you get the same portfolio management service as before.
  • For 0.40% per year you get portfolio management, plus an annual call with their CFP team.
  • For 0.50% per year you get portfolio management, plus unlimited calls with their CFP team.

In other words, it’s a price increase for people who have at least $100,000 with Betterment, and a price decrease for people who have less than $10,000 invested with them. And now there are two additional options to choose from (for people who meet the applicable minimum account sizes).

The price change makes Betterment’s portfolio management price nearly identical to that of their closest competitor, Wealthfront, which also charges a flat 0.25% per year for portfolio management (with the exception of the fact that Wealthfront will manage the first $10,000 of assets for free).

Compared to Target Date Funds

I’ve always found it instructive to compare robo-advisors to an alternative hands-off portfolio solution: all-in-one funds, such as target-date funds, balanced funds, or LifeStrategy funds.

In my view, relative to all-in-one funds, the primary advantage of Betterment’s portfolio management service has been the fact that it is more tax-efficient when there’s a taxable account in the mix, because it includes tax-loss harvesting, offers asset location planning, and uses muni bonds rather than taxable bonds when appropriate.

As a result, the situation in which Betterment always seemed most appealing to me was for investors who:

  • Have at least $100,000 to invest (such that they’d qualify for the lowest cost),
  • Want a hands-off portfolio management solution, and
  • Have a large part of their assets in taxable accounts (such that the improved tax-efficiency would provide significant value).

I think the same holds true today, except for the fact that there’s no longer a need to hit the $100,000 threshold for lower pricing. (Of course, for people who do have more than $100,000 to invest, the price just went up by 0.1%, thereby meaning that the value of the tax-efficiency must overcome an additional 0.1% annual hurdle in order to provide a net benefit to the customer.)

Compared to other Human/Robo-Advisors

Vanguard’s Personal Advisor Services costs 0.30% per year. For that cost you get portfolio management, plus phone/email/Skype contact with a Vanguard advisor whenever you want. The service does not, however, include tax-loss harvesting.

Similarly, Schwab recently announced that they’ll be launching a human/robo service later this year. The cost for that service is supposed to be 0.28% per year (with an annual maximum of $3,600). And what you get for that cost looks very similar to Vanguard’s service — portfolio management, plus as-needed contact with a Schwab advisor. One noteworthy difference: for accounts of at least $50,000, they will also provide automated tax-loss harvesting.

Schwab’s upcoming service and Vanguard’s Personal Advisor Services seem most comparable to Betterment’s 0.5% service level, because they each include unlimited access to human advisors.

The Betterment platform would be preferable to the Vanguard platform if you think that tax-loss harvesting will be worth at least 0.2% per year (in order to justify the additional cost). But I’m not really sure how it would be better in any way than Schwab’s new service once that is released, as the Schwab service appears to offer all of the same things, at a lower cost (0.28% annually rather than 0.5%).

(Of course, it’s possible that the Schwab service will have some “catch” that we have yet to learn about. Presumably we’ll get more information when the service is actually released and people try it out and report back on their experiences.)

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