What one doesn't know can cost them when saving for retirement. Often the reason costs rise are because advisors or brokers take advantage of this knowledge gap.
Eric Nelson, CEO and managing principal at Servo Wealth Management in Oklahoma City, Oklahoma, recalls talking to a client who had recently bought a $100,000 universal whole life insurance policy from an insurance provider who promised 4 percent returns.
When Nelson asked why the client bought the insurance, she couldn't say other than the insurance broker suggested it.
She got trapped in situation many of us will face in our lives: a sales pitch. Bad sales pitches prompt investors to make decisions that aren't necessarily in the best interest of their goals, costing middle-class Americans $17 billion a year, according to the Council of Economic Advisors.
It's so prevalent that Vanguard founder Jack Bogle recently said receiving bad advice while rolling over 401(k)s is one of the three biggest threats to U.S. savers.
The problem with bad advice is that the recipient can't tell good suggestions from the bad. Here are some red flags that should set off your skeptical antennae while discussing finances with an advisor.
How the finance expert gets paid matters. Nelson's client didn't need a $100,000 life insurance policy -- she already had $5 million in savings. And to make matters worse, the 4 percent promised return was closer to 0.5 percent to 1 percent, after fees were accounted for. "The insurance agent gets a commission," Nelson says. "She thought she could trust them."
Instead, the client fell for what many fall for: They think they're talking to someone that has their best interest at heart, but instead work by commissions and get paid by the company they're pitching products for.
Find an advisor that doesn't have any affiliation to a company or product that he or she tries to suggest. It ensures they're not keeping certain options hidden -- like cheaper mutual funds elsewhere -- while they develop the plan. Also, make sure to ask how they get paid. If it's by a percentage of the products they sell to clients, then find one that only takes a management fee.
Do they know why the saver saves? The process of retirement planning involves not just the execution of an investment portfolio, but also an exercise in imagining what one's life will look like in the future. It includes outlining how one dreams of living in retirement and what one will do for enjoyment. Without understanding that, "there's no basis for the recommendation," says Howard Pressman, a financial planner at Egan, Berger and Weiner in Vienna, Virginia.
Instead, Pressman must understand his clients' plans for retirement, like where they want to live, how big of a house they want to own, how much traveling they plan to do or how long they hope to work. He gathers this through multiple conversations before ever putting together a finalized plan.
Someone giving bad advice would do the opposite. Instead, it's not about what the retiree's needs, but how quickly the client can get locked into a payment plan. Avoid this type of unqualified advice.
Complex strategies or tools should raise a flag. Those that give out bad advice want clients to think that a retirement plan should be extremely complicated, using a whole bunch of terms that fly over the head -- and potentially intimidate -- the customer. In reality, most plans aren't overly complicated, requiring unusual products or exotic designs.
"The advisors need to be able to clearly explain the fees," Pressman says. "Not just with the advice, but with each piece of the strategy involved. If they can't explain, then it's definitely a red flag."
For instance, if Pressman provided advice to a client, they would receive a statement from the company where they hold and invest the money. This statement would provide the fees for each mutual fund invested in. It's straightforward, with little need to dig for the finer print.
He would also walk through every mutual fund on the statement, explaining why each one works for the client's needs.
In the case of someone giving bad advice, then load fees or a back-end cost would likely be included, which isn't clearly stated or maybe glossed over by the broker. If there are hidden fees, then it's time to run.
They promise to beat the market. Nelson had another new client in her early 40s that had invested nearly all her savings into a real estate investment trust. But this was a private REIT, with restrictions on when she can sell her shares.
"These non-traded REITs, you can't get your money out," Nelson says. "And if you can, only on a quarterly basis often times. That was swept under the rug by salespeople."
Promises of a big payday can lead investors to make bad decisions. But the promise for high returns isn't something that most respected advisors will give.
Pressman says that one of the first conversations he has with clients is about how he won't beat the market. "It's not realistic to happen over time," he says. "I'm trying to make sure they achieve life goals, with the least risk as possible."
Those that promise outsized returns often underplay the amount of risk involved. And the customer may or may not be aware of that risk when they sign over their retirement plan.
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