Optimize Your Maximization!

Posted at Advisors4Advisors.com on April 5, 2013

I learned long ago that financial plans that contain “maximization” in their names — for example, Wealth Maximization Strategy — are likely to be scams. “Optimization” gets the same reaction from me.

When financial professionals use these words, beware. More often than not, the intent is to promote the vague idea that the listener is going to receive some “best possible” service that is certainly worth paying for. This illusion can stand as long as the listener doesn’t ask probing questions to clarify what, exactly, the speaker means.

A financial planner recently gave me a list of his client’s goals, including “they are interested in maximizing the amounts they leave [to their children].”

What am I to make of this? What does it mean?

The client could maximize his estate value by using all of his money to buy a one-year term insurance policy and then conveniently dying during the year. Or he could buy a smaller five-year term insurance policy, giving him a five-year window to die. Or he could buy a no-lapse universal life policy, which functions as term insurance for life.

What about the uncertainty of future premiums and policy values? If he buys a non-guaranteed cash value policy, such as traditional whole life, will that maximize his wealth transfer compared with a no-lapse universal life policy? Is wealth transfer maximized by having cash values that can make a future policy replacement possible? Is it optimal to buy a no-lapse universal life policy today if interest rates increase in the future, leading to lower life insurance prices?

What about the planned premiums? Most cash value policies offer some degree of premium flexibility. What is the optimal premium schedule that minimizes the cost of the policy until death?

When academics talk about maximization, they usually have something specific in mind. They are thinking of an objective function, constraints and a mathematical method to solve the optimization problem.

For well-intentioned practitioners, the first step to get beyond fuzzy thinking is to specify the measure that you will use to compare one plan with another. How will you decide which plan is better?

When you know that, you can speak meaningfully — and probably with low expectations — about maximization.