3 Things Every 401(k) Participant and Plan Sponsor Should Know

As a wealth preservation attorney, one of the primary issues I address is the quality of a client’s investment portfolio. Far too often I see excellent estate planning strategies sabotaged by horribly unsuitable investment portfolios. Since many estate planning strategies are dependent on revenue from an investor’s 401(k) or other investment portfolio, it is critical that an investor’s portfolios are properly invested and managed.

Based upon my 30+ years of experience in the areas of fiduciary law and quality of investment advice, there are three key issues that I tell clients, both individuals and 410(k) plans, to key on.

  1. Most 401(k) plans mistakenly believe that they are compliant with ERISA’s rules and regulations. In a survey of 401(k) plan, 94 percent of the plans indicated that they felt they were compliant with ERISA. Compare that to the opinion of Fred Reish, one of the nation’s most respected ERISA attorneys, who has stated

[O]ur experience is that very few plans actually comply with 404(c). It is probable that most (perhaps as high as 90%) 401(k) plans do not comply with 404(c) and, as a result, the fiduciaries of those plans are personally responsible for the prudence of the investment decisions made by participants.(1)

While there are a variety of reasons why a 401(k) plan may be non-compliant, in my practice I focus on quality of investment advice/options issues since that is the area where I have extensive experience, having served a director of compliance for some broker-dealers and director of financial planning quality assurance for AXA Advisors. Which leads to my second point:

2. Most 401(k) plans use inadequate methods in selecting and monitor the investment options in their plans. To be perfectly honest, based on my experience as an ERISA/securities attorney and consultant, many 401(k) plans blindly follow the advice of their service providers, even though numerous court decisions have warned that doing so is not only improper, but constitutes a breach of their fiduciary duties to the plan and its participants.

A fiduciary’s independent investigation of the merits of a particular investment is at the heart of the prudent person standard.(2)

The failure to make any independent investigation and evaluation of a potential plan investment is a breach of fiduciary obligations….(3)

Most plans analyze potential investment options by only looking at an investment’s investment performance and its standard deviation. However, as everyone knows, past performance is no guarantee of future returns. Secondly, an investment’s fees and other expenses must be considered since each additional 1 percent in fees and expenses reduces an investor’s end return by approximately 17 percent over a twenty year period. Given the fees and costs associated with some investments, an investor could easily see his end return by one-third or one-half.

Noted investment expert Charles Ellis has noted the impact of fees on an investor’s end return. With the availability of low-cost index mutual funds, Ellis has suggested a simple, more effective way to evaluate expensive, yet often underperforming,  actively managed mutual funds.

[T]he incremental fees for an actively managed mutual fund relative to its incremental returns should always be compared to the fee for a comparable index relative to its returns. When you do this, you’ll quickly see that the incremental fees for active management are really, really high – on average, over 100 percent incremental returns!(4)

That’s right: All the value added – plus more – goes to the manager, and there’s nothing left over for the investors who put up all the money and took all the risks.(5)

Anyone who takes the time to use my simple proprietary metric, the Active Management Value Ratio 2.0™ (AMVR), can verify the accuracy of Ellis’ statements. Details on the AMVR can be found on this blog.

One of the key issues in evaluating potential investment options for a 401(k) involves proper consideration of the impact of a an investment’s fees and expenses. In addition to the absolute impact of the fees, each 1 percent reducing end return by 17 percent, there is the evaluation of the incremental fees of actively managed mutual funds, which leaves us with the third key issue, the value of a fund’s fees and expenses as predictors of a mutual fund’s future performance.

In the AMVR, we use a fund’s stated annual expense ratio and its stated turnover ratio in comparing an actively managed mutual fund a comparable index fund. We chose those two variables based on the findings of noted investment expert Burton Malkiel, namely that

The two variable that do the best job in predicting future performance [of mutual funds] are expense ratios and turnover.(6)

Burton’s findings on the impact of a fund’s fees have been corroborated by similar studies.(7). The impact of fees on performance was also reinforced by a study by noted financial experts Eugene Fame and Kenneth French, who found that only the top 3 percent of active managers were able to produce returns that even covered their funds expenses.(8)


So, what does this mean for 401(k) participants and plan sponsors, as well as investors in general. If your financial security is really important to you and your family, take the time to review the investment options within your 401(k) or other retirement plan.

People often tell me that they do not want to “cause any trouble,” so they just accept whatever they are given, in terms of investment options and/or investment advice. That rational is simply unacceptable, especially since the AMVR provides a means for 401(k) participants and plan sponsors, as well as any investor, to quickly and privately analyze mutual funds and avoid those actively managed funds that actually end up costing investors due to patterns of underperformance and/or situations where a fund’s incremental costs exceeds any incremental return the fund is able to produce. 401(k) participants and investors in general do not have to accept, and should not accept, such situations. The same applies to plan sponsors as well, especially since they can face personal liability for failing to detect and reject such imprudent situations.

This article is not designed or intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances.  If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought.


(1) Fred Reish, “Participant Investing: Forewarned is Forearmed,” ERISA Report for Plan Sponsors,” September 2004, No. 7, No.2., available online at http://www.drinkerbiddle.com/resources/publications/2004/participant-investing-forewarned-is-forearmed?Section=FutureEvents ; Fred Reish, “Just out of Reish: A Good Defense,” PLANSPONSOR, September 2205, available online at http://www.plansponsor.com/MagazineArticle.aspx?Id=4294991584 
(2) Fink v. National Sav. and Trust Co., 772 F.2d 951, 957 (D.C.Cir 1985)  See Donovan v. Cunningham, 716 F.2d at 1467; Donovan v. Bierwirth, 538 F.Supp. 463, 470 (E.D.N.Y.1981), modified on other grounds, 680 F.2d 263 (2d Cir.), cert. denied, 459 U.S. 1069, 103 S.Ct. 488, 74 L.Ed.2d 631 (1982).
(3) U.S. v. Mason Tenders Dist. Council, 909 F. Supp. 882, 887 (citing, Fink v. National Savs. & Trust Co., 772 F.2d at 957)
(4) Charles Ellis, “My Investment Letter: Words of Advice for My Grandchildren,” AAII Journal, October 2013.
(5) Charles Ellis, “Winning the Loser’s Game,” 6th ed., (New York, NY/McGraw-Hill 2018), 164.
(6) Burton Malkiel, “A Random Walk Down Wall Street,” 11th ed., (New York, NY/W.W. Norton and Co. 2015), 401.
(7) Carhart, “On Persistence in Mutual Fund Performance,” Journal of Finance, Vol LII, No. 1, (March 1997), 57-81.
(8) Eugene Fama and Kenneth French, “Luck versus Skill in the Cross Section of Mutual Fund Returns,” available online at https://www.dimensional.com/famafrenchessays/luck-versus-skill-in-mutual-fund-performance.aspx

Posted in ERISA, Fiduciary, Investment Advice, Investment Advisors, Investment Portfolios, Investor Protection, pension plans, Portfolio Construction, portfolio planning, Portfolio Planning, Retirement Planning, Wealth Accumulation, Wealth Management, Wealth Preservation | Tagged , , , , , , , , , , , , , , , , , , ,

Stable Value Funds and Disclosure Issue Regarding Fees

While I like to post original content for my blog, sometimes I run across articles that just say it as well, sometimes better, than I could. This article from Morningstar presents evidence on Stable value funds that every investor should consider before investing in a stable value fund. Many 401(k) plan contain such an investment option and, based on the plan’s Form 5500, it appears many choose to invest in the option. As the article points out, in some cases the issuer of the stable value fund actually makes more money off of an investor than the investor receives as a result of the “spread” involved with the management of the stable value fund’s assets. Investors need to always remember that any and all costs associated with an investment reduce the end return that the investor receives.

Posted in Asset Protection, ERISA, Fiduciary, Investment Advice, Investment Portfolios, Investor Protection, pension plans, Portfolio Construction, portfolio planning, Retirement, Retirement Plan Participants, Wealth Accumulation, Wealth Management, Wealth Preservation | Tagged , , , , , , , , , , , ,

7 Hidden Fees to Watch Out for in Retirement

While I usually only provide original content on this blog, I thought this article from the Motley Fool’s web site was very well done and worth sharing.

Posted in Uncategorized

Toxic or Terrific: Evidence Based Investing with the Active Management Value Ratio 2.0

As an attorney, I put a great deal of emphasis on the value of evidence. Two of the most persuasive pieces of evidence regarding investing have to do with the consistent underperformance of actively managed mutual funds. For instance:

  • The most recent SPIVA (Standard & Poor’s Indices Versus Active) report, for the year ending December 31, 2014, reported that 87.23 percent of domestic equity funds as a whole underperformed their respective index.  The long term performance of all domestic equity funds was equally dismal, with said funds underperforming over both a five and ten year period, 80.82 percent and 76.54 percent respectively.
  • A study by Schwab Institutional concluded that 75 percent of new customer accounts being transferred to Schwab were unsuitable as being inconsistent with either an investor’s financial goals or financial needs.

And yet, despite this overwhelming evidence, according to the Investment Company Institute 2014 Fact Book, only 20 percent of the estimated $16 billion invested in domestic equity mutual funds as of the end of 2014 was invested in indexed equity mutual funds. One positive sign is that the Fact Book reports that sine 2007, there has been an outflow of approximately $659 billion, hopefully due to an increased education and awareness among investors. Hopefully this trend will continue, as the evidence clearly shows that the investment numbers should be completely opposite to what they are now.

The Active Management Value Ratio 2.0™

Investing can be very intimidating to investors, as many are hesitant to question investment “professionals.” Studies have shown that this is especially true of women and the elderly.

Which brings us to the role of the Active Management Value Ratio 2.0™ (AMVR). My purpose in creating the AMVR was to provide a simple and effective means of quantifying suitability and best interests for investors to help them protect their financial security against some of the questionable sales tactics practiced in the investment/financial services industries.

The AMVR is a simple cost/benefit analysis that is a basic concept in every introductory economics class. What makes the AMVR different is that the metric uses a fund’s incremental costs and returns as the analysis’ input data. The use of a fund’s incremental cost and return data is based on the concept that since index funds provide a means of reliably achieving essentially the market return with no additional market risk, the value added benefit provided by actively managed mutual fund, if any, is reflected in the incremental, or additional, return provided by the fund and the relative incremental, or additional, cost incurred to achieve such return.

The AMVR calculation simple and straightforward, requiring only the basic math skills of addition and subtraction. Incremental costs are calculated on the basis of a fund’s annual expense ratio and its turnover/trading costs, since studies have consistently shown that

The two variables that do the best job in predicting future [of mutual funds] are expense ratios and turnover. High expenses and high turnover depress returns….– Burton Malkiel “A Random Walk Down Wall Street”

AMVR calculations will result in one of three scenarios:

  1. the actively managed fund will fail to produce any incremental return for an investor, therefore providing no benefit to an investor;
  2. the actively managed fund will produce an incremental return for an investor, however the incremental costs incurred by the fund in producing the incremental return will exceed the incremental return, therefore providing no benefit to an investor; or
  3. the actively managed fund will produce an incremental return greater than the fund’s incremental cost, therefore producing a benefit for an investor.

Scenario three will result in further suitability analysis of the potential investment focusing on issues such as correlation of returns and potential “closet index” status.


Most of my career in financial planning and investments has  been centered on quality of investment advice issues, first as a compliance director/officer and then a the director of quality advice for the financial planning division of a major international insurance company. All along I recognized the need for the public to have a simple, yet effective means to evaluate the financial advice they receive from investment “professionals.”

The AMVR metric finally provides the public with a means to evaluate both the investment advice they receive and the person providing such advice. The AMVR can be used to evaluate investments options in both personal retail investment accounts and company retirement plans such as 401(k), 403(b) and 457 plans. The cost of calculating the AMVR is free, as the calculation process in the “white paper” section of this blog, and the information is freely available online at sites such as morningstar.com under the “Funds” tab.

Are your investments toxic or terrific? How valuable is your financial security to you and your family? Investors now have the means to privately evaluate both their investments and their financial advisers to determine if their investments and/or their advisers are truly serving the investor’s best interests.

Posted in Uncategorized

God Bless Charles Ellis

I am often asked what I feel is the best investment book for investors and what one piece of advice I would give investors. Fortunately, the answer to both is the same – read “Winning the Loser’s Game” by Charles Ellis. The book is written in a style that anyone can understand and offers sound, practical advice for every level of investor, newbie or veteran.

When people come into my office, I think they expect to see volumes of investment related books. Instead they see just three investment books on my credenza – “Winning,” “The Intelligent Investor” by Benjamin Graham, and “A Random Walk Down Wall Street” by Burton Malkiel. In my opinion, those are the only three investment books an investor needs to be a successful investor.

I first read “Winning” back in its first edition in 1987, when it was titled as “Investment Policy.” The reason I chose “Winning” as my favorite investment book is that it introduced me to the concept of investment analysis using an investment’s incremental cost and incremental return, when Ellis advised investors that they

“should consider the true cost of fees charged by active managers not as a percentage of total returns but as the incremental fee as a percentage of risk-adjusted incremental returns above the market index.”

Ellis pointed out that since investors could essentially obtain the market return through an inexpensive index fund, using incremental fees and returns allowed investors to get a better picture of what value, if any that an active manager provided

That concept has been the core element of my entire practice, as it allows investors to avoid unnecessary costs, which reduce an investor’s end return. Remember, each additional 1 percent of fees and other costs reduce an investor’s end return by approximately 17 percent over a 20 year period.


Using an actively managed mutual fund’s incremental costs and returns reinforces what study after study has shown, namely that the majority of actively  managed funds fail to outperform passively managed index funds. The SPIVA report (S&P Indices Versus Active) provides a biannual analysis comparing the performance of actively managed funds versus passive indices.

For the year ending on December 31, 2014, the actively managed funds once again posted consistent under-performance versus the indices. The 5 and 10 year under-performance percentage for all domestic mutual funds was 80.82 and 76.54 respectively. For domestic large cap funds, the 5 and 10 year under-performance percentage was 88.65 and 82.07 respectively. For domestic mid cap funds, the 5 and 10 year underperformance percentage was 88.65 and 82.07 respectively. For domestic small cap funds, the 5 and 10 year underperformance percentage was 86.55 and 87.75 respectively. Despite these facts, the investment options offered by most 401(k)/404(c) plans continue to be dominated by actively managed mutual funds.

Incremental analysis also allows an investor to see that in most cases, actively managed mutual funds either fail to provide any benefit at all, or that the fund’s incremental costs exceed any incremental return produced. In both cases, an investor loses money.

My metric, the Active Management Value Ratio 2.0™, uses a fund’s incremental return and incremental costs to evaluate the intrinsic value, if any of an actively managed mutual fund. The information needed to perform the calculations are available for free on various web sites. The calculation process only requires simple subtraction and division.

There is a saying in the investment industry – the public focuses on investment returns, investment professional focus on investment risk. while most modern investment books focus on returns since that is what interests the public, Ellis focuses on the importance of the effective management of investment risk in successful investing.

The great secret of success in long-term investing is avoiding serious, permanent loss….[M]anaging market risk is the primary objective of investment management….We now know to focus not on rate of return but on the informed management of risk.

Few investors seems to realize the true impact of investment losses. When I do presentations, I often ask the audience a sample question to impress upon them the impact of investment losses. The question poses a situation where an investor suffers a 50 percent loss in year 1, followed by a 50 percent gain in year 2. The audience is then asked where the investor stands versus his beginning position.

Most of the audience will say that the two 50 percent numbers cancel each other out, so the investor is back where he began, with no loss. However, the correct answer is that the investor is still down 25 percent. If we assume that the investor started off with $1,000, lost 50 percent to $500, then gained 50 percent, or $250, on the $500, the investor only has $750, or $250 (25%) less than what he started with.

To calculate the gain needed to offset investment losses, an investor can use the following equation: [(1/(1-amount of loss))-1] times 100. For example, it takes a return of 100 percent to offset a loss of 50 percent. (1/(1-.50)) x 100 or (2 x 100) equals 00 percent.

The bear market of 2008 saw investor losses of 40 percent or more. To recover from a loss of 40 percent, an investor needed to achieve a return of  approximately 67%.

Ellis discusses several risk management options, including effective asset allocation/diversification. Many investors mistakenly believe that they are effectively diversified by holding various classes of mutual fund, e.g., large class growth, small cap value. However, since most domestic equity-based mutual funds share a high correlation of returns, owning various classes of domestic equity-based mutual funds does not provide an investor with the downside protection against losses that true diversification provides.

If you truly care about investing to protect you and your family’s financial security, do yourself a favor by finding “Winning the Loser’s Game” and investing a couple of hours in reading it. By doing so you will discover the truth of our blog’s tagline, “the power of the informed investor.”

Posted in Asset Protection, ERISA, Fiduciary, Investment Advice, Investment Portfolios, Investor Protection, pension plans, Portfolio Construction, portfolio planning, Portfolio Planning, Retirement, Retirement Plan Participants, Retirement Planning, Uncategorized, Wealth Accumulation, Wealth Management, Wealth Preservation | Tagged , , , , , , , , , , , , , , , , , , , , , , ,

Wealth Preservation – Avoiding Common Financial “Games”

When people ask me what kind of law I practice, I tell them that I am a wealth preservation attorney. To me, wealth preservation consists of three separate areas of wealth management – accumulation, protection and preservation. Wealth preservation involves estate planning, asset protection, retirement distribution planning and other related areas of wealth management.

There is a popular saying that “knowledge is power.” Nowhere is that truer than in the world of investing. Knowledge allows an investor to be proactive and protect their financial security.

In my experience as a securities compliance director and a securities and wealth preservation attorney, I have seen a lot of “games” often used by the financial services industry. In most cases, the “games” are employed to provide more compensation to the financial adviser at the investor’s expense.

Five of the most common “games,” or deceptive practices, used in the industry are:

1. Inverse pricing by variable annuities – This refers to the practice by the variable annuity industry to base their annual fees on the total value of the variable annuity rather than the cost of their legal obligation to the annuity owner, commonly referred to inverse pricing since the fee is not based on the actual potential cost to the variable annuity issuer. Most variable annuities obligate the variable annuity issuer to pay the annuity owner’s heirs the greater of the value of the variable annuity or the owner’s actual contributions.

Given the historical trends of the stock market, it is unlikely that the value of the variable annuity will be less than the owner’s contributions. Consequently, inverse pricing essentially guarantees the variable annuity issuer a substantial windfall at the owner’s expense. Most variable issuers charge an annual fee of 2 percent or more, despite the fact the fact that one well-known study estimated that the actual value of the protection for which the fee is charged is approximately 0.10 percent.

The annual fee charges is even more egregious when one considers that each 1 percent of additional 1 percent of investment fees reduces an investor’s return by approximately 17 percent over a twenty year. When you add the additional fees for a variable annuity’s sub-accounts, the total fees on variable annuities often exceed 3 percent or more, effectively reducing an investor’s end return by over 50 percent or more. For more issues with variable annuities, read our white paper, “Variable Annuities: Reading Between the Marketing Lines,” and “Stuart Berkowitz’s article, “5 Reasons you Should Be Wary of Variable Annuities.

A recent addition to the annuity product line is the so-called fixed-income or equity-based index annuity. While these products have a number of negative issues, the leading issue if that fact that such products come with various features that seriously limit the real return that investors can achieve. A more comprehensive analysis of these products is available here.

Wealth preservation “best practice”: Variable annuities and indexed annuities…just say no!

2. “Pseudo” or false diversification – This refers to the practice of providing investors with investment recommendations among various types of investments, e.g., large cap growth funds, small cap value funds, international funds and leading an investor to believe that the recommendations will provide the investor with with a diversified investment portfolio and protection against downside risk. But looks can be misleading.

True diversification provides investors with both upside potential and downside protection against substantial losses.  However, given the high correlation of returns among most equity-based investments, both domestic and international equity-based investments, the recommendations often do not provide the protection supposedly provided by diversification at all.

Looking at the five-year (2009-2014) correlation data for five equity-based categories often used in asset allocation recommendations, (large cap growth, large cap value, small cap growth, small cap value, and a popular international index, MSCI’s EAFE), the pattern of high correlation is obvious:

94% correlation between LCG-LCV
91% correlation between LCG-SCG
90% correlation between LCG-SCV
87% correlation between LCG-EAFE
90% correlation between LCV-SCG
94% correlation between LCV-SCV
86% correlation between LCV-EAFE
97% correlation between SCG-SCV
75% correlation between SCG-EAFE
76% correlation between SCV-EAFE

Looking at the ten-year (2005-2014) correlation data for the same categories further demonstrated the high correlation pattern for equity-based investments:

92% correlation between LCG-LCV
92% correlation between LCG-SCG
87% correlation between LCG-SCV
87% correlation between LCG-EAFE
88% correlation between LCV-SCG
93% correlation between LCV-SCV
87% correlation between LCV-EAFE
95% correlation between SCG-SCV
79% correlation between SCG-EAFE
77% correlation between SCV-EAFE

Bottom line, in most case, “pseudo” or false diversification simply provides an investor with nothing more than a false sense of security and an unnecessarily expensive index fund, with reduced returns due to the excessive fees.

Wealth preservation “best practice”: Investors should always ask their financial adviser to prepare a correlation of return analysis for both their existing investment portfolio and the investment portfolio being recommended by their financial adviser. After all, without a correlation of returns analysis, how can a financial adviser know whether his/her recommendations are in the best interests of the investor?

3. Closet index funds – Mutual funds with high R-Squared ratings are often referred to
“closet index” funds, as their high R-Squared rating indicates that investors may be able to achieve similar or better returns at a significantly lower cost by using index-based investments.

Morningstar defines R-squared as a measure of the correlation of the portfolio’s returns to the benchmark’s returns. An R-squared of 100 indicates that all movements of a portfolio can be explained by movements in the benchmark. Conversely, a low R-squared indicates that very few of the portfolio’s movements can be explained by movements in its benchmark index. Effective diversification involves combining investments with low correlations of return so that the investments provide downside protection against large losses, regardless of economic or market conditions.

There is no universally accepted R-squared rating level for classification of a fund as a closet index fund. Some use a rating of 95 as the threshold rating, while some us 80-85 as a threshold R-squared rating.

InvestSense classifies any mutual fund with an R-squared rating of 90 or above as a “closet index” fund.  This position is based upon our belief that the ability to achieve the same or similar returns of a benchmark index fund without the higher fees generally associated with actively managed mutual funds, often 3-4 times higher than a comparable index fund, is more more conducive to effective wealth management and preservation.

Wealth preservation “best practice”: Do not invest in “closet index” funds, funds with R-squared ratings of 90 or higher.

4. Cost inefficient actively managed mutual funds – One of my specialities is fiduciary law. One of the primary duties of a fiduciary is to manage any money entrusted to them in a prudent manner, always putting the best interests of the client first. One of the primary aspects of prudence is to avoid unnecessary fees and expenses.

There are two ways of evaluating the fees charged by actively managed mutual funds. The first involves calculating the effective cost of such fees based up on the actual active management component of a fund. The higher the R-squared rating of a fund, the lower the actual active management component of such fund.

Since closet index funds have a small active management component, their effective fees will be significantly higher than their stated annual fees. A study by Professor Ross Miller found that the effective cost of active management generally exceeded a fund’s stated annual expense, often by as much as 300-400 percent.

A second way of evaluating the fees of actively managed mutual funds is to use our proprietary metric, the Active Management Value Ratio 2.0™ (AMVR) to evaluate the cost efficiency of a mutual fund. The AMVR is a powerful, yet simple, cost/benefit analysis that requires nothing more than the ability to perform simple subtraction and division. And yet, the AMVR often indicates that actively managed mutual funds are cost inefficient, as the incremental, or extra, return provided by actively managed mutual funds, if any, is exceeded by the fund’s incremental , or extra, costs.

Wealth preservation “best practice”: Avoid “closet index” mutual funds and take the time to calculate the AMVR 2.0 rating for mutual funds currently owned and/or being considered as potential investments. 

5. Relative returns – aka the “we’re number 1” scam. Investment ads and advisers like to tout that their product has had the best performance compared to their competitors. This comparative, or “relative,” performance allows an investment company or financial adviser to make such a claim, even though the actual return was lackluster or even negative.

This is a common practice after a down year for the stock market, such as the bear markets of 2000-2002 and 2008, when many mutual funds suffered losses of 30 percent or more. The fact that one’s mutual fund suffered a 30 percent return while another fund suffered a 32 percent is hardly cause for celebration.

Investors need to focus on funds that have provided consistent absolute returns. Absolute returns are simply the actual returns that an investment has provided over time. An investment with a consistent history of positive absolute returns means that an investor has not benefited from the returns themselves, but also from the benefit from the compounding of such returns over time.

Wealth preservation “best practice”: Ignore mutual fund advertisements touting their relative returns and focus purely on a fund’s ability to provide consistent and positive annual absolute returns.

Posted in Asset Protection, Investment Advice, Investment Advisors, Investment Fraud, Investment Portfolios, Investor Protection, IRA, Portfolio Construction, portfolio planning, Portfolio Planning, Retirement Distribution Planning, Retirement Planning, Variable Annuities, Variable Annuity Abuse, Wealth Accumulation, Wealth Management, Wealth Preservation | Tagged , , , , , , , , , , , , , , , , , , , , ,

Conflicts of Interest and Full Disclosure

Your account is a brokerage account and not an advisory account. Our interests may not always be the same as yours. Please ask us questions to make sure you understand your rights and our obligations to you, including the extent of our obligations to disclose conflicts of interest and to act in your best interest. We are paid both by you and, sometimes, by people who compensate us based on what you buy. Therefore, our profits and our salespersons’ compensation may vary by product and over time.

The referenced disclosure, commonly known as the Merrill Lynch Rule after one of the leading broker-dealers in the U.S., was proposed by the Securities and Exchange Commission (SEC) as an alternative to enforcing the law requiring that those who provide investment advice for a fee must register as an investment adviser. The Financial Planning Association (FPA) eventually sued the SEC to force them to enforce the Investment Adviser’s Act of 1904 and to require the broker-dealers providing investment advice for a fee to register. The FPA eventually won their case and the SEC withdrew the conflict of interest disclosure requirement.

The conflict of interest problem still exists today. Both the Department of Labor (DOL) and the SEC are involved in heated disputes regarding the need for a universal fiduciary standard that would require that anyone providing investment to the public would have to always put a customer’s or a client’s financial interests first.

While it would seem that such a requirement is simply common sense and fair, the financial services industry claims that such a requirement would result in financial advisers refusing to provide advice to certain segments of the public and that such a requirement would result in disaster for investors. To date, the financial services industry has failed to produce any hard evidence of such claims, basing their claims on pure speculation.

The conflicts of interest issue has recently been addressed in an excellent article, “Is Your Financial Advisor Really Putting You Before Profits.”  As the article states, studies have consistently shown that the public mistakenly believe that anyone proving investment advice is required to put the customer’s best interests first. As the conflicts of interest disclosure points out, that is not true. Fiduciaries, such as investment advisers, are required to always put a customer’s best interests first. Stockbrokers and other financial adviser are generally not considered to be fiduciaries and there are allowed to, and often do, put their financial interests ahead of their customers’ best interests.

The key for investors is to recognize and understand the conflicts of interest issue and to take the time to review and evaluate any and all investment recommendations for the potential impact of same on them. To that end, I have previously published one of my proprietary metrics, the Active Management Value Ratio 2.0™, (AMVR) which allows an investor to perform a simple cost/benefit analysis on actively managed mutual funds to determine the cost efficiency of a mutual fund.

The information needed to calculate a fund’s AMVR score is available for free online. Once an investor becomes acquainted with the AMVR calculation process, it should take no more than a few minutes to calculate a fund’s AMVR score. Surely, one’s financial security is worth their investment in such a minimum amount of time.

Unfortunately, as Mark Twain once noted, the adoption of a law does not guarantee that everyone will follow it.  The power of greed will probably result in some financial advisers continuing to put their own financial interests ahead of the best interests of their customers. Therefore, the need for investors to be able to independently evaluate any investment advice they receive will continue to be a valuable skill.



Posted in Investment Advice, Investment Advisors, Investment Fraud, Investment Portfolios, Investor Protection, portfolio planning, Portfolio Planning, Wealth Accumulation, Wealth Management, Wealth Preservation | Tagged , , , , , , , , , , , , , , , ,