I do not know any of the 1000 financial advisors mentioned in the article.  They may be the best financial advisors ever to grace this planet.  Many of the advisors will no doubt use their rankings for marketing purposes, and investors, with no knowledge of the evaluation criteria, may blindly rely on the ranking itself, without knowing the criteria that was actually used in making the rankings

What concerns me is that the standards used by Barron’s in making the evaluations focus more on the benefits that the advisors provided to their firms than on the benefits they provided to their clients.  The article states that evaluations were based on the amount of an advisor’s assets under management (“AUM”), the amount of revenue that the advisor produced for their firm, and an undefined standard as to the quality of their practices.  

As an investor, I would be somewhat concerned to learn that Barron’s evaluations were based partly on the amount of revenue that an advisor generated for their firm instead of how, and if, the recommendations actually benefitted me. Given the current debate over a financial advisor’s duty to put a client’s interests first, one would hope that such a standard would have been included in Barron’s evaluation criteria.  Perhaps it was part of the undefined “quality of practice” standard.  Barron’s failure to provide the criteria for this mystery standard is a perfect example of why many are calling for greater transparency in the financial services industry.

However, the most alarming statement in the article is the statement that 

Investment performance isn’t explicitly a criterion , because the advisors’ clients  differ widely in their goals, but most of the advisors have been attracting lots of       new business through referrals, a clear sign of customer satisfaction.

How soon we forget!  If I remember correctly, most of Bernie Madoff’s clients were supposedly satisfied and, thus, provided Madoff with clients through referrals.  This in no way suggests or is intended to suggest that any of the advisors named in Barron’s article were involved with Madoff or that they are or have been engaged in any unethical or criminal activity.  Again, I do not know any of the advisors named on Barron’s.

I have two concerns with the Barron’s rankings, the first being that simply to rank advisors without taking into account some level of performance vis-a-vis the client is potentially misleading and dangerous, as some people will simply look at Barron’s list without realizing that Barron’s criteria apparently did not stress the benefit the advisors provided to their clients as much as they did the financial benefits the advisor provided to their firms. While Barron’s properly disclosed this shortcoming, the fear is that some people will simply go directly to the rankings without reading the article.

Secondly, the use of assumed customer satisfaction and resulting client referrals is likewise potentially misleading and dangerous.  As a securities attorney and former compliance officer,  many “satisfied customers” quickly become unsatisfied customers when they learn that their advisors did not put the customer’s best interests first, regardless of the applicable legal standard, and that the advisor sold the customer investment products based upon the financial best interests of the advisor.  In too many cases, seemingly satisfied customers simply lack the information or experience to be unsatisfied customers…yet. (See Madoff)

Barron’s attempt to provide useful information for investors, while done with good intentions, simply falls short of their high standards.  Unless and until Barron’s provides full disclosure as to the evaluation criteria used in evaluating the advisors, specifically the “quality of practice” standards, and includes some sort of criteria that evaluates an advisor’s performance and their actual benefit to their clients, as opposed to the advisor’s financial benefit to their firms, investors should perform their own investigation and evaluation instead of blindly relying on Barron’s rankings. 

In both cases the parties were given so-called “asset allocation” plans with the obligatory multi-color pie charts and recommendations for the purchase of both a large variable annuity and substantial equity investments. Both cases were perfect examples of the ”weasel” rule. 

And people wonder why I fight so hard for a universal fiduciary standard for anyone providing investment advice.  Whether it is a case of ignorance or greed and dishonesty, these parties could have been seriously harmed by such careless advice had they actually followed the adviser’s recommendations.

I always advise investors to take a financial adviser’s advice and then ask both themselves and the adviser - ”Why?”  Far too often advisers ”fail to see the forest for the trees,” focusing on the theoretical issues instead of practical and honest real world solutions . 

The children’s inheritance represents all of the money they have, at least for the time being.   While capital preservation is an obvious issue, recommending a variable annuity for children…really? And I am sure that some compliance officer or branch manager would have approved it.  Furthermore, the equity products were primarily proprietary funds with high commissions, high annual fees and historically poor performance.  The children and the grandparents did not know to ask “why,” so I did.   

The widow’s husband had invested wisely and their portfolio provided sufficient income to cover their living expenses.  That being the case, the recommendations for a variable annuity and  equity funds would have served no purpose other than to provide the “adviser” and his company with a financial windfall at the widow’s expense.  While the inheritance created a need for some advanced estate planning, the portfolio she inherited met her current needs.  As in many marriages, the widow’s husband had handled all the financial matters, so she was uncomfortable asking “why?”

Unfortunately, this happens all too often, especially with widows, children, and the elderly.  In many cases, the reluctance to ask “why” is due to what is known in psychological circles as the “truth”, or “trust,” bias, a situation where someone defers to a someone’s apparent authority or expertise.  Far too often the speaker has no expertise whatsoever, but is simply a salesmen trying to make a sale.  A study by CEG Worldwide estimated that 96 percent of those holding themselves out as wealth managers and advisers were nothing more than product salesmen.

So whenever a “financial adviser” offers you ”investment advice,” hand the pretty little multi-color pie charts back to them and ask him/her “why.”  Then ask them to redo the asset allocation numbers using the actual products they have recommended to show you how their recommendations would benefit you as opposed to them. (Note – It can be done with an Excel spreadsheet program. However, many advisers cannot do this with their software, so then how do they know their recommendations are actually in your best interests?).  Then tell them to “fuhgeddaboutit” and walk away.

As a securities attorney and a former securities compliance officer, I can assure you that it is far more beneficial and less stressful to avoid investing in unsuitable investment in the first place than it is to try to recover unnecessary financial losses in the courts or through arbitration.

In light of the abuses revealed during the bear markets of 2000-2002 and 2008, with investor losses of $6 trillion and $7 trillion respectively, there is a need to protect investors against perceived ongoing abusive practices in the financial services industry.  The new white paper, “Battle of the Best Interests: Closing Argument in People v. The Financial Services Industry and Congress,” focuses on the current debate and provides details on the abusive practices so that investors can identify and avoid unnecessary investment losses.

The new white paper can be found by selecting “Closing Argument” in the white paper section of our site at investsense.com.

What sets “Winning the Loser’s Game” apart from many other investment books is its emphasis on risk management, not the management of returns, as the key to successful wealth management.  Throughout the book, Ellis provides practical advice with supporting details.

While “Winning the Loser’s Game” is my choice if I am limited to just one choice, my second choice would be “The Intelligent Investor” by Benjamin Graham.  Graham’s classic is almost always on any list of “must read” investment books and his advice and recommendations have stood the test of time.

Either of these books would be worthy stocking stuffers for the investors in your family.

Thanks for following my blog.  Hopefully we have provided some useful information this year.

Happy holidays and best wishes for a prosperous new year!

Every fraud is made up of simple components.  Stupidity of the client plays an important role, but trust and betrayal of it is the key component.  Warning No. 1: Clients do stupid things because they trust their advisors.

While I agree with the sentiments regarding fraud in terms of trust and the betrayal of such trust, I feel that the remarks regarding a client stupidity is overly harsh.  I would replace “stupidity” with “inexperienced and lacking sufficient education.”  That’s what this blog is all about. providing information to investors to help them become more proactive in protecting their financial security.

While everyone would like to trust everyone else, blind trust is often harmful.  The quote, “trust, but verify,” was often used by President Reagan in connection with his relationship with Russia.  A little skepticism is never harmful, especially when it involves personal finances.  Any investor whose financial adviser who is offended by a client’s request for information or explanations should seriously consider finding another adviser.

As an attorney, investment/wealth management adviser, and a former compliance director, I openly admit that I have a viewpoint that is quite often significantly different from other industry professionals.  Some find it odd that I advise both investors and investments advisers.  My goal is to improve the overall quality of advice being provided to the public in order to prevent unnecessary financial losses.  I feel the best way to do that is helping both the public and the industry.

That being said, there are two current financial planning/wealth management practices to which the “trust, but verify” definitely apply, portfolio construction and portfolio management.  Here is a simple test I suggest to everyone who has had, or is planning to have, a financial plan and/or portfolio optimization plan prepared for them.  Ask the planner to provide you with a plan that provides you with projected risk, return and correlation of returns information based upon the actual investment products being recommended.

Seems like a logical and a reasonable request, right?  But do not be surprised when they tell you that they cannot provide such a report.  The problem lies in the fact that most financial plans are prepared using software programs that can only prepare plans based on generic asset classes.  These generic asset classes do not take into consideration common investment concerns such as fees, expenses and taxes, items that can drastically reduce the return to an investor.

Given the failure of investment advisers to provide a “real world” analysis of their investment recommendations, I have always wondered how advisers can verify the suitability of their recommendations and the consistency between their investment recommendations and the representations in the plan that was used to convince a client to buy/sell investment products.  In fact, when I question advisers about this and ask them why they do not provide “real world” analyses, especially since there are Excel programs that can provide such analyses for their clients, I generally get the blank, “deer in the headlights” look.  I am not alone in my question, as Nobel laureate Dr. William F. Sharpe has also questioned the failure to provide analyses based on an investor’s actual investments.

Furthermore, I have always found it strange that advisers use generic data to provide recommendation, information analogous to passive, index funds, then attempt to sell clients actively managed investment products, despite the fact that studies have consistently shown that the majority of actively managed investment products underperform their passively managed counterparts.

The second “trust. but verify” topic is portfolio management.  Time and time again I see cases where a client says their adviser explained portfolio losses by saying that “it’s the market, everyone is losing money.”  We have a separate white paper on our site that deals with this situation (under the “Market Myths” tab) on a more detailed basis.

The bottom line is that everyone is not losing money.  The reason people supposedly hire investment mangers is to avoid large and unnecessary investment losses.  There are a number of sound, proven techniques that can be used to protect an investor’s portfolio.  The courts have rules that the failure to implement or discuss such strategies with a client can constitute a breach of the adviser’s fiduciary duty to a client.

There are still a number of investors and investment professional who adhere to the antiquated buy-and-hold approach to investing.  To quote Will Rogers, “even if you’re on the right track, you’ll get run over of you just sit there.”  A buy-and-hold approach blindly ignores the facts that history has clearly shown the market is cyclical, with definite bull and bear markets.  If anything good has come out of the 2000-2002 and 2008 bear markets, hopefully it has been to reinforce to investors that buy-and-hold makes no sense and that successful investment management is a reasoned, yet dynamic, process.

When I am asked what one piece of advice I would give investors. my response is “be proactive.”  Ask questions and keep asking questions.  To paraphrase Denzel Washington from the movie “Philadelphia,” insist on explanations that a four-year-old can understand.  Do not fall victim to the “truth bias”, blindly accepting anything told to you by someone who appears to be knowledgeable and have authority.  Do not be intimidated by spreadsheets, calculations and the almighty pie charts.  Here is a little inside secret.  Redo the first few lines of one of the spreadsheets and discover for yourself the “oops” quotient often found throughout these plans.

Trust, but verify.  Willful blindness simply exposes an investor to unnecessary risk of financial loss.  If you do not act to protect yourself, then maybe Bobbin is correct after all.

The Chinese philosopher Lao Tzu once noted that the best way to control anything is to take advantage of its nature.  The market is dynamic and cyclical.  Therefore, an effective portfolio management system should also by dynamic to take advantage of the cyclical nature of the market. 

Buy-and-hold ignores the nature of the market and exposes investors to unnecessary risk of financial losses.  Market timing, trying to catch every move of the market, is equally impractical.  However, monitoring the market and using defensive strategies to avoid unnecessary losses is sound investment management, not market timing.  Studies have consistently shown that avoiding losses has a significantly greater impact on an investment portfolio than missing a potential gain. 

Financial service companies often tout that they are number one over a certain period of time or have led in a particular investment category.  The problem with such ads is that they can paint a misleading picture.  A fund or adviser with poor performance, even negative returns, can still make such representations as long as they outperformed their peers.

Investors should focus on the ability of an investment or an adviser to achieve consistent, positive returns.  Consistent, positive returns allow an investor to reap the benefits of compound returns, which allows their portfolio to grow even faster. 

Correlation of returns among potential investments is an important factor in creating and managing an investment portfolio.  One of the biggest problems in the investment industry today is what I refer to as “pseudo” diversification.  Pseudo diversification involves evaluating diversification based on the quantity and different types of investments in a portfolio.

The problem with evaluating diversification on quantity and types of investments is that is that it does not factor in the extent to which the investments react similarly in different market conditions. A portfolio consisting primarily of highly correlated investments simply does not provide an investor with the benefit of downside protection during downturns in the market.  Expense control is an an area often overlooked by investors.  One study estimated that over a twenty year period, an investor’s overall return is reduced by 16% for each 1% increment of expenses.  Other posts and white papers on our blog have discussed a measure known as the “active expense ratio,” a measurement that calculates the effective cost of actively managed funds against a similar index fund.  Generally speaking, the effective cost of active management results in an effective overall management fees signficantly higher that the fund’s publicly stated fee, often three to four times higher.

While we use PACE in constructing and advising portfolios for individuals, PACE is also appropriate for institutional investors.  The four components of PACE address a fiduciary’s duty of prudence under ERISA.

The acronym PACE was also chosen based on the fact that it distinguishes the difference between true investing and speculation.  As Ben Graham, recognized by many as the greatest investors of all time, once noted, the true secret to successful investment management is the management of investment risk, not investment returns.  The four components of PACE allow an investor the best of both worlds by focusing on risk management, while at the same time creating a portfolio that provides both upside potential and downside risk protection.

As you review ERISA and other applicable retirement plan related legislation, you notice three persistent themes, or duties, for fiduciaries: prudence, diversification and the avoidance of large losses. In discussing these duties, modern portfolio theory is constantly mentioned as the standard in assessing compliance with these duties.

Dr. Harry Markowitz introduced the concept of Modern Portfolio Theory (MPT) in 1952. Prior to MPT, most portfolios were constructed based purely on risk and return data. With MPT, Markowitz introduced the concept of including the correlation of returns of available investment options as a factor in constructing investment portfolios. By factoring in the correlation of returns, an investor can combine investments that behave differently in various market conditions, which theoretically reduces the overall volatility of the investment portfolio. While MPT’s calculations have been the subject of legitimate criticism, the benefit of combining assets with low correlations of return is still valid. Both the Department of Labor and the courts still point to the principles of modern portfolio theory as the applicable standard for assessing the prudence of actions taken under ERISA.

And yet, based upon my experience, most retirement plans do not provide retirement plan participants with correlation of returns information to help them make informed investment decisions. Participants are generally only provided with information regarding an investment’s annual returns and standard deviation. As a result, plan participants often end up with portfolios that are not effectively diversified, leaving the participant needlessly exposed to investment risk.

Plan participants are often offered various investment options, with funds described as large cap, small cap, growth, value, international, and emerging. Without correlation of returns information, a plan participant often constructs a portfolio seemingly diversified based purely upon the number of funds and the difference in names of their investments. Investors are therefore lulled into a false sense of security by this “pseudo” diversification.

Without correlation of returns information on the plan’s available investment options, plan participants are unaware that many of their investment choices behave similarly in different market conditions, thereby providing little if any protection against downturns in the market. Studies have consistently shown an increase in the correlation of returns of equity based investments of all kinds, including international equity investment products. Furthermore, studies have shown that over the past decade, the correlation of returns among equity based investments has increased even more during periods of volatility in the market, effectively reducing the perceived benefits of diversification.

Most 401k plans have chosen to adopt participant directed plans under Section 404(c) of ERISA. One of the requirements for qualifying under 404(c) is that the plan sponsor provide plan participants with “sufficient information to make an informed decision” regarding the plan’s available investment options. Given the fact that ERISA, the Department of Labor and the courts have recognized MPT as the applicable standard for prudence with regard to retirement plans, and that the cornerstone of MPT is using correlation of returns in the portfolio construction process, one can legitimately question whether a retirement plan’s failure to provide plan participants with correlation of returns information for a plan’s investment options allows a plan participant to make an informed decision as required under the law. Furthermore, a question arises as to whether the failure to provide such information constitutes a breach of fiduciary duty by the retirement plan’s named fiduciary.

I believe that these are questions that are soon to be presented given the LaRue decision, which established the right of plan participants to bring personal actions for losses incurred in their retirement accounts, and the investment losses that plan participants are suffering. While many retirement plans offer some sort of investment education programs, my experience has been that such programs are usually provided by companies that are serving as service providers to a plan and are seriously lacking in meaningful content.

The typical education programs that I see consists of a number of multi-color pie charts and simplistic recommendations such as to select an asset allocation and never change that allocation, except for an occasional re-balancing to the original allocation. This “buy-and- hold” approach, sometimes referred to as the “buy, forget and regret” approach to investing, completely ignores the cyclical nature of the market and is contrary to the standards for prudent investing established by the Restatement of Trusts (Third) Prudent Investor Act. Investors would be better served to follow the advice of Chinese philosopher Lao Tzu, who advised that “the best way to manage anything is by making use of its nature.”

I have yet to come across one retirement plan educational program that discloses the correlation of returns data for a plan’s actual investment options or addresses the use of such data in constructing an effectively diversified investment portfolio, even though there is no legal prohibition from providing such information. In fact, ERISA Section 404(c) and Department of Labor Interpretive Bulletin 96-1 clearly support disclosure of such information.

Plan participants are legally entitled to information that allows them to make informed decisions, to protect their financial security. Correlation of returns data provides valuable information to plan participants as it allows them to effectively diversify their investment portfolios in order to prevent large losses. Court decisions have indicated that the failure to provide such information to plan participants raises questions as to whether a participant can truly exercise control over their retirement account, which is one of the requirements for a 404(c) plan.

Plan participants should request up-to-date correlation of returns data annually for every investment option offered in their retirement plans. A refusal by a plan’s sponsor to provide such information should be noted and the plan participant should seek such information from an independent investment adviser in order to properly protect their financial security. My feelings, warnings and advice with regard to the typical retirement plan educational programs can best be summed up by points eight and twelve at http://bit.ly/4zkE5k.

For additional information on wealth preservation strategies and avoiding unnecessary investment losses, please read our white paper, “Everyone Is Not Losing Money – Investment Myths and the Unnecessary Investment Losses They Create,” by selecting the “Investment Myths” tab on our home site, investsense.com