PACE Your Way to Investment Success

Posted on October 7, 2011 by

In reviewing and creating investment portfolios, InvestSense uses the acronym PACE as a fundamental guideline.  PACE stands for proactive portfolio management, absolute returns, correlation of returns and expense control.  By focusing on these four areas, we not only provide useful information for both individual and institutional clients, but we also address the major fiduciary requirements set out in ERISA.

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.

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New White Paper

Posted on September 24, 2011 by

New white paper posted on our web site, CommonSense InvestSense, at www.investsense.com.  “Investment Fraud ‘Secrets’: How to Avoid Becoming a Victim of Investment Fraud,” examines the role of internal beliefs and biases that often prevent investors from recognizing investment fraud and properly protecting themselves from becoming a victim of fraud.  The white paper is available under “Investment Fraud Secrets” tab on the main page.

Posted in Asset Protection, Investment Portfolios, Investor Protection, Portfolio Construction, Uncategorized, Wealth Preservation | Tagged , , , , , , , , | 2 Comments

401k Investors’ Right to “Sufficient Information to Make an Informed Decision”

Posted on August 23, 2011 by

Watching the recent sell-off in the markets and the reported trillion dollar daily losses for investors, I cannot help but wonder how much of those losses were preventable, especially for 401k investors. 401k plans are increasingly opting for participant directed retirement plans that shift the risk and burden of retirement investing on the plan participants. Even though ERISA permits plan sponsors to provide investment education programs for plan participants, there is increasing concern among plan sponsors and others that participants may not be able to effectively manage their retirement accounts.

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

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Three Numbers Every Investor and Fiduciary Should Remember

Posted on July 28, 2011 by

The abundance of investment products and investment information available today can be intimidating and confusing to many investors, both novice and professional.  Over my twenty-plus years as an attorney and investment adviser, I have tried to help others focus on some of the critical information in order to avoid unnecessary investment losses, to help level the playing field against some of the ne’er-do-well that continue to defraud the public and plague the financial services industry.

Speaking with a colleague the other day, he commented on the fact that a lot of the important information we get through trade publications such as InvestmentNews rarely seem to get mentioned in the mainstream media and press.  And when we mention such information to clients, they often comment on how useful such information would have been.

After my conversation with my colleague, I started thinking about some of the “inside” information I have shared with my clients that produced the most reaction and appreciation.  In hindsight, I think five numbers and five fats have stood out the most to me and my clients.  In this post, I will discuss the five numbers.  I will discuss the five facts in my next post.  That being said, the five numbers every investor and fiduciary should know are as follows:

1. “75″ – The number “75″ is actually important for two reasons.  First, a study by Schwab Institutional found that approximately 75% of investor portfolios were poorly structured and unsuitable for their investors given the investors’ financial needs and goals.  I believe that this is primarily a result of the fact that (1) stockbrokers are not required to act in a client’s best interests, and (2) investors are often mislead by portfolios that appear to be diversified because they hold a number of different types of investments, but such portfolios are often not truly, effectively diversified.

The second reason that the number “75″ is important is because research and history have shown that approximately two-third, or 75%, of stocks follow the general trend of the market.  This simply supports the popular Wall Street adage, “[don't] confuse brains with a bull market.”

2. “94″ - While there are many firms and individuals in the financial services industry calling themselves wealth managers, a study by CEG Worldwide, a well-respected financial services consulting firm, concluded that only 94% of those calling themselves wealth managers or claiming to provide wealth management services failed to meet the criteria used to qualify as wealth managers.  The criteria that CEG used in their study to determine true wealth management was based primarily on advisers who practiced wealth management as a process as compared to those who simply used “wealth management” as a marketing ploy to push product.  This is the same criteria that investors and fiduciaries should use in choosing a financial advisor to work with.

Secondly, one expert has suggested that this number (OK, actually 93.6, which rounded off is 94), and the study that produced it may have caused more damage to investors than any other number/study.  The number comes from the famous 1986 Brinson, Hood and Beebower (BHB) study that stated that 93.6% of the variation of a portfolio’s returns could be explained by the portfolio’s asset allocation. 

The study did not say that asset allocation explained 93.6% of the portfolio’s actual returns, but rather the variation of the portfolio’s returns.  Nevertheless, dishonest brokers and advisers misrepresented, and still do misrepresent,  the BHB study’s findings to convince investors to choose an asset allocation and rigidly adhere to it, despite the proven cyclical nature of the markets.  This is the mantra of the” buy and hold” approach to investing, an approach that some have suggested is better described as the “buy, hold and regret” approach to investing.  Just ask investors how well that worked during the 2000-2002 and 2008 bear markets. 

Unfortunately, given the current budget issues that exist at the time I write this post, static asset allocators may soon get yet another costly education.  Dr. William Sharpe, a Nobel laureate for his work in the area of investment management, now stresses the need to be proactive and adjust portfolio allocations when changes in the economy and/or the market dictate such moves. 

3. Zero – This number represents the number of variable annuities (VA) and equity indexed annuities (EIA) an investor should own.  As a former compliance officer and a current securities attorney I have heard all the convoluted and conniving justifications for these atrocities.  I have written posts and articles warning investors about these products.  While there may be a few limited instances where they may make sense, such as wealth preservation for high net worth investors, the way they are marketed to the masses is extremely questionable. 

One Wall Street Journal article reported that variable annuity salesmen were told to treat potential annuity clients as “blind twelve-year-old,” and to “put a pitchfork in their chests,” and provide questionable responses to potential client’s questions.  VA salesmen and VA advertisements often tout that by purchasing a VA the investor will never run out of money. 

What is often not made clear that in order to guarantee that lifetime stream of money, you give up all rights to the money invested in the VA.  Once you annuitize your VA, the balance goes to the insurance company once you die, not to your heirs.  In most cases the insurance company offers various choices for payout, such as joint survivor and a guaranteed period, but these options generally result in lower periodic payouts and, in  some cases, additional fees. 

One of the most onerous aspects of VAs is the excesssive fees that most VAs charge, especially with regard to the so-called death benefit.  VAs typically guarantee that in the event the VA owner dies with out having annuitized the VA, the owner’s heirs will receive either the accumulated value of the VA at the time of the owner’s death or the amount of the owner’s actual investment in the VA, whichever is greater.  So the VA issuer is only insuring the amount that the VA owner actually puts in the VA.

Meanwhile, the insurance company assesses the VA’s annual death benefit fee not on the basis of their actual legal obligation, which is the amount of the VA owner’s actual investment, but rather on the accumulated value of the VA.  One study estimated that the actual expense of the annual was approximately 0.10-0.12, but that the insurance companies often charged approximately 1.50%, or approximately fifteen times the estimated value, resulting in a nice windfall for the insurance company.  The additional fee also cost a VA investor by reducing this investment return.

EIAs are also problematic.  EIAs are generally sold with the pitch that investors can earn the same return that the stock market does, with the guarantee that even if the market is down, the EIA investor is guaranteed a minimum return.  What many investors are told is that the potential return is usually capped at a relatively low number, say 10%, and then  is reduced even more by a “participation rate,” usually an additional 2-3% reduction.  In short, the EIA investor is looking at annual rate of between 2-7%.  If the market is up 20% or more for the year, just who is getting the benefit of the excess over the investor’s return?  

There may be other significant numbers that I have omitted.  However, investors and fiduciaries that remember these numbers and the reasons for their significance will be in a better position to protect both their financial security and/or their clients’ financial  security.

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The Power of the Proactive Investor, Part Two

Posted on July 9, 2011 by

In Part One of this post, we highlighted strategies that proactive investors can use to better protect their financial security.  The strategies mentioned in Part One were more oriented toward the investment account as a whole.

However, most securities claims involve allegations of unsuitability and/or breach of fiduciary duty regarding investment products and/or investment advisory services.  Given the number of investment options available to investors today, it is easy for an unscrupulous stockbroker or investment adviser to take advantage of an investor, especially an inexperienced investor.

The following strategies can be used by the proactive investors to avoid some of the more common complaints in securities claims.

1.  Choose appropriate classes of mutual fund shares to reduce expenses.  Fees and other expenses reduce an investor’s return.  Therefore, no-load mutual funds and/or exchange traded funds should generally be an investor’s first choice due to their reduced fee structure.

If an investor chooses not to use either no-load funds or exchange traded funds, A shares and B shares are the only type of mutual fund shares most investors should consider.  Many investors immediately lean toward B shares since they do not require the investor to pay front-end sales charges, or commissions.  B shares, however, may not be the best choice for the long-term investor due to the higher annual fees associated with B shares.

Generally speaking, A shares are often a better deal for a long-term investor due to the fact that annual fees for A shares are typically less than the annual fees charged by B shares.  If an investor has a large amount of money to invest, A shares often offer breakpoints to reduce any applicable sales charges.

Breakpoints are not generally offered on B shares.  B shares are often a better deal for short-term investors, since B shares do not impose a front-end sales charge.  While B shares generally carry higher annual fees and often impose deferred sales charges if an investor redeems the shares within a specified period of time, the holding period during which deferred sales charge are applicable is usually relatively short.

The investor’s ability to redeem B shares without penalty within a short period of time also allows the investor to minimize the effect of the higher annual fees of the B shares.  Some mutual fund companies offer to convert B shares into A shares after a certain period of time has elapsed.  Each investor must evaluate their own situation to determine the choice that is best for them.

Investors with managed accounts should always check to see whether their advisor is using A shares or B shares in the management of their account.  In most cases, it is generally agreed that advisors should only use A shares in managed accounts due to the lower annual fees charged by A shares and the fact that most mutual funds offer to waive sales charges for A shares held in managed accounts.

Another factor favoring the choice of A shares over B shares in managed accounts is the deferred sales charges on B shares.  Since managed accounts often involve frequent reallocations of the account’s assets, holding B shares in a managed account may ensure that the value of the investor’s account is reduced by the payment of deferred sales charges.

2.  Use breakpoints, when possible, to reduce the commissions on mutual fund purchases.  Most mutual fund companies offer investors a discount on front-end sales charges once an investor has invested a certain amount of money in their mutual funds.  Most mutual funds begin to offer such discounts once an investor has invested a cumulative total of $50,000 in their funds, with additional discounts for certain levels of additional investments.  Recommendations spreading investments among a multitude of asset classes may be cause for questioning, especially when large amounts of money are being invested and/or the recommended amounts are just below breakpoint levels.

3.  Get more than one opinion.  Medical patients are often advised to get a second opinion on major medical decisions.  Decisions affecting one’s financial security are equally important.  Unsuitable investment advice can drastically affect one’s life.  Unfortunately, some people holding themselves out as financial planners and investment advisors may be more interested in selling insurance and investment products than in the quality of the financial advice they are providing.

4.  Avoid the variable annuity trap.  Without question, variable annuities are one of the most over-hyped, most oversold, and least understood investment products.  A much publicized article in the Wall Street Journal reported that annuity salesmen at an annuity “boot camp” were instructed to treat potential annuity customers “like blind twelve-year olds,” and to tell customers that the annuities were “like credit cards.”

The NASD and the SEC are investigating various complaints regarding the sale of these investment products and have already imposed sanctions in some cases.  The high fees and expenses associated with variable annuities, along with their lack of liquidity and their negative tax aspects, make them an unwise investment choice for most investors.

Annuities can also have devastating effect on an investor’s estate plan, resulting in most of the investor’s money going to the company issuing the annuity rather than the investor’s heirs and loved ones.  For a more detailed analysis of variable annuities, click “Variable Annuities” on the navigation bar on our site.

5.  Don’t buy life insurance for investment purposes.  A popular mantra among insurance agents is that variable life insurance is the “Swiss army knife of financial planning.”  Anyone who hears such advice should look for another financial adviser.  If an investor needs life insurance, then they should buy life insurance that guarantees the amount of protection needed, which is the intended purpose of insurance.

Life insurance is neither intended for or appropriate for investment purposes.  The high fees and expenses associated with insurance are totally inconsistent with one of the basic tenets of investing, namely to minimize loss of principal so as to maximize the amount of money working for the investor.  While it is illegal for an insurance agent to misrepresent the nature of an insurance product, recent cases involving the alleged misrepresentation of life insurance as retirement/ investment programs demonstrate the need for investors to get advice from more than one investment advisor to better protect their interests.

6.  Beware of “black box” financial planning and portfolio recommendations.  Many financial advisers will offer to provide customers and potential customers with financial plans or asset allocation plans.  The price for such plans can range from free to thousands of dollars.

In most cases these are created with software programs based upon the input entered by the financial adviser.  While investors are warned that “past performance is no guarantee of future returns,” and we scoff at fortune tellers predicting the future, that is exactly what is generally used in creating such plans, historical returns or “guesstimates” of future returns, resulting in the familiar “garbage in, garbage out” scenario.

Furthermore, such software programs can be easily manipulated to produce whatever results are desired.  Most of the commercial software programs are based upon a financial theory known as Modern Portfolio Theory, which is known to have an inherent bias toward certain types of investments.

By manipulating the input data in favor of the preferred investments, certain results can be guaranteed.  This inherent instability of such computer programs has led one expert to refer to such programs as “error-estimation optimizers.”  For a more detailed analysis of “black box” financial advice, click “Faux Financial Planning” on the navigation bar on our site.

© 2011 InvestSense, LLC.  All rights reserved.

The information provided in this post 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.

Posted in Asset Protection, Investment Portfolios, Investor Protection, Portfolio Construction, Retirement Plan Participants, Retirement Planning, Wealth Preservation | Tagged , , , , , , , , , , | 1 Comment

The Power of the Proactive Investor, Part One

Posted on July 9, 2011 by

“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 under-stand 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 salesperson’s compensation, may vary by product and over time.”

The foregoing disclosure was part of a rule enacted by the Securities and Exchange Commission (“SEC”) in an effort to address an ongoing dispute about the disparity of standards for stockbrokers and investment advisers. The Financial Planning Association sued the SEC over the disparity and won, with the court striking down the rule and requiring that stockbrokers charging fees for investment advice register as an investment adviser.

The long-needed disclosure finally made the conflict of interests regarding stockbrokers very clear to investors. An SEC commissioned study by the Rand Corporation revealed that an alarmingly high percentage of investors mistakenly believed that it was stockbrokers, not investment advisers, who owed clients a fiduciary duty. A TD Ameritrade study resulted in similar findings. And yet the SEC did not require stockbrokers to continue to disclose the conflict of interests issue.

The recently passed Dodd-Franks Act included provisions which would allow the SEC to enact a universal fiduciary standard that would apply to anyone providing investment advice to the public. It is hard to see how anyone could legitimately argue against such a common sense requirement, as it furthers the express intent of the federal securities laws and the expressed purpose of the SEC, namely to protect investors. And yet Congress continues to stall and delay implementation of a universal fiduciary standard, even suggesting that yet another study should be done.

In an effort to help Congress and save taxpayers’ money, I conducted an informal survey of 210 people based on the following question – At the present time, investment advisers are required to always put a client’s interest first, but stockbrokers are allowed to put their own personal and financial interests ahead of their clients’ interests. Do you feel that anyone providing investment advice to the public should always be required to disclose any actual or potential conflicts of interest and always put their clients’ interest first? Of the 210 people polled, 100% answered in the affirmative, with many expressing surprise that this situation even existed. You are welcome Congress.

The SEC’s failure to continue to require the conflicts of interest disclosure for regular brokerage accounts highlights the need for investors to be proactive in managing their investment accounts. Not all stockbrokers are dishonest and not all investment advisers are honest. A healthy dose of skepticism never hurts. That being said, based upon my experience as a former compliance officer and a current CFP® professional, Accredited Wealth Management Professional™ and attorney, I offer the following proactive strategies.

1. Always keep copies of all forms and documents that are filled out and/or signed. Documents have been known to disappear or change when questions come up.

2. Never sign blank documents and leave it to someone else to fill the document in.

3. Never give anyone discretionary control over investment accounts. Abuse of discretion is one of the leading complaints regarding stockbrokers and investment advisors. The potential risks simply outweigh any alleged benefit. If an investor is asked to sign a trading authorization so that a brokerage firm can accept orders from the investor’s broker or advisor, the investor should write “NO DISCRETION” on the form to avoid any confusion as to the power being authorized.

4. Read all account statements and correspondence received from a brokerage firm, a broker or an advisor. If wrongdoing is going on in an account and is reflected in the account statements or correspondence, failure to promptly notify the brokerage firm and to object to such questionable activity may prevent an investor from recovering any losses resulting from such activity.

5. Ask questions. Ask why certain investments are being recommended. Ask whether a purchase of a recommended investment product would result in a commission for the broker or the advisor making the recommendation and, if so, what the amount of the commission would be. Ask whether the recommended investment product is a proprietary product of the company that the broker or the advisor is affiliated with and, if so, ask whether the broker or the advisor can recommend similar non-proprietary products. Ask whether the recommended product has ongoing fees and, if so, how much those fees are. Even if an investor is turning the management of their investment account over to a money manager, the investor should continually ask questions in order to protect against losses due to “black box” asset allocation.

6. Consider all aspects of an investment. Some investors only look at the historical or projected return of an investment before making an investment decision. Investors should always consider factors such as the risk/volatility of an investment, the fees associated with an investment, and the tax aspects of an investment. This is particularly true when considering the purchase of an annuity.

7. Be alert to brokers and advisors possibly “working their book.” When business is slow, brokers and advisors may be advised to “work their book.” This may explain unexpected phone calls suggesting that an investor review their investment portfolio and reallocate their assets, switch mutual funds to buy funds from a different fund family, or perform an annuity exchange.

It is illegal for a broker or an investment advisor to make investment recommendations for the purpose of generating commissions. Certain practices should raise red flags for investors. Recommendations that an investor sell funds of one mutual fund company and buy the same or similar type funds of another mutual fund company should be questioned. Recommendations that an investor sell funds of one mutual fund company and buy different types of funds from another mutual fund company should be questioned if the original mutual fund company offers the same or similar type funds as those being recommended, as most mutual fund companies allow an investor to make internal fund exchanges without incurring new commissions.

Recommendations that an investor exchange one annuity for another annuity should always be questioned since the exchange will result in new commissions for the broker or the advisor.

Recommending that an annuity owner exchange annuities is especially suspicious when the current annuity is still subject to surrender charges, as the client would lose money as a result of having to pay surrender charges for the exchange. An investor who becomes aware of such practices should promptly notify the appropriate regulatory organizations.

8. Don’t be lulled into a false sense of security by an advisor’s credentials or designations. The number of letters after an advisor’s name does not ensure the skill or the integrity of the advisor. The most widely respected and recognized designation in the financial planning industry is the CFP designation conferred by the CFP Board of Standards. The CFP designation signifies that an individual has a certain level of experience in financial planning, has completed an extensive examination, and has complied with continuing education requirements.

Always ask for both Parts I and II, and all schedules, especially Schedule F, of an investment advisor’s Form ADV. Take the time to read the material to find out about the planner’s background and qualifications. Although registered investment advisors are allowed to use a disclosure brochure instead of their Form ADV, insist on the investment advisor’s Form ADV. Many disclosure brochures are nothing more than glorified marketing brochures, while the Form ADV contains the information the investment advisor filed with regulatory officials. Also check the planner’s records at the NASD’s web site (www.nasdr.com).

© 2011 InvestSense, LLC. All rights reserved.

The information provided in this post 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.

Posted in Asset Protection, Investment Portfolios, Investor Protection, Portfolio Construction, Retirement Plan Participants, Retirement Planning, Wealth Preservation | Tagged , , , , , , , , , , ,

Street Smarts

Posted on June 3, 2011 by

Wall Street has a lot of colorful sayings.  Some of the sayings actually contain useful information for investors.  I often refer to some of my favorite Wall Street sayings during my presentations.  Interestingly enough, I often have people come up to me and tell me they remember and use the sayings in managing their investment accounts.

As an attorney as well as an investment adviser, my favorite Wall Street saying is “don’t confuse brains with a bull market.”  If more investors took heed of this warning, I believe that there would be far less unnecessary losses in investors’ accounts.   Studies have consistently shown that approximately 75% of stocks follow the overall trend of the stock market.  “A rising tide lifts all boats ” and “the trend is your friend” are two further acknowledgements of the studies’ findings.

Quite simply, it’s hard not to make money in a bull market.  As Sir John Templeton said, “financial genius is a rising stock market.”  The key for investors is to acknowledge the impact of the primary trend in the stock and not be lulled into a false of security during bull markets.

Along those same lines, Warren Buffett took the “rising tide” principle one step further, adding that “it’s only when the tide goes out that you learn who’s been swimming naked.”  “Swimming naked” in this regard refers to investors who fail to implement risk management strategies into their investment portfolios.  While many investors focus only on return, investment legends like Ben Graham, Harry Markowitz, William Sharpe and Charles Ellis have suggested that risk management is actually the secret to investment success.  As another Wall Street saying goes, “don’t tell me how much you made, tell me how much you were able to keep.”  There are any number of risk management strategies that investors can use to manage their investment risk, including hedging through the use option strategies and inverse index investments.

“Bulls make money, bears make money, pigs get slaughtered” is just an acknowledgement of the cyclical nature of  the market.  A buy and hold approach to investing simply ignores the cyclical nature of the stock market and ensures that “pigs” will suffer unnecessary losses during bear markets and then have to spend time catching up in the subsequent bull market.

Advocates of a buy and hold approach point to issues such as market timing and the “best days” to support market timing.  We’ve addressed these issues in earlier posts and articles.  There is nothing in the works of Ben Graham and Nobel laureates such as Dr. Markowitz and Dr. Sharpe that suggest the superiority of a buy and hold approach to investing.  In fact, each of these men, as well as numerous other leaders in the field of investment management, have stated that it is important that investors make changes in their portfolios as conditions in the economy and the market change.

As our tag line suggests, informed, proactive investors have the power to better protect their financial security.  All I know is that I’ll rely more on Nobel laureates and investment legends and act to preserve my financial security.  After all, “no one ever went broke taking profits.”

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