I Told You So!

“Stock picking and market timing are expensive, risky, and ultimately futile exercises.” – William Bernstein.

As you may recall, on Friday, March 6th I wrote that it was a mistake to be scared out of the stock market.  The stock market actually hit its bottom on the next business day, Monday, March 9th.  Since then, prices have soared, not in a perfectly straight line, true, but the increases have indeed been spectacular.

What does that mean?  That I can predict stock market prices?  No, absolutely not.  That remains an “unacquired” skill.

What it does mean, though, is that I follow a buy and hold philosophy, because getting out of and into the stock market again and again is a losing strategy, simply because you are not going to do it well.  One benefit of working with a fee-only financial advisor is avoiding the emotional swings that accompany volatile stock prices.

Please read my March 6th post, Nobody is Buying Stocks?  in which I mocked the total negativity that was seemingly everywhere in the media.  I pointed out just how overblown the language used at the time was:

“With so much uncertainty, investors are parachuting out of companies…”

“No one is taking a back-seat approach. Everyone is just selling.”

“It’s like an unending nightmare.”

Please take a moment to read the entire post (if you haven’t already), but here is the conclusion if time is pressing:

“No one knows what tomorrow will bring, but unless capitalism ceases to function, stockholders will be rewarded in the long term for owning stocks and for taking risks. Yes, there is risk in owning stocks, as we have recently experienced. Since we’ve already seen the risk, how about staying around for the reward?

An old Wall Street proverb is that “Nobody rings a bell at the top or the bottom of a market.”

Are you waiting for that bell to ring?  Don’t.”

As I pointed out, since March 9th stock prices have soared.

Understand, though, stock prices can go down again.  In fact, I can  guarantee that.  Once again, I am not clairvoyant, and I rarely make predictions.  But, I have counseled a buy and hold strategy for many years. There is no evidence that anyone can get in and out of the market at the right time and improve on a buy and hold approach.

Heaven help the person who got out of the market earlier this year.  The March 6th post quoted financial advisor Bijon Mishras who said, “I want to wait for a firm turnaround, and be as safe as possible.” I wrote, “Whoa, Nelly. Remember this quote and see how it turns out.”  So, Bijon, is now the time to get back in?

On March 16th I wrote a series which started with Is Buy and Hold Not Working? Part 1.  I said that timing the market was impossible, “The evidence shows that most investors get it wrong over and over again.”

“Historically, stock markets have had sharp increases following a bear market.  The difficulty is identifying when that move is for real.  Bear market rallies, bear traps, etc. tend to keep investors gun-shy, so a sustainable bull market rally will only be identifiable in hindsight.

Nevertheless, individuals who keep their investments in cash or Money Market funds will miss out on most of the move.”

Conclusion

I’ll stick with what I said on March 27th, “Given what does not work, what is the recommended approach?  In my opinion, it is a diversified, low cost, buy-and-hold portfolio matched to your time horizon and risk tolerance.”

A good advisor should help you do that and also avoid the “big mistakes” of buying high and selling low.  Is that worth the annual amount you pay a fee-only advisor?  I certainly think so.  Do the math.

Read more

Investors Seek Objective Advice

“In the aftermath of the financial-market crisis, investors are leaving Wall Street to sign on with independent investment advisers.” – Wall Street Journal.

A perennial topic for articles in the mainstream press (and, subsequently, in this blog) is how individuals do, and also, should, choose a financial advisor.

Wary Investors Are Seeking Out Objective Voices in Wednesday’s Wall Street Journal is the latest installment on that subject.  They report that “registered investment advisers brought in more than $108 billion of net new assets into the three largest custodians” while “the four major Wall Street brokerage firms saw an outflow of $8 billion in 2008.”

While an individual investor may find it difficult to identify with billions and billions of dollars, that’s still good news; it means (in my opinion) that the good guys are winning.  Recall as I said in previous posts that registered investment advisors must act in the best interests of their clients, while brokers follow a less stringent rule.

More and more prospective and actual clients are getting that message, as the article reports that “investors seeking to repair their damaged nest eggs say the chief lure of independent advisers is more-objective guidance.”

The subhead of the article is a somewhat wordy, “Independent Advisers Are In Demand, but Picking One Means Homework.”  If not for that, the article would have been suitable for a Twitter post!  Nevertheless, the writers offer some good advice, which I summarize below.

…while most independents call themselves “advisers,” they aren’t all required to adhere to the same fiduciary standards.  As a result, the degree to which each must put a client’s interests before his or her own can vary.  The upshot, says Marilyn Dimitroff, chairwoman of the board of directors of Certified Financial Planner Board of Standards Inc., is that “the public is so confused.”

“To hire an independent who suits your needs, you should consider how much you have to invest, how much you can afford to pay and whether you want someone to oversee your entire financial life, or just pieces of it. It’s also important to probe the potential conflicts of interest your adviser may face.

Here are some questions to consider:

What type of adviser do you need?  As with their counterparts on Wall Street, independent advisers come in two basic flavors: brokers, who typically focus on investment advice, and registered investment advisers, or RIAs, who may help you with everything from saving for college and retirement to tax and estate planning.

What are the potential conflicts of interest?  Brokers’ income depends on commissions from client trading. As a result, they have a financial incentive to steer clients to products that pay them the most, such as variable annuities or mutual funds with high sales “loads.”

Still, many independent brokerage firms receive so-called revenue-sharing payments from mutual-fund and other financial-services companies.  In return for making such payments, fund companies may be given opportunities to promote their products to a firm’s advisers.

Investors wary of such potential conflicts may want to consider an RIA.  RIAs not only generally refrain from accepting commissions but are held to a higher “fiduciary” standard—a legal requirement that they act in clients’ best interests.  Brokers follow looser “suitability” guidelines, which means they can’t put clients in inappropriate investments. (A recent Obama administration proposal would require brokers to operate under the higher fiduciary standard.)

What are the adviser’s credentials?  To find an adviser with specific skills, look for certain credentials.  A Certified Financial Planner must complete courses in investments, taxation, estate planning and insurance.  They also must pass a two-day exam, have at least three years of experience, and comply with ethical standards that require them to put a client’s interests ahead of their own.

To be continued… (as always)

60 Minutes – The 401(k) Recession

Sunday’s 60 Minutes piece on 401(k) retirement plans was rather shallow, and not at all what you would hope (and expect) from CBS’s popular, long-running show. The template for this type of exposé is generally that there is a problem/scandal and some party has been physically hurt or financially injured, and some other party has to bear the blame.

According to the 60 Minutes portrayal (sadly, all true, by the way), people have lost jobs, their portfolios were destroyed and retirement dreams must now be deferred. Steve Kroft interviewed discouraged job seekers at a job fair, which, if nothing else, provided sympathy and some activity to televise. It’s curious (and quite a coincidence!) how the interviewees just happened to have their 401(k) statements with them.

Naturally, he only interviewed older people, and that’s fine; after all, it’s the older folk who are more severely impacted. In my opinion, younger investors will be fine, as long as they continue to contribute to their own 401(k) plans and invest in stocks. In fairness to 60 Minutes, they did spend about a dozen words on this distinction.

According to my analysis of the 60 Minutes template, we must find victims and we must identify villains. Indeed, they found a very sympathetic woman who not only lost a lot of money in her retirement account, but lost her job as well. She cried on camera. And 60 Minutes made a veteran industry spokesman appear unabashedly unsympathetic, though that may have been the result of heavy editing of his comments.

Actually, the 13 minute piece combined two things: (1) people have lost money, and (2) fees are hidden in 401(k) plans and may be excessive. What they downplayed is that more consumer education is needed. Surely, they could have spared a few more sentences than the paltry few they uttered on that particular, very important, issue.

What can we actually learn from the 60 Minutes segment?

People Lost Money

Well, yes. But, what wasn’t said is that that has been true of other investment accounts as well, not just 401(k) plans. Small business owners have also suffered, as have people who have lost their jobs. Why only claim that 401(k)s have let down participants?

Fees

Yes, high fees can hurt investment performance, so 60 Minutes got it right that high (and hidden) fees can be a big problem in retirement plans. But they chose merely to list the types of fees, not quantify them or put them in a useful context. In my experience, some 401(k) plans are quite good. Some are too expensive. On the other hand, many 403(b) plans have very high fees, yet no one is examining them.

Risk

Defined Benefit Plans (pensions) have been in decline for some time. The old pensions were much better for average Americans, because loyal employees knew (more or less) what they would get, and they didn’t have to worry about making investment decisions. But employers were happy to get rid of traditional pensions to help reduce future costs and to reduce the business risk of achieving adequate market returns. Accordingly, employers have emphasized Defined Contribution Plans and largely dropped pensions.

In essence, investment management and investment risk were transferred to employees, and they were not prepared to make wise choices. In a bull market this was not so noticeable.

The Solution

The nature of defined contribution retirement accounts, such as a 401(k) or 403(b) plan, is that, while they provide a tax-deferred avenue to save for retirement, they need to be managed. Someone has to determine an appropriate asset allocation, based on a number of factors. Moreover, if you have other investments, it is ideal to treat all of your investments as one portfolio. And your allocations should probably change over time. As you get closer to retirement age, you generally will need to be somewhat more conservative in your investments.

The fundamental problem is that people thought that they could simply invest in the 401(k) plan without putting too much consideration into the asset allocation. Or it could be that they chose hot funds based entirely on past performance. The show did not go into any details as to why the participants had done so poorly, only that they had.

Clearly, more consumer education is needed. Fortunately, there are efforts currently under way to provide independent, unbiased support that will assist more employees to make informed decisions about their retirement plans.

Suggestion for 60 Minutes

The producers could have done a much better job. Next time, they should compare and contrast two people. One individual who had read a couple of personal finance/investment books or had consulted a financial planner who explained risk and return, asset allocation and the need to become more conservative as one approached retirement. The second individual would be one who did not understand any of these issues and pretty much just winged it with what amounts to a large part of her net worth.

While this comparison would have been useful and very telling, it would, of course, have made for pretty boring TV.

Rolling over to an IRA account

If you have a defined contribution account – 401(k) or 403(b) – from a former employer you can do a tax-deferred transfer to an IRA account. This would give you more control and more choices, but it should be done carefully. To that end, I recommend that you consult a fee-only financial planner. Otherwise, you may end up paying even higher fees than what you are now paying! You might even, heaven forbid, be sold a variable annuity to put in your new IRA.

To be continued.

Avoiding Financial Fraud

Ron Lieber’s New York Times column Even Vigilant Investors May Fall Victim to Fraud was quite disturbing and not a little worrying. It recounts how Matthew Weitzman, a founder and principal at AFW Wealth Advisors, a Registered Investment Advisor, and a fee-only firm, is no longer with AFW. The firm informed its clients of “certain irregularities in a limited number of client accounts.”

You can read Lieber’s article for the details. What is not clear, though, is how much money was involved nor how quickly the irregularities were discovered. Though, from my point of view, they are not the most worrying aspects. What concerns me most is that Mr. Weitzman was a member of the National Association of Personal Financial Advisors (NAPFA).

When a member of the advisory community violates the trust that clients place in him, all clients and advisors suffer. What this country does not need right now is any further deterioration in what little confidence we have left in the banking system, the federal government or our financial advisors.

I have been a fee-only planner since 2003, and whenever possible, I recommend that investors seek out financial planners who are compensated directly by their clients, rather than by commissions. In this way, you will avoid obvious conflicts of interest.

Members of NAPFA all practice a fee-only method of compensation and sign a Fiduciary Oath, which means that they swear to act only in their clients’ best interest. So it is with great discomfort that I heard that not one, but two, former members of NAPFA have been accused of bilking their clients.

What to do? As Ronald Reagan once said, “Trust but verify.” And of course, you should never write checks directly to your advisor, but only to an independent custodian. It is the independent custodian who should be providing you with confirmations of all transactions and trades, and a monthly statement. These are sensible precautions in the age of Madoff.

As Lieber says, “Open your mail. Confirm the accuracy of your trades and fund transfers. Read your account statements. Every month. Every number. Every single word.” I am not sure about reading every number, every word, but I get his drift.

Lieber further recommends that you handle all of your stock transactions yourself. I believe most investors will find this “solution” impracticable, inconvenient and unnecessary. I believe a better solution is for you to sign a limited power of attorney, allowing your advisor to enter transactions on your behalf, but which does not allow him to withdraw your funds. Only you should have the ability to withdraw funds from your account. I am not an attorney, but I believe that this provides adequate protection. (Attorneys, please weigh in.)

My mother always said “A promise is a promise.” Unfortunately, there are always people who will promise one thing and do another. It’s disappointing to have your expectations dashed.

I don’t know about you, but I expect firefighters to be brave, judges to be moral and rabbis and priests to comfort the troubled. Yet, there have been judges who, instead of upholding the law, bend it out of shape for personal gain. And there have been priests and rabbis who have preyed upon our young and betrayed our trust.

Lieber says, “I’ve always believed that advisers in the (NAPFA) association were plenty smart and morally upright, but it’s hard to recommend them now without at least including an asterisk.”

In my experience, NAPFA members have the highest standards in the profession. But like every profession, there may be individuals who choose to violate the trust of clients they serve.

It’s not easy to protect yourself against out and out theft, but you can take some small comfort from the fact that if financial advisors break the law, they are subject to prosecution by the regulatory authorities.

In my opinion, a great majority of investors will lose countless dollars because of the continuance of “Standard Operating Procedures” at Wall Street investment firms. Every day these firms peddle ill-conceived, hard-to-understand, expensive investments, because it is profitable for them to do so. Investors will lose more money in the ordinary course of business than they will ever lose due to outright fraud.

Unfortunately, what is legal on Wall Street is bad enough.

And so, I will continue to heartily recommend NAPFA members, because the fiduciary standard is the right way to do business.

And yes, monitor your accounts. Remember, “Trust but verify.”

Questions to Ask When Picking a Financial Adviser

An article in the April 13, 2009 edition of the Wall Street Journal entitled Seven Questions to Ask When Picking a Financial Adviser largely misses the boat. Granted, it is a challenge to find a “reliable” financial advisor; however, the article did a poor job of advising you on how to go about it. Reading it may leave you with the conclusion that it is impossible to find a financial planner you can trust. There can be nothing further from the truth.

I take exception with the emphasis of the article and several of its points.

How does the adviser get paid?

Mentioning that there are different methods of compensation, as the article does, is not sufficient.

As I’ve said in previous posts, the key issue in choosing a financial advisor is finding one who will act in your interests. To determine that, you must know exactly how and who compensates your chosen advisor. If an advisor is fee-only, you’re off to a good start.

Remember that a stockbroker must act in the employer’s best interests, and that you are not his employer. A Registered Investment Advisor, on the other hand, must act in a fiduciary capacity, i.e. in the clients’ best interests.

Stockbrokers are subject only to a “suitability” standard. They are regulated by FINRA, which (despite their rhetoric) is dedicated to protecting stockbrokers and their employers, not necessarily investors.

What do the adviser’s clients say?

This may or may not be relevant or helpful.

Registered Investment Advisors are governed by the 1940 Investment Advisor Act, which expressly prohibits providing “testimonials,” which client references would fall under. Of course, a client recommendation or testimonial could easily be concocted anyway.

What’s the adviser’s track record?

The WSJ article didn’t even come close to getting this issue right. Choosing an advisor based on his/her supposed investing track record is the wrong approach on several counts!

Even if you did find an advisor with a “superior” track record, we know that it is meaningless, because, as has been stated before, “Past Performance is No Guarantee of Future Results.” If you’ll recall, Bernard Madoff had a superior track record, many testimonials and lots of personal references and endorsements. And we all know what he did.

Key Financial Solutions does not try to “beat the market.” We are not active managers, because studies show that the added costs offset any possible gains of active trading.  Market timing and stock selection do not work.

Since we are not mutual fund managers, we do not have one uniform documented track record. Real financial planners take into account their client’s needs, financial objectives and tax situation before investing their money.

Because our clients have different risk tolerances and time horizons, they naturally have different portfolios and, therefore, different investment performance.

Financial Planning versus Investment Performance

Understand that beating an index is not a financial plan. What a good financial planner will do is give clients the best chance to achieve their goals.  Because the financial plan sets the parameters of the portfolio, a portfolio is simply a tool to realize clients’ goals.

Don’t get me wrong, we are quite proud of our portfolio design, because we use low cost, tax-efficient mutual funds to build globally diversified portfolios.  I am personally fascinated by asset allocation and portfolio strategy.  I use automated reports and individual spreadsheets to monitor a portfolio and to make changes, when appropriate.  Certainly all of these necessary tasks contribute something to investment performance, but not as much as having a plan and sticking to it.

Real Life Returns

Since investor behavior is a very large component of investment returns, we act as coaches so that clients do not make big mistakes.  For example, we manage how clients respond to the euphoria near market tops and to the panic and despair around market bottoms.

Behavioral advice – coaching clients to continue to do the right thing and to avoid doing wrong things – will have a greater impact on investment returns than attempting to choose next year’s hot sector or mutual fund.

Believing in full disclosure and transparency, we report results quarterly so that a client can see exactly how well his or her portfolio is doing. This report is net of all fees, which are clearly stated, rather than being hidden. But I do not recommend giving quarterly results much importance.

Conclusion

When considering whether to retain an adviser for a long-term relationship, avoiding conflicts of interest should be the first consideration. A strict fee-only method of compensation is the best approach for most people. Members of the National Association of Personal Financial Advisors are strictly fee-only planners who sign a Fiduciary Oath.

NAPFA has always maintained that an advisor who is compensated solely through commissions faces immense conflicts of interest. This type of advisor is not paid unless a client buys (or sells) a financial product. A commission-based advisor earns money on each transaction—and thus has a great incentive to encourage transactions that might not be in the interest of the client. Indeed, many commission-based advisors are well-trained and well-intentioned. But the inherent potential conflict is great.

Searching for a Better Investment Guru

U.S. stocks declined yesterday to the lowest prices in more than 12 years. The Standard and Poor’s 500 closed at 700. You would think that now would be a very good time to have a reliable investment guru offer sage advice and words of wisdom. Times are tough, the economy is tanking and there is panic in the streets (Wall Street and Main Street, both). What is an investor to do? Should she buy, sell, hold? “Surely,” you think, “the ‘experts’ must know.” Unfortunately, you’d be thinking wrong; the correct answer is that he or she really doesn’t.

Last month, in an article titled Why the Experts Missed the Crash, Money Magazine published an interview with UC Berkeley Haas Business School professor Philip Tetlock. The professor has spent his career evaluating experts and authorities in a variety of fields, and he is not at all surprised that the vast majority of financial “gurus” failed to predict the recent steep market decline.

Here is a summary of the article:

Despite everything, we can’t shake the belief that elite forecasters know better than the rest of us what the future holds.

The record, unfortunately, proves no such thing. And no one knows that record better than Philip Tetlock, 54, a professor of organizational behavior at the Haas Business School at the University of California-Berkeley. Tetlock is the world’s top expert on, well, top experts. Some 25 years ago, he began an experiment to quantify the forecasting skill of political experts.

Tetlock has analyzed “not just what the experts said but how they thought: how quickly they embraced contrary evidence, for example, or reacted when they were wrong. And wrong they usually were, barely beating out a random forecast generator.”

Why did so many experts miss the economic crash?

The people intimately involved in packaging [financial derivatives like] CDOs must have had some sense that they were unstable. But their superiors seem to have been lulled into complacency, partly because they were making a lot of money very fast and had no motivation to look closer. So greed played a role.

But hubris may have played a bigger one. … In this case the biggest source of hubris was the mathematical models that claimed you could turn iffy loans into investment-grade securities. The models rested on a misplaced faith in the law of large numbers and on wildly miscalculated estimates of the likelihood of a national collapse in real estate. But mathematics has a certain mystique. People get intimidated by it, and no one challenged the models.

Money has written about human mental quirks that lead ordinary folks to make investing mistakes. Do the same lapses affect experts’ judgment?

Of course. Like all of us, experts go wrong when they try to fit simple models to complex situations. (“It’s the Great Depression all over again!”) They go wrong when they leap to judgment or are too slow to change their minds in the face of contrary evidence.

An Alternative to Finding a Better Forecaster

A good part of the article explores the question “What makes some forecasters better than others?” Professor Tetlock has a detailed answer, which makes interesting reading. He recommends looking for “self-critical, eclectic thinkers who were willing to update their beliefs when faced with contrary evidence, were doubtful of grand schemes and were rather modest about their predictive ability.”

But my answer to the same question is radically different. I believe that it is futile to rely on gurus who have been right more often than others. Various “experts” will be right or wrong at different times, and you cannot, regrettably, know in advance when that will be. So if in essence, the future is unknowable, and experts are so unreliable, you need to have a strategy that does not depend on “accurate” forecasts.

No one, yes no one, knows how markets will behave in the short term. Accordingly, my recommended approach has been and continues to be a disciplined long-term strategy. To understand why, it is absolutely necessary to have perspective on financial history:

• There have been many financial crises in the past; none have proven fatal.
• We have experienced a dozen other Bear Markets since World War II.
• Stock prices have rebounded from all previous declines, even steep ones.
• The stock market goes up in roughly 3 out of every 4 years.
• Stock market losses are temporary; stock market gains are permanent.

Furthermore, waiting for the “right time” to invest doesn’t work for most people, most of the time. The likelihood is that you will miss out on the really strong rebounds that happen when you least expect them. In other words, don’t wait until it looks safe to invest in stocks.

Accordingly, I leave forecasting to the “experts” who according to Professor Tetloc “barely beat random guesses – the statistical equivalent of a dart-throwing chimp – and proved no better than predictions of reasonably well-read nonexperts.”

I do believe in controlling what I can:

• Costs (through low cost mutual funds)
• Risk (through global diversification and sensible asset allocation).

I believe in staying the course so as to participate in the eventual and inevitable recovery.

In short, I do not have a forecast; I have a philosophy and an approach. It’s not perfect, nothing in this world is, but experience shows that it works better than any other approach.

Don’t Put Your IRA in a Variable Annuity

I recently received an email from a couple in their 60s requesting advice regarding how to invest their IRA funds. They had been to a “financial planner” who recommended a variable annuity. Luckily they had read my posts on the subject and said in their email that they were “skeptical because of the costs and early withdrawal penalties.”

I heartily concur.

Jeffrie Voudrie’s article Don’t Put Your IRA in A Variable Annuity explains why.

Here’s a quick summary.

If you’ve talked to a broker or agent about rolling over your retirement account, there’s a good chance the advisor recommended you invest in a Variable Annuity. Don’t do it! I believe the only reason a variable annuity is recommended for an IRA is so the advisor can earn more money. Let me explain.

One of the main sales ‘hooks’ used in selling a variable annuity is that you don’t have to pay a commission. That can be very compelling when compared to a mutual fund in which you pay the all the commission up-front. Many advisors will even say that they get compensated by the insurance company, not you. Do you really believe that? Insurance companies are not charitable organizations. If they are paying the broker, they’ll recoup those costs from you—the costs are just hidden so you don’t think you’re paying a commission. The second main argument for using a variable annuity for an IRA is the death benefit (not offered with a mutual fund). “That way you’ll never have to worry about your beneficiary getting less than you invested”, the thoughtful advisor says. This feature may seem nice, but you end up paying through the nose for it.

The real reason that you are recommended a variable annuity for your IRA isn’t that it’s better for you. It’s because it’s better for the advisor. If you invest $500,000 in a commission-based mutual fund, the advisor’s gross commission will only be about $10,000. The same investment in a variable annuity would yield gross commission to the advisor of $30,000-$35,000 or more! If an advisor can earn 3 times more by getting you to invest in a variable annuity instead of a mutual fund, which do you think will be recommended? 

Don’t fall for the ‘put your IRA in a VA’ trap.

Conclusion

I am not sure which is more shameful (1) Wall Street titans who took outsized bonuses that turned out to be based on illusory profits or (2) the bad advice given to consumers every day by “financial advisors.” This self-serving advice costs consumers billions of dollars every year.

There is a better way - fee-only financial planners. To find one near you, consult this web site:

National Association of Personal Financial Advisors (NAPFA)

Making Better Financial Choices, Part 2

“Poor asset allocation, ill-considered active management, and perverse market timing lead the list of errors made by individual investors.”- David Swensen.

In my last post, I suggested that a great many investors would benefit from a financial advisor who could help them create and implement a comprehensive financial plan and who can manage their investments. Whether or not you heed my suggestion depends on whether you consider yourself a do-it-yourselfer or a delegator.

To handle your own investments, you must first know yourself. Be honest. Do you have the time, inclination, and emotional fortitude to do this right?  Successful investing takes both knowledge and discipline.

Do you understand risk management, asset allocation and asset location? Are you capable of writing and sticking to an Investment Policy Statement?

Perhaps you’ve shot yourself in the foot one too many times? It happens to a lot of novice (and not-so-novice) investors. Many individual investors tend to be too enthusiastic after market prices have gone up and go into a buying frenzy; conversely, they become overly pessimistic after market prices have fallen and then are anxious to sell.

If you realistically doubt your investment skills, then you are a delegator, someone who will rely on a professional to invest your hard-earned money for you. If that is the case, you should be looking for an investment manager who will listen to your needs and goals and implement an investment strategy that makes sense to you and for you.

In my opinion, and I’ve said this numerous times, you should only work with someone who has your best interests at heart – and that means someone who is a fiduciary.

The most common arrangement in working with a Registered Investment Advisor (RIA) is to pay an annual fee, which is based on a percentage of assets, though some financial advisors do work on a retainer basis.

If you are not clear on what fees you are paying, or if your prospective advisor cannot explain what fees you will be paying, you are most likely working with a stockbroker or insurance agent, i.e. someone who receives a commission. I cannot and do not recommend this approach for two simple reasons: It is not transparent, and there are possible conflicts of interest.

For most individuals, the investment management or retainer fee is well spent, because you will avoid the costly mistakes that most investors make. Since the manager will be both an implementer and a behavioral coach, it is crucial that you understand and accept his or her investment philosophy.

Trusting someone to manage your personal investments is one of the most important decisions you will ever make. Here are two books I recommend that you read in preparation for your search for an investment manager.

Simple Wealth, Inevitable Wealth (3rd Edition) by Nick Murray

Wise Investing Made Simple by Larry Swedroe

Notice that both books have the word “simple” in the title, but don’t let that mislead you, investing is not a slam dunk. As Warren Buffet is quoted as saying, “Investing is simple, but not easy.”

Making Better Financial Choices, Part 1

New Year’s Resolutions are often included as a part of every individual’s holiday tradition. My own resolution – not new, because it’s the same every single year – is to get more exercise. In general, though, resolutions don’t have a good record of success. Even as you’re reading this now, it’s likely that many of your own resolutions have already been abandoned.

But, if your resolution was and is to make better financial decisions in 2009, I applaud you. It’s an honorable and worthy goal, and one that can be achieved with relatively little pain. Helping individuals to make better financial decisions, so that they maximize their chance of achieving their goals: That’s my professional objective; it’s also another of my perennial resolutions, but one I faithfully keep.

Rather than writing my own killer “Top Ten Things to do to Get a Grip on your Finances,” I did a Google search on what has already been written. There’s an amazing amount of stuff out there on the net, some of which is quite basic – spend less, save more, have an emergency fund – but still apropos. There is one standout among the crowd, The Best Financial Advice Ever by Liz Pulliam Weston.

Assuming you already know the basics, here is an excellent article: 10 Resolutions to Fix Your Finances by Allan Townsend.

Although the last update was more than a year ago, this Money Central article is still a keeper. It definitely goes beyond the basics.

No. 1: Set up a system.
No. 2: Bank online.
No. 3: Take stock of what you own.
No. 4: Get out of debt.
No. 5: Create a budget.
No. 6: Review your 401(k) plan.
No. 7: Check your insurance coverage.
No. 8: Check your estate plan.
No. 9: Don’t give your money to Uncle Sam.
No. 10: Make new goals.

You’ll either find this list “old hat” or quite intimidating. There are links to further information on the various suggestions, and if you’re at all confused by what you’ve read, I urge you to read on.

Conclusion

For most people, developing a financial plan is well worth their time. Just as you plan a vacation, by carefully selecting a destination based on your needs, wants and desires, and determine the best way to get there given your individual situation, your financial decisions should involve the same type of strategic thinking.

After reading Townsend’s article, you may decide that you need help in analyzing your current situation, your required savings, and in developing a long term strategy. Thinking strategically and monitoring your results regularly will let you know if you are on track to reach your goals.  It will also indicate when you need to adjust your existing financial plan to match your new or changing financial situation.

It may not be easy to set up a financial plan by yourself, but you needn’t do it alone. A good financial planner will help you analyze where you are and what you need to do to achieve your goals. For most people, having an experienced financial advisor prepare a comprehensive financial plan is well worth the time and money.

Although you may be very successful in your own field of expertise, you may not have the time or inclination to keep up with changing tax laws and new investment products. There is no shame in delegating these tasks to someone who does them full time. You may also not have the discipline to manage your own investments, and there’s no shame in that, either.

The key is to start immediately. You need to harness your motivation now, create a plan and then begin to take the steps to implement it. A good planner will outline all of the steps required to reach your goals.

Lessons from the Bernard L. Madoff Fiasco

“Many aspects of the Madoff affair are depressingly familiar: the lure of high returns with little risk, glowing testimonials from early investors, the sense of membership in a special club for those fortunate enough to be ‘in the know,’ the trust in the promoter due to religious or social affiliation, the vague documentation of investment strategy, the skimpy accounting, and the speed of the ultimate collapse.” – Weston J. Wellington.

There has been much written about Bernard L. Madoff, who is accused of running the largest financial fraud scheme in history, and all of it sordid and sad. The sorry tale raises serious questions and concerns about how well (or how poorly) the Securities and Exchange Commission, the so-called watchdog of the U.S. securities sector, did its job. It also makes you wonder how it was that so many “sophisticated” investors could have been so thoroughly fooled.

A recent New York Times column, Be Smart, but Don’t Think That You’re Special  by Ron Lieber and Tara Siegel Bernard, summarizes the debacle as follows: “When wealthy investors are willing to hand over a sizable sum to a single money manager they heard about at the country club, certain first principles of investing bear repeating.”

Here are some useful quotes from the article:

… scores of people made outsize bets on his prowess without taking the time to fully understand what they were investing in.

All investors, but especially those with a high net worth, need to maintain a healthy sense of humility about their level of ignorance. Alternative investments, whether they are hedge funds or venture capital or private equity, can be complicated. They contain unpredictable levels of risk. But all too often, people are willing to overlook those risks because, well, everyone else is doing it. Or they simply place too much trust in too few hands.

Humility

Investing, in general, requires humility. Few people have enough of it. It is the reason so few people put most of their money in index funds, which track various asset classes rather than trying to pick the winners in each.

One problem with hedge funds is that they appeal to all the wrong instincts. They are for the privileged. Investors need to have a minimum net worth to qualify. In the case of the money managed by Mr. Madoff, many people seemed to have gotten in on it by belonging to the right country club.

“He was dealing with extremely wealthy individuals,” said Harold Evensky, president of Evensky & Katz, a financial planning firm in Coral Gables, Fla. “All too often, they make relatively easy marks because the pitch is, ‘You’re special, you can get something that other people can’t get.’ ”

But you are probably not special. Bill Gates is special, and he is the beneficiary of the best investment opportunities from the smartest people in the business. The Ford Foundation is special. The people who run Harvard and Stanford and Yale’s endowments are special.

You, however, are probably hearing about the second- or third- or fourth-tier ideas in the world of alternative investments. That does not mean the managers pitching them cannot make them work. But be honest with yourself: if you are in on them, how special could they really be, given the enormous demand for truly unique investment opportunities?

Smarts

You may be rich and you may be smart. But smart about this sort of investing? Not so much.

There is no shame in not understanding Mr. Madoff’s split strike conversion strategy. Admit your ignorance, question your investment adviser’s certainty and seek a plain English explanation of the opportunity that is in front of you.

Secrets

One hard part about investing in hedge funds is that some of the most successful ones will not say much about how they work. If they disclose too much about their tactics, others will copy them and their investors will be hurt. (So will the managers’ take-home pay.)

While Mr. Madoff’s supposed returns were fully available to all, investment advisers were less successful in understanding how he did what he did. “I knew that their returns were always good, but I knew that nobody could explain how they made their money,” said Mr. Weinberg. “In our attempts to look under the hood, it was impossible to ascertain what they were doing.”

Conclusion

Let’s review some of the “red flags.”

Madoff had complete control of his clients’ investment funds. This is absolutely contrary to the recommended procedure of having your funds held separately, in custody, at a broker-dealer firm which is regulated by the Financial Industry Regulatory Authority and backed by the Securities Investor Protection Corporation. As an investor, you should be receiving copies of your statements directly from the (independent) custodian, not from your investment manager.

You need to understand the investment strategy that your investment manager is recommending. Avoid the “black box” approach to investing; look for investments that are clear and transparent.

Question any investment record that looks too steady over the long term. All investments have some risk, no investment is a “sure thing.” (Bear in mind that other investment managers could not duplicate Madoff’s investment performance, using similar strategies, so what “magic” did he possess that others did not?)

As the saying goes, “If it seems too good to be true, it probably is.”

Next Page »