Archive for March, 2010

Today Senator Dodd dropped from his financial reform packet the demand of a fiduciary duty on those who give investment advice. Simply put, this means that you the client will continue to be taken advantage of by the vultures that put themselves first at all times and that this will remain legal!

There are a myriad of financial products that will continue to be sold due to their high commissions and the story selling that surrounds them. Whether they are appropriate for you will continue to be up to you to determine. Of course, whether these are good solutions for you or not will require you to study investments and financial planning for a few years as many of these products are complex and intentionally opaque. An equity indexed annuity is a prime example of the difficulties you will encounter in understanding and evaluating whether something is a good investment. Not only are these complicated (though the sales pitch is simple), but you are unlikely to know about similar or better products available with FDIC insurance that may be preferable. Why won’t you know about them? Because they pay far smaller commissions so they will not be presented by sales people who do not have to put your interests first.

The thought that you would pay someone for investment advice (whether that is by fee or commissions) who is not legally bound to at least try to put your interests first is absurd. That the financial services industry at this late date would campaign to avoid this level of responsibility is deplorable. Given all that we have gone through, you would hope that putting clients first would be acceptable to all moving forward.

What should you do? I think there are two questions that should be foremost in your mind when dealing with anyone in financial services (insurance, stock brokers, financial planners, etc.). First, ask them if they are acting as a fiduciary? If they do not respond in the affirmative, make sure you ask them how they are compensated for a transaction and how much they are compensated for the transaction. If they are not forthright in disclosing these answers (e.g. they say their compensation is built into the product and you don’t pay anything additional), then you need to run for the exits. If you get a reasonable answer, then you may choose to proceed with the transaction. Just remember-caveat emptor.

We have finished one of the most disappointing decades for investors imaginable. In real terms (i.e. taking into account the decade’s inflation), the returns on stocks were negative for the decade. Those investors who sprinkled in bonds did a bit better, but may or may not have kept up with inflation. Those investors who veered from the traditional and had the vision to add commodities, real estate, etc. probably were able to actually experience growth for the decade. However, they still a rather muted return.

The “sales forces” of financial services are out there now beating the drums for this new decade. Surely after a poor decade we should return to the norm by having excellent returns on our investments, shouldn’t we? Unfortunately, this decade is not really setting up to be any easier for investors than the previous one.

Stocks are certainly not beginning the decade by being cheap by historic measures, so we should expect an average to below average return. Thus, the range bound or secular bear market is likely to continue for some time in equity markets. Unfortunately, commodities and bonds are no longer cheap like they were at the beginning of the past decade. So, returns will be still tough to come by moving forward.

We think the key moving forward will be to be tactical with your risk budget. By that, you or your advisor needs to keep an eye on what are the risks and what are the potential returns of investments. So, if the stock of a great company has fallen to a very low price, buying the stock may increase your risk but be justified by potentially large gains. On the other side, if a stock is very expensive by historic measures it may have rather limited potential appreciation and considerable potential loss. To sell that position and reduce your risk may be the prudent decision. 

So, while investors traditionally have to decide on how much risk to take and stuck with that decision, we believe the prudent course is to adjust your risk budget by the opportunity available to garner good returns. You might still average the same amount of portfolio risk through a market cycle, but get to that average in a way that benefits your bottom line.