Is Dogbert your Financial Advisor?

Have you really reviewed what your investment fees are?

Many dont even know what they are paying due to hidden fees in mutual funds and the way many advisers bill their clients.

A fee-only advisor will openly disclose all the fees you are paying and how you are paying them.

To find a Fee-Only advisor in your area go to: http://www.napfa.org/

For more from Dilbert's creator Scott Adams read this great piece from the WSJ:

http://online.wsj.com/article/SB10001424052748704913304575370913870866820.html?mod=ITP_thejournalreport_0 

VERY SIMPLE YET VERY POWERFUL

The following quote is from Mike Pipers book "Investing Made Simple"
It is a simple expansion on Nobel prize winner William Sharpe's explanation of why index funds beat most other investors.

Why Index Funds Win: If the entire stock market earns, say, a 9% annual return over a given decade, and the average dollar invested in the stock market incurs investment costs (such as brokerage commissions and mutual fund fees) of 1.5%,  …then the average dollar invested in the stock market must have earned a net return of 7.5%.

Now, what if you had invested in an index fund that simply sought to match the market’s return, while incurring only minimal expenses of, say, 0.2%? You would have earned a return of 8.8%, and you would have come out ahead of most other investors. It’s counterintuitive to think that by not attempting to outperform the market, an investor can actually come out above average. But it’s completely true. The math is indisputable. John Bogle (the founder of Vanguard and the creator of the first index fund) refers to this phenomenon as “The Relentless Rules of Humble Arithmetic.”

Piper, Mike (2009-10-01). Investing Made Simple: Index Fund Investing and ETF Investing Explained in 100 Pages or Less (Kindle Locations 453-458). Simple Subjects, LLC. Kindle Edition.

The Truth is "I Dont Know"

Above is from the brillant Ally Bank commercial.

Below is a quote from the 1940 investment book "Where are the Customers Yachts"

For one thing, customers have an unfortunate habit of asking about the financial future. Now if you do someone the signal honor of asking him a difficult question, you may be assured that you will get a detailed answer. Rarely will it be the most difficult of all answers - "I Dont Know"

The lesson is that as much as we crave AND PAY for financial prognostications. In the long run, we really dont know. In fact, what we do know is embedded in the price of the security. In other words the expected is built into the price. The problem comes when the expected fails to happen. Then we have volatility in our investments.

I am often confronted by investors that think that if they pay high expenses to large firms they will get some insight into the future. Unfortunately, after all their charts and graphs and analysis they do not prove to know more than the market as a whole. And, after the fees for the crystal ball gazing, the big firms underperform the market over time.

This reminds me of the Malcom Gladwell piece in The New Yorker. He tells the story of the brilliant investor: Victor Niederhoffer, who in 2001 was predicting that the markets would be quite. He had his fortune invested that way. Then planes flew into the world Trade Centers.

http://www.gladwell.com/2002/2002_04_29_a_blowingup.htm

In the end: we just cant predict what tomorrow will bring.


What I do know is this: The best thing one can do is build a stock portfolio that looks like the market, then balance it with short term bonds based on the amount of risk you need to mitigate.
This can be done with low cost index funds and ETFs and the help of a fee-only advisor who can help you determine how much risk you are comfortable with and who can then gude you to an appropriate portfolio - all at a reasonable cost.

Where Are The Customers Yachts?

Once in the dear dead days beyond recall, an out-of-town visitor was being shown the wonders of the New York financial district. When the party arrived at the Battery, one of his guides indicated some handsome ships riding at anchor. He said "look, those are the bankers' and brokers' yachts."
"Where are the customers' yachts?" asked the naive visitor.

-Ancient Story

The above is the epilogue to the classic investment book: "Where are The Customers Yachts."

 Many feel that they have to pay large sums to large firms to help them with the elusive idea that their investments will consistently beat the market. Unfortunately, nobody has found the formula to beat the market. The only ones getting rich are the banks and brokers. So why not just be the market?
The best thing one can do is build a stock portfolio that looks like the market, then balance it with short term bonds based on the amount of risk you need to mitigate.
This can be done with low cost index funds and ETFs and the help of a fee-only advisor (if needed).

The Power of Hope Over Probability

Las Vegas, Reno, Atlantic City are built on the simple premise that humans want to believe they will end on the winning side of a bet -  even when the bet is rigged against them. Gamblers know the house is always a net winner. Some will win and more than half will lose. They know that the Vegas strip was not built because casino's have been lucky. They just hope that luck will be on their side.



The same can be said in the investment world. The  investors who place their money with active managers are analogous to the swarms of gamblers hoping for the big pay off.

Investors place their money with active managers even though many know that over 10 year periods, active managers underperform indexes almost 90% of the time. Investors are willing to incur high fees and transaction costs in the attempt to beat the market. But year after year only 1/2 of active managers beat their index benchmark, the other 1/2 underperform. This is a mathematical fact. When you add in fees and transaction costs well over 1/2 of active managers/mutual funds underperform their respective market index.




Why do investors ignore this mathematical certainty and continue to pay high fees for active management?

It is the power of HOPE over PROBABILITY.




Like a gambler at a casino, many investors ignore the probabilities and hope to find a way to beat the market. They pay for stock and mutual fund picking advice, they pay high mutual fund fees, they pay for expensive newsletters, all in the hope that they can have an edge in outsmarting the market and be on the winning side. Unfortunately, to date, there is no system that exists that will outperform the market on a risk adjusted basis. If there was wouldn't we all be following it?????

When it comes to your future does it make sense to put hope over probability?

Remember these 5 truths about capital markets:

1. Higher return means higher risk. Your friend who talks about his big returns is taking a bigger risk than you. That means that when times are bad he is likely losing more than you.
2. The index return of a market is the average of all investors returns in that market. That means about 1/2 outperform and the other 1/2 underperform that particular market.
3. Net of fees, more than 1/2 must underperform the respective index of the market.
4. Over time very few stock pickers or mutual funds  consistently outperform the market -  the one who outperforms in a given year is not the same who outperforms in the following year.
5. It is impossible to predict the winners ahead of time.

When investing in the stock or bond markets why not invest in index funds and be like the casino - knowing that math is on your side and that over time you have a high probability of outperforming the average active investor.

NOTE: This does not mean that you are guaranteed to have a positive return with index funds. It simply means that over time, net of fees, indexes outperform the  majority of active managers with the same investment style.

Are you an investing Ahab?

"I need Facebook IPO" phone calls and a recent WSJ article on zombie funds leads me to reflect on the fact that most investors are like Moby Dick's captain Ahab. Ahab was obsessed with catching the white whale, Moby Dick. An obsession that lead him down a path of his own destruction.

Many spend their money paying advisers to produce market beating returns and in the end don't do better than a simple buy and hold strategy. Then there are those who invest with the Madoff's of the world and end up losing much more than a good return.

They somehow believe that they can get instantly rich in the market, they spend money on  software systems or advisory services. They spend hours watching CNBC, and watching the market, and worry about whether they should own more gold or Facebook. 

Unfortunately, many drive themselves into an Ahabian obsession with finding the great return.  They ignore the fact that a simple buy and hold strategy of holding an index of the US stock market since 1973 would have earned 10.5% through 2010. Holding the US market since 1927 would have earned 9.8%. 

Two years ago I attended the Get Motivated seminar at HSBC Arena in Buffalo NY. It is more of a day of infomercials interspersed with motivational speakers. One of the pitches that day was a stock picking software system - just buy on the up arrows and sell on the down. The crowd swarmed to the sales desks by the thousands to purchase the system. They were never told about trading costs or  short term taxes, nor was there discussion about what to do when negative news on one of your stocks hits the market when you are out golfing. I just shook my head at the power of a great sales pitch and the desire of humans to get rich quick and easy.

Study after study shows that over the long run very few outperform the market on a consistent basis. Yet so many sail the seas trying to beat the market. In the end it is the brokers and advisers that sail the seas in their customer paid for yachts. 


 In fact when Harry Markopolos, author of the book No One Would Listen, tried to warn regulators in 2000 that the 15% sustained return promised by Madoff was impossible in the capital markets no one would listen. The point here is that Markopolos knew that those kind of consistent returns dont exist in the stock market. So why do so many continue to reach for returns that have never existed?  Probably because we believe in America that we can get rich overnight, that we can time the market, pick the winning stock. In the end, those tasks are nearly impossible to achieve. Therefore, most investors would do themselves a favor and just purchase a diversified portfolio of index funds that give them exposure to the US stock market, the global stock market and the bond market and relax while the Ahabs of the world make themselves crazy. 

The "Perfect Portfolio" - great advice from the Oblivious Investor

Below is a short section of a recent blog from one of my favorite financial bloggers: The Oblivious Investor (http://www.obliviousinvestor.com). It is about as perfect advice on portfolio structure that you can get.

Forget about Perfect

Even the idea that it’s possible to have a perfect portfolio is problematic. It can make people want to change their portfolios all the time based on the most recent convincing-sounding argument they’ve read. (I know this personally, because I used to struggle with it myself.) And it can keep people from focusing on other things — such as savings rateor retirement age — that are generally more important than asset allocation.

Instead of searching for a perfect portfolio, I’d suggest the following approach:

1. Work out a “good enough” portfolio.
2. Recognize that it will not be perfect and that there will always be well-reasoned portfolios/strategies that have outperformed you over any particular period you choose to examine.
3. Implement the portfolio anyway and move on with your life.

What Makes a “Good Enough” Portfolio?

As far as what makes a portfolio “good enough,” it’s not anything tricky:

• It should be diversified. (This does not necessarily require several mutual funds.)
• It should have a roughly appropriate asset allocation for your risk tolerance. (Consider limiting your stock allocation to twice your maximum tolerable loss.)
• It should have low costs.