Friday, July 30, 2010

DIY Investing – 4 Questions

I am often asked by prospective clients why they should work with an investment advisor. This question usually comes up after I have explained the differences between active and passive investing and why Cascade Wealth uses only passive investment strategies. At this point, most people are convinced that they should have a passive portfolio. It seems pretty simple. The goal is to capture the returns of the market and minimize expenses. There is no active management. No effort to beat the market. No trying to pick the next hot mutual fund. Just build a portfolio using low cost index and passive funds and keep an eye on it. … So, why would anyone want to pay an advisor for this?

I respond to this question by asking four questions. I tell these people that if they can answer “yes” to each question, then they probably don’t need an investment advisor.

1. Are you capable of learning how to passively manage your own investments? This requires understanding basic investing principles. It also involves learning a bit about Modern Portfolio Theory. The concepts are not extremely difficult to grasp. But becoming knowledgeable and competent takes some capacity for math.

2. Do you have the time to learn how to build your own portfolio? Do you have the time to monitor it and adjust it when necessary? The initial construction of the portfolio is important to the ultimate success of the portfolio over time. You really need to get that right. But you also need to monitor the portfolio over time. Passive investing is not neglectful investing. Also, will you systematically rebalance the portfolio when appropriate?

3. Will you enjoy managing your investments? We tend to avoid the things we do not enjoy. So, if you are not interested in managing our investments, you will probably not put in the effort that it requires. On the other hand, I do get concerned about those who are a bit too enthusiastic about managing their investments. They are prone to tinkering with things when it is not necessary.

4. Can you manage your emotions and make rational decisions about your investment regardless of what is happening in your personal life and in the world around you? This is the most important question. I meet many people who are able to answer the first three questions in the affirmative. But when they ponder their past experiences with investing, they realize they have not been able to keep their emotions out of the process. I believe a good investment advisor adds the value to client relationships by helping them manage the emotions we all feel towards investing.

Those who can check all four boxes probably can manage their own accounts and experience satisfying long term results.

Wednesday, July 21, 2010

A Convicted Criminal Speaks of Ethics

I just attended the local chapter meeting for the Financial Planning Association. I do not often attend these meetings. But this luncheon offered 3 hours of Ethics credits which I need to maintain my professional credentials.

Over the years I have found most of these ethics-related sessions rather tedious. It has long amazed me that financial services representatives do such stupid things and cause such harm to their clients. While I acknowledge my own professional failings, I have never engaged in fraud, cheating, embezzlement, etc.

The speaker today was Patrick Kuhse. You have probably never heard of him. I had not until today. I won’t forget him.

Here’s what Patrick says about himself on his web site, www.speakingofethics.com, “I'd like to take you on my own personal journey, from successful stockbroker with a loving family and home in the suburbs of San Diego, to the jungles of Costa Rica as an international fugitive, to incarceration in two countries and back again. After spending four years in prison, I now devote myself to speaking to audiences worldwide about the importance of ethical behavior.”

This presentation was riveting. It had a message that was far more than how to be “ethical” in the financial services industry. It was about how any of us can lose perspective, commit critical thinking errors and slide into an ethical morass. I found it humbling.

Patrick opened his presentation with a reference to Socrates. The famous Greek philosopher would evaluate an issue, an opportunity or a situation by asking three simple questions:

1. Is this truthful?
2. Is this good?
3. Is this useful?


If Socrates could not answer each of these questions positively, he would simply move on.

How simple. We should ask ourselves these questions whenever we are uncertain about how to react to a set of circumstances.

Wednesday, July 14, 2010

Successful DIY Investors

I recently read William Bernstein’s The Investor’s Manifesto. He wrote this in the aftermath of the recent stock market crash. Bernstein seeks to help investors regroup and reminds them of the strategies that lead to long term investing success.

In the foreword to the book, Bernstein identifies the characteristics of successful investors:

  1. They possess an interest in the process of investing.
  2. They have a basic knowledge of probability and statistics.
  3. They have a firm grasp of financial history.
  4. They have the emotional discipline to execute successful investing strategies.

How many self-directed investors truly possess these qualities? Indeed, how many investment advisors can make this claim?

Wednesday, July 7, 2010

The Responsibility of the Media

An article from The New York Times News service ran in yesterday’s (July 6, 2010) Oregonian. The article was titled, “Get out now, stock theorist warns.” The article described how one stock market forecaster, Robert Prechter, is predicting that the Dow “is likely to fall below 1,000 over perhaps five or six years …”

Apparently, Mr. Prechter is a forecaster and social theorist who basis his work on something called the Elliott Wave Theory. I will admit that despite having been an avid student of investing for a decade and I have never heard of this theory. So, I went on the web and did some research.

As I suspected, Elliot Wave Theory is a form of technical analysis (source: Wikipedia.org). It is used to forecast trends in financial markets by identifying extremes in investor psychology, highs and lows in prices and other collective activities. The concept was developed by Ralph Nelson Elliott (1871-1948) who was a professional accountant.

I have studied technical analysis. It uses price and volume data in an effort to predict the direction of a security or the market in general. It has been widely discredited in the academic community. Burton Malkiel’s book, A Random Walk Down Wall Street, is probably the most well known work that refutes the notion that security prices follow any pattern. The Efficient Market Hypothesis, even in its weakest form, dismisses the usefulness of pricing data in market forecasts.

I find it disturbing that the media would pick up the shocking predictions of one prognosticator and suggest the investors should “get out” of the market. This to me is completely irresponsible journalism. I could easily find several equally credible market forecasters who predict that the market will reach some glorious new level in the next five years.

The truth is that no one knows where the market is going. A read of the most credible work on investing consistently warns readers to be wary of anyone who claims to know where the stock market is headed. There are two kinds of people. Those who know they do not know and those who don’t know they don’t know.

Shame on The Oregonian for printing an article that was clearly intended to incite the reader. Just what we need. Millions of investors panic and sell their investments. Then Mr. Prechter’s predictions just might come true.

Friday, July 2, 2010

SEC to “Study” Fiduciary Issue

As I suspected all along, the House and Senate punted on the imposition of a fiduciary standard for all financial advisors. The financial reform bill has been renamed the Frank-Dodd Wall Street Reform and Consumer Protection Act of 2010 after House Financial Services Committee Chair Barney Frank (D-Mass.) and Senate Banking Committee Chair Christopher Dodd (D-Conn.). It calls on the Securities and Exchange Commission (SEC) to conduct a six month study of the issues surrounding the standards of care under which various financial advisors operate. Currently, stock brokers, insurance agents and other advisors operate under a “suitability” standard. Registered investment advisors must adhere to a “fiduciary” standard. [See my previous blog posts for an explanation of the differences in these two standards.]

The SEC must develop regulations that reflect the findings from this study. The bill’s provisions empower the SEC to impose the same “fiduciary” standard on broker-dealers that applies to registered investment advisers. Indeed, Representative Frank has indicated that he expects the SEC to do so. “We gave the SEC the power to do it,” said Mr. Frank from the House floor, “and they’re going to do it.”

We shall see. The bill must still pass in the Senate. With the recent passing of Senator Robert Byrd (D-West VA), that won’t happy until after the July 4th recess. There continues to be significant opposition to the bill in the Senate and it is not clear that the bill will pass as written.