investments

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I’ve been seeing a lot a recent press warning investors about Financial Advisors.

Most FAs aren’t your advisors. They are just salesmen of financial products. The titles on their business cards don’t mean anything. Financial Advisor, Wealth Manager, Private Wealth Manager, Your Personal CFO….they’re just made up titles with no minimum qualification. See this article in the New York Times cautioning you against advisors with fancy titles.

For the most part, they’re brokers (and thereby fully commissioned salespeople), whose main objective is to make as much money for their firm and for themselves. They do this by “selling” you a financial product like a mutual fund or insurance vehicle with an investment component.

Only they don’t call this “selling”. They call it “investing” your money.

But when someone puts my money in a vehicle with high up-front fees and ongoing expense ratios, I call that selling. Plain and simple.

One of my friends recently had an “advisor” put him in a bunch of mutual funds offered by Mass Mutual. These funds all came with a 5.75% front-end load (or fee) and an annual 1.75% expense ratio. All of the front-end load and part of the expense ratio was a commission back to his advisor.

One of the funds was a unit trust and even came with an expiration date. After a couple of years the fund automatically sells everything and you get the cash value of the stocks at that time. At that point your “advisor” is free to put you in another fund with an upfront fee and restart the whole process again. Read this excellent article about the mutual fund industry’s rating scam.

It’s not uncommon for unsuspecting victims, I mean customers, of such “advisors” to pay 6% in upfront fees and 2% a year in mutual funds fees. And then pay an additional 0.5% or 1% as the advisor fee!

But that doesn’t mean advisors don’t add value.  Here’s a great piece by the White Coat Investor on the benefits of using a Financial Advisor.

Before hiring a financial advisor, or planner, make sure you ask a few important questions.

Are they your fiduciaries?
That is, do they have a a legal obligation to put your interests first? Or does their firm come first?

How are they compensated?
Do they get commissions from any of the products they sell? If so, will it be disclosed upfront?

Ideally, you’d want to use a fee-only advisor – they only get compensated by the fees you pay them and don’t except any commission. This removes any conflict of interest.

What’s their investment methodology?
Do they just put you in a bunch of stocks or mutual funds? Or do they use Modern Portfolio Theory to put you in a well-diversified portfolio where they show you (and take the time to explain) the portfolio’s alpha, beta, standard deviation and sharpe ratio (see definititions at investopedia.com). If they use mainly low-cost ETFs instead of mutual funds, they might be able to pay for their services just by the reduction of fees alone. For example, if their portfolio of ETFs has an expense ratio of 0.4% and they charge 1%, that’s like you buying a mutual fund charging 1.4% on your own. But without the upfront load fees and mis-management that comes with it.

If you’re looking for financial planning advice then you want to make sure they have a background in finance, or a CFP to make up for it if not. Many ex-pharmaceutical sales reps (read pretty blonde women) make a career change and become financial advisors. Don’t just go for the cutest saleswoman. Make sure they understand investing and all the aspect personal finance like estate planning, and taxation.

When looking for a financial advisor, try looking for a Registered Investment Advisor Representative. People with this designation usually have a fiduciary duty and are more often than not fee-based instead of commission based. Go to Brokercheck.finra.org and put in the advisor’s name and you’ll find out whether he’s just a Broker or an Investment Advisor Rep. If he’s both, you definitely want clarification on how he is compensated.Investment Advisor Reps are required to provide prospective clients with a firm brochure called the ADV-2, which describes the services they provide, how they are compensated, their investment philosophy. Brokers are not required to provide this document. Make sure you ask for, and get this document from your advisor.

A trusted advisor can be a great resource. A salesperson can be disastrous to your financial future.

Do you have any advisor horror stories to share?

Byron Wien, chief investment strategist for Pequot Capital, has once again published his annual list of economic, market and political surprises. Last year, he got about half of his predictions right. He predicted gold bullion at $800, oil at $80, surging grain prices, and the rise in Latin America’s economies.

Wien believes that his ten surprises have at least a 50% chance of success in 2008. Although not a very high probability, they still make for interesting reading. Here’s his list for 2008, courtesy of Portfolio.com.

  1. In spite of Federal Reserve easing, and other policy measures, the United States economy suffers its first recession since 2001 as housing starts stay soft and banks are reluctant to lend to anyone where a whiff of risk is apparent. Federal funds drop below 3%. The unemployment rate moves definitively above 5% and consumer spending is lackluster.
  2. I think this is highly likely to come true. I’ve been saying there’s a chance of recession for a while, so maybe I’m biased, but I think there’s a 90% likelihood of this prediction coming true.

  3. Standard and Poor’s 500 earnings decline year-over-year and the index drops another 10%. Energy and materials stocks hold up relatively well in what is viewed as a correction rather than a bear market. Market conditions start to improve during the summer.
  4. Again, I agree with most of this. If the economy does go into recession, S&P500 stocks will see their earnings shrink. I’m heavily weighted in energy and commodity and I think they’ll do well. Don’t know about the summer prediction though. I thought the market usually went through summer doldrums as everyone goes on vacation! Maybe due to the weak dollar, inflationary climate and recession people might not go on vacations this summer!!!!

  5. The dollar strengthens in the first half reaching US$1.35 against the euro and weakens in the second exceeding US$1.50. The European Central Bank begins an accommodative monetary policy. Foreign investors flock in to buy cheap assets in the US early in the year but the dollar declines later as several countries holding large reserves diversify into other assets.
  6. Not sure if the dollar will strengthen that much, but at the end of the year, I’m definitely expecting it to be weaker than it is today. It seems that me that most countries are in a race to weaken their currencies and so-far the US is “winning”. I think that foreign investors and sovereign wealth funds will definitely start to pick up US assets as their currencies become stronger. Not that its necessarily a wise thing to do, but it’ll probably happen anyway.

  7. Inflation rises above 5% on the Consumer Price Index as higher commodity prices and oil finally begin to have an impact in spite of modest wage increases. The 10-year US Treasury yield rises to 5%. Stagflation becomes a frequent presidential campaign and Op-Ed discussion topic.
  8. I agree with the inflation part. I think that the 10 year US Treasury yield will drop a little bit. Its currently at 3.9%. I think it’ll go to 3% rather than 5%. Stagflation is definitely on the cards.

  9. The price of oil goes down early in the year and up later, sinking to US$80 a barrel in the first half as western economies slow and inventories are drawn down, and rising to US$115 in the second. Established wells continue to decline in production while China, India and the Middle East increase their consumption.
  10. Very likely scenario. That’s why I’ve been buying Canroys on dips.

  11. Agricultural commodities remain strong. Corn rises to US$6 a bushel and cotton to US$0.85 a pound. Gold reaches US$1,000 an ounce as disillusionment with paper currencies spreads across Asia.
  12. Bush’s great ethanol idea will cause Corn prices spike. As more crops are replaced to plant Corn, they’ll start rising too. Since corn is used as animal-feed, milk prices might also increase along with meat prices. I definitely agree with Gold rising further. I’ve been bullish since it was $505/oz and I think it’ll eventually exceed $3,000/oz.

  13. The recession in the United States slows the Chinese economy modestly but its stock market declines sharply. Investors recognize that paying biotechnology stock multiples for highly cyclical companies doesn’t make sense. The Chinese revalue the renminbi by another 10% to control inflation and as a gesture to foreign governments participating in the Olympic Games who complain that Chinese terms of trade are unfair. Several long distance runners refuse to compete in certain Olympic events because of continuing air pollution problems.
  14. The Chinese market correcting definitely sounds plausible. Not too sure about the Olympic runners though. I think the Chinese Government will ban all polluting vehicles and industries 2 months before the games!!! Heck, they might even enforce a ban on cooking!

  15. The new Russian President Dmitry Medvedev, under the tutelage of Vladimir Putin, becomes more assertive in world affairs. He insists that Russian oil and gas be paid for in rubles and demands a Russian seat at major world conferences. Russia and Brazil stock markets lead the BRICs. The Gulf Cooperation Council markets begin to attract interest among emerging market investors.
  16. The Petro-Rubble? Well, why not? Seems like the smart thing to do!

  17. Infrastructure improvement becomes an important election theme for both parties and construction and engineering stocks rally in anticipation of huge programs beginning after the new President’s inauguration. Water becomes a critical problem world-wide and desalination stocks soar.
  18. After the bridge that collapsed in Mississippi, I hope infrastructure development does become more important. Water is probably the next “oil”.

  19. Barack Obama becomes the 44th President in a landslide victory over Mitt Romney. With conditions in Iraq improving, the weak economy becomes the determining issue in voters’ minds. They want to make sure that gridlock ends and Congress gets something done for a change. The Democrats end up with 60 Senate seats and a clear majority in the House of Representatives.
  20. I hope not! I’m keen on Ron Paul winning.