Financial Advisor-Fee Only vs Broker

While a broker is required to offer "suitable" investments, they are perfectly within their rights to ignore the investments that would be best for you. That's right, if given the choice to put your money in a very good low-cost investment and a so-so investments that pays them a fat commission, there is no law preventing them from selling you the poorly performing investment. In many cases brokers do not have low cost or no load investments available to sell. There is a lot of confusion among consumers about the different rules guiding brokers and advisors. These rules that differentiate a broker from an advisor go back to 1940. Unlike a broker, a registered investment advisor is considered a fiduciary, a term that means they are legally required to recommend to you only what is in your best interest. Of the vast amount of financial 'experts' only some are actually fiduciaries. What makes matters even worse, until recently, brokers were allowed to act as both advisors (fiduciaries) and brokers with the same client. The U.S. Securities and Exchange Commission took a small step to correct the problem in October 2007, after a court ordered it to change the rules that allowed brokers to wear both hats. Under the new rules, brokerages now must maintain clients in advisory accounts, complete with fiduciary duties or move them into regular brokerage accounts, with lower level of consumer protection. To maximize the chance that you are receiving objective advice hire a fee only advisor, they charge an upfront fee or a percentage of assets under management (usually about one percent per year). Not only are such advisors legally bound to work in your best interests, but there's also a structural advantage. They don't earn a commission so they have no incentive to recommend one product over another, or to do anything for that matter.

When Is The Best Time To Be Prudent?

When is the best time to be prudent? Most investors respond, “It is always the right time to be prudent.” And they’re exactly right. If imprudent risk-taking and speculation has cost you money, the worst thing that you could do is participate in imprudent, speculative, and risk-taking activities going into the future. So why do people often insist on continuing with the imprudent behavior? Because to admit that there’s a better way, they, in effect, have to admit that they were originally wrong. To admit that our own behavior or decisions were ill-founded in the past is threatening to the personal ego. This realization can be extremely painful to deal with. For many people, it is easier to make a bad decision even worse by continuing the destructive process than to face it head on. The opportunity, here, is to realize that you are not your decisions, and just because you made an improper, or imprudent decision in the past, does not mean that you are less of a person, or less intelligent. As a matter of fact, it’s a sign of intelligence and growth to solve and put an end to a destructive process when you become aware that it exists.

Will it ever end?

When you are in the middle of down markets like this.....it feels like it will never end-but it will. To draw a comparison. If the value of your home dropped due to a bad real estate market, you wouldn't sell it a loss just because of a temporary market drop. The same should be true for your investment portfolio. Investors who stay the course, remain diversified, and "tough-it-out" realize the rewards of rebounding markets. The truth of the matter is no one can predict the future with any certainty. You will always find someone whose "prediction" comes true, however you can never know who the "someone" is before hand. We know that market timing does not work consistently. To Do's for the Prudent Investor:*Turn off the hype. Ignore the messages of chaos and panic thrown at you from the media circus. *Focus on the long term. Your goals and investment objectives for the long term have not changed...your portfolio should be designed to weather market storms like this. *Hire an investor coach and attend their Investor Education sessions....it will make a HUGE difference in your confidence and understanding of what is happening. *If you have questions or concerns, call your coach; I will help you do the right thing (which may be nothing at all). *Trust in the process. You should be invested a globally diversified portfolio which is designed to protect and preserve your portfolio-even in volatile and turbulent times. I have no idea when the market will turn or change. I am confident, however, that the markets will do exactly what it has always done, and investors who are diligent will reap the rewards that historically have followed down periods. We will do everything we can to help you understand and embrace these wild and free markets, so that you can gain all the rewards inherent in the system.

Should I Get Out?

Recent weeks have brought with them tough and rocky times relative to the stock market. Many investors are feeling the anxiety and fear that comes along with these unstable market conditions. What we are experiencing in the market right now is nothing new--it is simply market volatility at work. It is the downside that we all take for being in the market. Accepting this volatility is what makes investing so rewarding in the "good times." I know you have heard this all before, but sometimes it bears repeating.....Market prices and movements are random. No one knows where the next 20% move will be, but the next 100% move is always up. I understand that you are being bombarded every day by messages of doom and gloom from the media. The best thing you can do for yourself and your portfolio is turn it off, ignore it, do anything you can to get away from those toxic radio programs, television shows, and magazines that would have you make imprudent investment decisions out of fear and panic. Encouraging you to sell now or any type of market timing would compromise your opportunity for long term success. Remember that large wire houses and brokerage firms make these recommendations so that they can profit from increased trading induced by the fear created with the deep pockets of their marketing machines. The reason you need me, an investor coach, is to get you properly diversified and to help you see your way through the uncertain times. It is my job, your coach, to help you do the right thing and keep you on the best course for long-term investment success.

Three Factor Model

Ninety six percent of a portfolio's variation in returns is due to risk factor exposure (Fama & French, 1991). The Three Factor Model allows the investor to structure a portfolio based on these three distinct factors without the need to stock pick, market time, or rely on past performance of a manager or investment. After fees, traditional active management (stock picking, market timing and past performance) underperforms passive investing (Bogle, 1998). Therefore, by structuring a Three Factor Model portfolio, an investor can capture unique dimensions of return in the market without the need to stock pick, market time or base investments on past performance. The Three Factor Model consists of three distinct factors: 1. The Market Factor(equities vs fixed income in the portfolio) 2. The Size Factor (large company stocks vs small company stocks in the portfolio. 3. The Value Factor(value vs growth stocks in the portfolio) Free Market Portfolio Theory allows the investors to capture the market rate of return with broad asset class exposure while adhering strictly to diversification.

Modern Portfolio Theory

The second component of Free Market Portfolio Theory is Modern Portfolio Theory. Dr. Harry Markowicz discovered Modern Portfolio Theory in the early 1950's and won the Nobel Prize in economics in 1990. It took nearly 40 years for computer technology to advance to the point where Dr Markowicz's theory could be proven. By building a portfolio with asset classes with low correlation, ie, dissimiliar price movements, an investor can capture better returns with less volatility (a function of standard deviation). Modern Portfolio Theory is an excellent tool for investors to diversify their portfolios and prudently allocate their investments. Through Modern Portfolio Theory, the prudent investor builds a portfolio without guessing and forecasting the future. By diversifying in a full girth of asset classes, the prudent investor can capture a return which matches their risk tolerance. These asset classes consist of U.S. Large, U.S. Small, U.S. Microcap, U.S. Large Value, U.S. Small Value, International Large, International Small, International Large Value, International Small Value, Emerging Markets, Emerging Markets Value, Global Bonds, U.S. Government Bonds. These asset classes when combined with other asset classes offer low correlation and provide broad diversification to the portfolio. The next article will cover the component of Free Market Portfolio Theory, The Three Factor Model.

Free Market Portfolio Theory

There is an investment approach backed by academic and Nobel Prize winning research called Free Market Portfolio Theory. Free Market Portfolio Theory is comprised of three academic and scientific components:

• The Efficient Market Hypothesis
• Modern Portfolio Theory
• The Three Factor Model

This article will focus on the first component The Efficient Market Hypothesis. Future articles will address Modern Portfolio Theory and The Three Factor Model.

The Efficient Market Hypothesis is based on the work of economists Adam Smith, who wrote Wealth of Nations in 1776 and is the backbone of our free enterprise system today, F.A. Hayek and Eugene Fama. Fama published a groundbreaking work in 1965 in the Financial Analysts Journal aptly named “A Random Walk in Stock Market Prices.” Borrowing from the work of Adam Smith and F.A. Hayek, Dr. Fama posited that the market prices goods and services appropriately and that prices are random and unpredictable. Further, since all knowable information is already in the current price, it is unlikely for someone to consistently find undervalued or overpriced securities. What this tells us is that it is not possible for anyone to consistently predict where prices will go. Since it is difficult to predict market movements and capture additional returns unrelated to risk. Therefore it is prudent to build portfolios that capture the returns of all markets including all global markets.

When we utilize this concept we take out the speculation from investing. Stocking picking, market timing and track record investing all are based on the premise that there is someone who can predict the future. Unfortunately there are two groups of individuals when it comes to investing, those who don’t know where the market is going and those who don’t know they don’t know where the market is going. A great example of this is the second richest person in America and a very successful investor, Warren Buffet. While the market was earning 20, 30 or 40% per year during the 1990’s Mr. Buffet was earning far less, in fact with a 15% loss in 1999. Had Mr. Buffet known where the market was going he would owned only the right ‘things’. If anyone knew where the market was going why would they tell you? We can be successful in investing by following a disciplined, long term approach. To be successful, often requires the assistance of an investor coach. It is difficult for us as individuals to ignore the media, our friends, associates and family when the markets are going against us. On our own we often make trades that are not in our own best interests.

Future articles will address Modern Portfolio Theory and The Three Factor Model.