Comprehensive Advisor

Investment discipline

There are 3 keys to every disciplined investment program.  The 3 keys to disciplined investing are to implement a diversified portfolio, rebalance the portfolio on a regular basis, and to avoid responding to the hype in the media.

Implementing a diversified portfolio should not be a problem for most people.  Unfortunately, too many 401(k) investors let their balances accumulate in money market funds or something called a stable value fund.  Stable Value funds are another name for a money market-like investment.  In either the money market or the stable value fund approach, investors are taking on large amounts of inflation risk.  These types of investments tend to lose purchasing power over the years.  While using a stable value fund may look disciplined from the outside, it is a very bad idea over the long run.

Rebalancing is another problem for most investors.  People tend to want to hang on to their winners thinking the good times will continue.  And, people will hang on to their losers hoping for a turnaround.  The concept of rebalancing is not difficult, but people tend to want to time the markets instead of letting the markets work for them.  Rebalancing ensures you sell some of you investments at a high price while buying into investments at a relatively low price.  This helps you to attain the investor's holy grail, buy low and sell high.  But it is difficult for most investors to rebalance on a regular basis.  We recommend quarterly rebalancing.

Avoiding the media hype is certainly difficult for anyone to be completely successful at.  The media is omnipresent and the messages keep getting louder.  The current hype around hedge funds is an excellent example.  Now that hedge funds are being reported in the media as huge winners (some big losers, too), the price for most investors is just too high.  Most of the gains have already been achieved.  There may be some gains ahead still, but most investors jumping into these tools will be taking on the chance for much more downside than upside.

The 3 keys for discipline are to implement a diversified portfolio, rebalance it, and avoid the media hype machine.

In our next entry, we will discuss portfolio monitoring.

Delegating investment responsibility

Since most of us are investing experts, there's absolutely no reason to consider hiring anyone else to help.  Right?  No way my friends!  One of the basic guideposts for a fiduciary is to hire experts to select the individual investments, whether stocks and bonds or mutual funds.

The reason we hire experts is exactly because we are not experts.  No matter how much time we spend examining the Wall Street Journal, watching CNBC, or dissecting Morningstar reports, we are not experts.

Consider the definition of expert.  An expert is a person with special or superior skill or knowledge in a particular area or someone having, involving, or demonstrating great skill, dexterity, or knowledge as the result of experience or training.

No matter how much self-study you might perform, you are not an expert when compared to the folks at American Funds, Davis Funds, or just about any high quality mutual fund.  These managers have years of dedicated experience.  They went to college, graduate school, and many went on to earn their PhDs in the area of investments.  Many earned Chartered Financial Analyst designations and other specialty certificates.

Does this sound like you?  If so, then you're an expert.  If not, then hire an expert!  Do not fool yourself just because you might know the difference between yield and total return.  Hire experts.

In the next entry we will discuss the importance of discipline over the long term to implement your investment decisions.

No load mutual funds

Most people might think a blog about no load mutual funds belongs in the Investment category, au contraire!  Most people who are using broker-sold funds are either paying a front load or a very high annual load.  Hence, this is all about being a fiduciary, that is, looking out for the client's best interests.

Any stockbroker who sells a loaded mutual fund while knowing no loads exist is clearly breaching fiduciary duties.  In other words, the sale of a load mutual fund is always in the broker's best interest, never the clients!

The best advice any investment advisor can offer clients is to use well known investments with a low cost that are run by experts.  The no load mutual fund fills this description most fully.  Even a recent Wall Street Journal article touted the low costs of open end mutual funds when compared to their ETF competitors (often mistakenly touted as being cheaper than no load mutual funds).

So the next time your broker wants to sell you one of their expensive load funds, remember that almost every quality load fund has a no load or load waived sibling.

In our next entry, delegating investment responsibility will be the topic.

Determining risk tolerance

Determining risk tolerance does not start and end with a questionnaire filled out in your advisor's office.  Think of it this way, do you want your dentist to start with a questionnaire asking you how far in can the drill go and how much pain can you stand before injecting any Novocain?

Of course, not!  Determining risk tolerance is not a one-time event. Nor is determining risk based on an analysis at the person-level. Instead, risk tolerance must be assessed at the individual investment level.  Risk tolerance should be determined for each asset and every asset class in the investment portfolio.

People can invest in pretty much any asset class that fulfills the risk and return goals of investor. Where the investor has to be concerned is in understanding how the individual investments’ risks could impact the rest of their financial lives. For example, a dip in vestment portfolio value immediately prior to retirement may be much more detrimental to achieving goals than a dip 10 years earlier.

Investing at a risk level that addresses overall investor goals is appropriate, while every other approach is not.

In the next entry, we’ll discuss approaches to asset class selection.

Plan goals, objectives and strategies

The very first and most important component of any Investment Policy Statement (IPS) is to figure out the goals and strategies.  With a destination, you arrive where, when and how you want to.  Without any idea or just a vague idea, well, any road will get you there, or not!

The IPS should fit into the larger goals of the organization, or family, or maybe, the individual.  This broader context is the fabric of your life and what makes you happy.

The decisions made in selecting and evaluating investments must be made to support this broader view.

Specific goals should be set for investments using appropriate benchmarks.  The benchmarks will help to evaluate your investment choices.

Next time, we'll look at managing risk.

Center for Fiduciary Studies

The Center for Fiduciary Studies fills the substantial void surrounding the nearly 5 million fiduciaries in this country.  The Center is focused on research into fiduciary duties and providing training for investment fiduciary responsibilities.

The overwhelming majority of fiduciaries in this country receive no formal training whatever.  The Center looks to rectify this notable shortfall.

In conjunction with the Center is the Foundation for Fiduciary Studies.  The Foundation is not-for-profit and devoid of any links to investment companies.  While fiduciary legislation clearly calls for a due diligence process in selecting investments, until the Foundation developed a series of handbooks, there was no process at all.

With the proper handbook and by taking the actions indicated in the handbook, any person with fiduciary duties can meet those obligations in a repeatable, justifiable, and sufficient manner.

To learn more about the Center and the Foundation, visit www.fi360.com.

Additional roles for the fiduciary

What about the roles of loyalty, diversification, impartiality, investment costs, and delegation for a fiduciary?  What do they mean?

In summary, fiduciaries must place the interests of their clients ahead of their own.  Fiduciaries must be loyal to their clients.  Not necessarily slavish, but be aware of the needs of their clients.

Of course diversification is a must when it comes to managing investments.  Diversification's main benefit is to reduce the risk of concentrated positions.  Anyone remember Enron and the employees who lost all of their retirement savings due to the concentrated positions these people had in Enron stock?  The fiduciaries at Enron didn't have a clue about their duties.  It may even be true the administrators of the Enron retirement plan didn't know they had a fiduciary duty to the plan's participants.  Now you know better.

As for investment costs, it is critical for a fiduciary to monitor the costs of investments.  For example, there can be no sales of load mutual funds by a fiduciary.  Since any fiduciary knows about the existence of no-load mutual fund equivalents for many excellent load bearing funds, fiduciaries cannot sell those loaded funds.  I know this is my soapbox and I'm on it!

Finally for today, fiduciaries should know what they don't know.  Unless a fiduciary is an expert in selecting investments, the fiduciary should delegate this activity to an expert.  The expert might be a CFP practitioner, CFA, or other accredited individual.

The next entry will discuss the role of the Center for Fiduciary Studies.

UPIA & Third Restatement

These two documents are closely linked.  They lay out the actual legislation and interpretations adopted by most states.  Since most of my work is in Virginia and these documents apply here, you may want to check out whether these apply in your state, or not.

Also, just in case you can't find the Third Restatement, try looking for Restatement of Trusts 3d:  Prudent Investor Rule.

Both pieces generally impose "the obligation of prudence in the conduct of investment functions."  The person overseeing investments considers "the purposes, terms, distribution requirements and other circumstances" of the investments.  Further, the investment activities must be viewed not in isolation, but in the context of the whole responding to the goals and objectives of the investment policy.

The heart of these documents is the list of parameters a fiduciary should consider when overseeing investments.  This list includes general economic conditions, inflation/deflation, tax consequences, the overall components of the investment pie, other resources, needs for liquidity, and more.

Next time, we'll discuss the role of loyalty, diversification, impartiality, investment costs, and delegation for a fiduciary in the light of the UPIA and the Third Restatement.

You're a fiduciary, so what?

You've heard the term fiduciary, especially lately, ever since the recent FPA lawsuit victory over the SEC.  A fiduciary duty can be imposed on a person in a number of ways.  Wait, let's define fiduciary.

According to dictionary.com, a fiduciary is a person entrusted with the property of another party and in whose best interests the fiduciary is expected to act when holding, investing, or otherwise using that party's property.

A fiduciary can be a person from many walks of life, including small business owners who have 401(k) plans for their employees.  A fiduciary can be a member of a board of directors.  The point is someone can be a fiduciary and not even know they are liable for the tremendous responsibilities.

A person registered as a Registered Investment Advisor with the government, usually the SEC or the state is a fiduciary.  Most often the RIA has no training or special knowledge of what their role as a fiduciary means to themselves or their clients.

As a minimum, a person holding themselves out as an RIA ought to be versed in the Uniform Prudent Investors Act, the 3rd Restatement, and the Center for Fiduciary Studies.

In the next entries, each of these will be discussed.

Working With a Pool of Specialists

The second part of comprehensive advice is being able to call upon a vast pool of specialists.  In a firm like ours, these specialists neither pay us, nor do we pay them.  Each of them and us receives compensation solely from our clients.

Having these specialists as separate firms brings a level of professional services and client dedication that is impossible to achieve in large consulting firms.  Since each professional is responsible to their own firms and small staffs, we all must demonstrate to every client our service and commitment to our clients at all times.  We can never hide behind a corporate veil, nor can we blame circumstances beyond our control.

Finally, having specialists as outside entities ensures the solutions we provide are as unique as our clients.  We avoid the approach of providing cookie cutter responses to clients' needs.

In our next entry, we will talk about the differences between those who are supposed to act like fiduciaries and those with the training and skills to do so.  The difference is vast.