BUILDING A HOUSE OR A HOUSE OF CARDS?

BUILDING A HOUSE OR A HOUSE OF CARDS?

In reviewing portfolios I have noticed that client issues are most often concerned with the performance of an individual security….or several individual securities. It obviously makes sense that a security that you own will catch your eye when it is dropping in value! The main challenge with this approach to portfolio management is that the damage is most often done long before the security caught your eye!

You are not an insider and neither am I. If we were we would be filthy rich and not overly concerned with our daily or quarterly portfolio movements. The investment professionals are the first ones in on a good thing and the first ones out when things go wrong. That’s where the expression “buy on rumour and sell on news” comes from. In fact, unless you are a full time and well networked analyst, you are unlikely to ever get a truly worthy stock tip. The way we small investors can make money in the market, is through two key rules: never chase last year’s winners and always look at the big picture.

The first is obvious. If you never listen to the "Mad Money" or read the business section of the paper and if you ensure that on pain of death you never attend an investment seminar, you should be well on your way to success. Money is made by working hard, saving your spare cash, and investing over long periods of time in quality investments. The secret is to understand that the quality investments are only the building blocks in the big scheme of investing.

Your portfolio needs a good architect if it is to survive in tough times as well as thriving in good times.
Building on the architect theme, your house is designed to look great and meet all of your functional needs with windows, a furnace, plumbing and all the services and rooms you require. But the builder did not just drop by the hardware store and see what was on sale or what paint is the latest hottest colour (hopefully). They filed a plan of subdivision and the building design had to be approved to ensure the house was safe. Then they hired skilled trades to ensure the plans were followed and everything was within the building codes. Your portfolio is built exactly the same way, or at least it should be.
Unfortunately, many portfolios are built from a series of security purchases based upon what is hot today. If kitchens are not big winners with buyers lets not put a kitchen in the house, ditto for bathrooms that just need to be cleaned regularly. Sounds crazy but look in some portfolios and you see huge gaps in the basic asset classes because they were not in favour, were not sexy enough, or simply did not pay the advisor enough commission.

To get specific:
-think of cash as being the furnace and electrical components of the house. Flexible in that they are not always needed, but important because when you do need them you need them at the flip of a switch.
- lets look at fixed income as the foundation and basement of the house; a solid foundation that assures no matter how bad the weather, the house is not going to blow away or float away!
- equities are the siding, the landscaping, the paved drive, the Jacuzzi tub, the chandelier. They are the portion that gives the place curb appeal and provide pride of ownership. Quality equities are often the difference between successful portfolios and drab portfolios. They give your portfolio the lift that allows you to hold inflation in check and build that new addition on the house.
- alternative investments are the four car garage with a Porsche and a BMW. You do not really need them but if you can afford the cost then live a little and spend your mad money! Who know they may become classics and go up in value!

Okay, that’s a bit of a stretch, but you definitely need to have a portfolio that is built with sound planning and that includes the five basic asset classes: cash, fixed income, Canadian equities, U.S. equities and Global equities. You need them in the correct proportion and you need to understand the purpose they serve.

When you are buying a new investment you need to ask yourself, which asset class should I be looking at and what purpose is the investment going to fulfill. There is no sense buying a door when you need a window! Similarly there is no sense buying an equity when you need a bond! Do not get carried away worrying about what security to buy until you know what asset class you should be shopping for!

SOIS MIKE

BUY OR SELL SOMEBODY WINS AND LOSES

YOUR BUY IS MY SELL!

I had an interesting discussion with my broker today about a stock that was underperforming the expectations we had when we bought it. Coincidentaly at the same time I was reading an analyst review of the same security in the newspaper. It got me to thinking about how the industry handles analysis and recommendations on securities.

Let’s say you work with a portfolio manager who has every initial after his name. Your portfolio is a diversified mix of 30 securities. Your portfolio manager/advisor has 120 clients; all unique just like you! Allowing for overlap, your advisor needs to track and analyze say about 125 securities. If each security is given 5 hours of review quarterly that means approximately 2500 hours of work! Of course, you want your advisor looking at new securities and opportunities too, as well as meeting with you quarterly and of course she needs to prospect for new clients to stay in business. It becomes clear that analysis is truly a full time job for the research team not the advisor!

That is why they have specialists who utilize their CFA degrees and statistical skills to probe deeply into each security in a given sector. Far from your advisor being a one person show, they have the benefit of the brilliant minds and skills of all the top analysts. That obviously explains why we never lose money on a recommended stock selection! Just kidding folks.
With all the geniuses burning through the data and a skilled advisor reviewing the data it’s just like having a guarantee of performance! So why doesn’t it work that way? Well we all can make a mistake so maybe it’s not so much a guarantee as an extremely likely outcome that we will not lose money! Okay, that’s not really how it seems to work either…..what gives?

Well to get back to my discussion with the advisor; after a lot of discussion over several months we finally decided to unload a phone stock that was not adding value. The advisor had done their homework and provided the research results from the in-house sector expert who after following the stock for years had finally put up the sell sign. We were getting out with a small loss and a couple of years wasted.

What was interesting is that the newspaper I was reading was quoting a telecom analyst of some renown who had just reviewed the stock in depth and switched from a “hold” (industry code for a sell recommendation) to a vigorous “buy”. Hang on folks; they reviewed the same material, used the same math, and likely have the same accreditation. So how does it end up that they both come to the decision they had previously been wrong and it was time for a change in recommendation? And then, they both come to the exact opposite decision from the same data!

Just think; one of them will be considered brilliant and one will be considered a moron! Which one am I listening to? Well the obvious answer to those who know the industry is that they are both wrong! The data is obviously not clear and both are making bets on how things will end up. The thing is they are betting with my money and your money! The investor is the pawn in the game; the sucker with the money in many cases.

So who wins? Well the security industry wins of course. I sold and thus generated a commission and somebody bought my security based upon the opposite analysis and paid a commission. So are the analysts and brokers in cahoots to get our money? Not really. They all think they are right and they all think they are helping us get rich!

In six months I will let you know how it comes out! Until then I will keep reminding myself that my advisor has guessed right more often than not. How do I know that? Look up composite benchmark and then start tracking the performance of your advisor. Hopefully my advisor is doing the same with her researcher! As my friend John Home says, “You get what you inspect; not what you expect”!
Tracking results, SOIS MIKE

GAFFLEGAB COSTS MONEY

Today we are going to talk about how the challenges of today will inspire the financial wizkids of tomorrow! Most recently we have felt the impact of the "skill" or perhaps more appropriately, the "cunning" of financial engineering. The increase in "structured" solutions has come at a tremendous cost as we have all seen with the Sub Prime situation and ABCP fiasco.

While rationale minds might think that would lead to the sale of more "vanilla" securities like stocks and bonds and Index funds, that is not likely to happen any time soon. Financial engineering is "industry speak" for hiding the fees behind the concept. So whats coming next.....

What will actually happen is that the financial "engineers" will construct more of the same structured stuff that got us into trouble today! If real engineers and construction firms worked the same way as financial engineers, houses would be falling down all around us as I write. But one needs to assume we are not crazy enough to buy the same risky securities as the ABCP and bad mortgage products we bought; so this time around the engineers will have a whole new approach to the products. Look for the word "GUARANTEED" to become prevalent in the sale of the "new" structured products! Having just been burned they know we are all looking for a "sure thing" before we dip our investing toe back into the shark tank.

How will they manage this engineering feat? Think of a rundown dilapidated house, but with a new coat of paint and new vinyl siding! The risks and future repairs are hidden by the cheap covering to provide a sense of quality that is not there.

Securities are actually quite basic. They are investments upon which you earn a rate of return determined by rent and risk.
Rent is the return you could get from a zero risk investment such as a short term government guaranteed treasury bill. That is known as the "risk free rate of return".
The "risk" portion is the additional return you get for accepting volatility and some amount of uncertainty in your return. As an example with bonds that risk portion would be the credit risk of the issuer and the impact of interest rate changes on the bond value.

So, if somebody is offering you returns above the risk free rate, and suggesting you have a guarantee, then where did the risk end up? The return over and above the T-Bill rate means there is risk, but the guarantee means somebody else is taking the risk for you! Sounds great! So, just one question(?) what are they getting in return?

Well, for the most part they are getting a significant chunk of the return you might think you will be getting! The neat thing, for the engineers, is you are the only one putting money into the proposition! They are taking a per cent of your positive returns and none of the negative returns because the guarantee is paid for from your deposit. Perhaps now you can see where the cunning comes into the equation!Perhaps these products need to come with a warning on the label:

CAUTION: Guarantees may significantly reduce the value of your investment while drastically increasing your costs!

While that is never likely to happen, the real disgrace is that these products will be sold to those seeking the least risk and who can often least afford the costs.

So what should you be watching for:

Guarantees: Unless you are buying a bank GIC with CDIC coverage or a short term Government Bond, do NOT ever trust a guarantee.

GaffleGab: If you do not understand a product, do NOT think it is because you are stupid. There is a great chance the confusion is intentional and a pretty good chance your advisor does not really understand it either.

Fees: Structured products are often designed to hide fees. Ask for a clear description of all fees in writing from your advisor along with comparable fees without the guarantee. In fact ask your advisor why they can not create the same product for you from standard easy to understand securities.

The attached leads to a great Ken Hawkins article on structured products for those wanting to learn more!

sois mike

http://www.investopedia.com/articles/financial-theory/08/structured-products.asp

If the article does not open when you click the address, paste the address in your browser

Its Not A Lie If My Fingers Are Crossed

I can remember playing around as kids with my brother and sisters. Our general rule was "it's not a lie if your fingers were crossed when you said it". Of course, as kids our little white lies did not have the power to destroy wealth or mislead strangers. It was more likely to involve who took the last cookie or who left the milk out.

As we read through the tangle of information and dis-information from those selling securities, the little errors of ommission or implied information becomes a much bigger risk to investors.

A great example was exposed in the recent article by Rudy Luuko in the Toronto Star this week. For those that follow Mutual Funds, Mawer has been a great company that delivers on its promise of quality investing at a reasonable price. While many firms have partnership agreements, one of the Mawer partners sells what is basically the same fund as Mawer sells, but at a much higher MER. That higher management expense ratio funds a bigger trail of commissions back to the advisor. So once more the advisor has a choice: I can sell you the Mawer funds directly from Mawer at a low investor cost, or I can make a big commission by having my client buy the same fund through a partner firm. Hmmmm, I wonder how the disclosure works on this sale.

My guess is that the advisor crosses her fingers and says this is a great company with a great track record and maybe just forgets to mention the investor can buy the fund a lot cheaper if the agent looked past self interest and focused on wealth building for clients. For those who think maybe this is an isolated situation, please refer back to the sale of DSC style funds. The concept is the same. WHAT THE INVESTOR DOESN"T KNOW DOES HURT THEM!

Sois Mike

Bad Advice Has Consequences

One of the most common questions I receive is "what clues are there that I might have a bad advisor?". That is inevitably followed by the question "what is it costing me?". The answer is that bad advise may cost you a few dollars in fees and a few dollars in lost performance during a strong market, or it may cost you a substantial portion of your portfolio and a lot in fees in a soft market, or it may cost you your retirement lifestyle, your savings and your hard earned retirement in a tough market. The above is not a scare tactic. A bad advisor becomes readily apparent in rough markets when earlier decisions made in a strong market are exposed to the negative market forces. When investors take the "flight to safety" you will quickly know if you are holding "safety" or excessive risk. Warren Buffet expresses this concept by stating "only when the tide goes out can we tell who was swimming without a swimsuit". In investor language that is what is known as "naked risk exposure". Lessons are very expensive for investors who discover that their advisor is a great talker but not much of a portfolio architect
The below link to another Ken Hawkin article may help you self diagnose some challenges in your own situation.


The Cost And Consequences Of Bad Investment Advice
by Ken Hawkins


Many investors still rely on their investment advisors to provide guidance and to help them manage their portfolios. The advice they receive is as varied as the background, knowledge and experience of their advisors. Some of it is good, some of it is bad, and some is just plain ugly.


http://www.investopedia.com/articles/pf/08/bad-investment-advice.asp?Page=1

THE FEE QUESTION AN ADVISORS DILEMMA

ADVISOR DILEMMA, THE FEE QUESTION

One of the big challenges for an advisor is how to answer the question, what are your fees?

The question is a key one for investors because the way the question is answered tells a lot about how you will be treated as a client!
We have talked in the past about the variety of ways in which fees are charged. I want to state first thing, fees are necessary and you will pay them one way or another. The best of money managers and the worst will all charge fees. The best of course earn the fees they charge and it becomes a win-win situation. But lets get past the fact that fees are a given. Lets talk about how advisors respond to the question.

First Example: In a recent industry magazine I read a letter from an advisor who stated with conviction that his clients did not care for the details on the fees as they were netted from performance which is the bottom line measure for an advisor.

I would challenge that viewpoint by extending the logic to everyday transactions. Assume you were buying a car and wanted to know what you were paying above list price. That tells you how much the dealer is earning on the sale and allows you to decide if it is reasonable. It may not change the price offered, but it provides the buyer with disclosure and an ability to compare dealers. Similarly, if you hired somebody to paint a house you would want to know the cost of the supplies and the cost of labour so you could adjust costs as needed (faster painter or cheaper paint).

Another challenge to the “big picture” defence is the fact that performance numbers are excluded from most statements. If you can’t get pure rates of return or benchmark comparisons then the ability to measure the advisor’s net value is lost. Of course that may be the real intent.

Second Example: Advisor’s often are paid via a combination of up front sales commissions and trailers. Again, let me say that that is not necessarily a bad thing. The commissions are generated from the fund company for the most part and are not disclosed on an individual investor basis. Advisor’s often state that the client is made fully aware of the Management Expense Ratio (MER) on funds purchased, which discloses the fee the client is paying. That is indeed true. It does not however enlighten the client as to how much of the MER is given back to the advisor. That presents a challenge for clients who might explore different options that pay less to the advisor and have lower MER fees if they in fact could make a straight comparison with all facts disclosed. It might be bye bye DSC fees.

Third Example: Many advisors are telling clients that they are charging a flat fee as a percentage of the accounts assets, say for example 1.5%. That is an all cost absorbed fee and is transparent and easy to understand. Finally success you say. Well, not so fast. If these advisors purchase funds or wraps for the client there is often a double payment of the MER and the flat fee. That may not be a real problem when it is clearly explained up front on the fund purchase and an allowance is made to the total fees charged. The problem is when the added MER is quickly shuffled aside in the conversation before the client gets a chance to ask a key question.
If I am paying you 1.5% to manage my account, why am I also paying the fund manager to manage my money as well? If the fund manager is managing the fund, what are you being paid for? Again, disclosure and transparency are the key. A good advisor should be able to justify the fund purchase and should purchase low cost funds and or exclude the asset from the 1.5% flat fee.

So, what do great advisor’s do when asked the question about fees. Well, they actually get out the paper and pencil and go through the various fees they may earn, who is paying them, and why they are being paid, and most important of all how they will report the fees to you. They discuss their role in the process, how they add value, what they commit to on your behalf. You see the best of advisors know that if they treat you like you are the one who is the paying client you will understand how they are helping. They also know that you will not likely switch advisors, because the odds are the new advisor won’t answer the fee question to your satisfaction. The truly great advisors will provide you with full fee disclosure, an annual summary of fees paid, and proper performance results for the funds you are paying to own. They provide a variety of cost options with recommendations as to what is most efficient when you are buying a new security. They discuss the new issue commissions they earn on many products to ensure you understand how your purchase decision impacts their earnings.
It’s not rocket science to make informed decisions with all the relevant facts clearly disclosed to an investor. If a client is “not interested” in the fee discussion then the advisor needs to slow down, back-up, and start the conversation again because clearly they are not conveying the message of how large the fees become over time and how much they can siphon from an account if not properly monitored.
The best portfolios have full disclosure by an honest hard working advisor to an informed and involved client. So does that sound like your situation?
soismike

Fox in the Hen House

Retirement is often a battle between you and your advisor. Can you guess who is winning?

The success you have in preparing for retirement will depend on whether you or your advisor wins control over your investment accounts. Recent studies have made it extremely clear that you will need to grow your savings to supplement your government retirement income. For those fortunate enough to have a defined benefit pension, the battle is for maximum happiness versus a tight budget. For those without a defined benefit pension the battle will be for a reasonable standard of living versus dependency on others.

For many investors, they believe they have acted prudently, hired an advisor who will assist them, and worked diligently to save their money. Many will realize far too late that the fox is in the henhouse!

While there are a growing number of advisors who put the client first, the overall trend is still very disappointing. Most advisors put themselves first, their employer second and the client third. What proof do I have for such a bold statement? Recently there have been a number of surveys completed by reliable sources that suggest the industry in Canada charges the highest Mutual Fund expense ratios (MER) in the industrialized world. In fact, Alia McMullen in the Financial Post on Friday May 30th, does a good job of outlining the issues. Her articles is supported by the Rotman International Centre for Pension Management which has raised the alarm that MER’s may rob Canadians of the ability to fund their retirement years.

The issue of excessive MERs have been addressed ad nauseum in Canada but with little tangible results. So advisors work for companies that charge high MERs , what can they do you may ask yourself? Well, for starters they can reduce the damage instead of compounding the matter. However many put themselves first and sell products with the highest fees they can get when cheaper options would benefit the client. The sale of expensive deferred sales charge (DSC) funds makes the problem worse for investors but makes the advisor wealthier. The question I have yet to hear an answer to is “how does the investor benefit from purchasing expensive DSC style funds”. The obvious answer seems to be that they benefit by having a very, very happy advisor and fund company. There appears to be no tangible benefit to the client. I realize the advisor needs to earn a living, but not at the expense of the client.

The product selection between Canada and the U.S. shows how a closed shop in Canada allows for the sale of substantially more DSC funds in Canada versus the comparable U.S. per centage. Instead, Americans purchase a much higher percentage of Index funds. Would it surprise you to know Canadian advisors also have access to the same options but consistently choose higher cost alternatives?

What can you do? Have a strongly worded conversation with your advisor about any funds sold to you via the DSC option. Ask how you benefit by being locked into one specific family of funds by penalties outlined in the DSC schedule? Then ask the advisor how he/she was compensated and if it differs with the DSC versus say a front end loaded fund. The smart investor hires an advisor to work "for you" NOT "with you". You can hire better friends cheaper so do not be fooled into thinking you are part of a team approach. It all starts and ends with your money!
Watching your retirement slip away......
Sois Mike

SCORPION AND THE FROG

Many of you may be familiar with the fable of the frog and the scorpion. It is a story that holds a number of parallels with the investment relationship you may have with your broker or advisor.

The story is poignant as I have recently seen a number of cases where Investors react with disbelief when they are informed that the DSC on their funds was neither necessary nor advisable. Their immediate thought is that there is a misunderstanding because their advisor would never inflate the cost of their investments by selecting the more expensive sales option. In fact, I try to explain that the advisor actually cannot help themselves. Hence the fable.

The fable involves a scorpion asking a frog for a ride on the frog's back so the scorpion can cross the stream. The frog at first declines, fearing the scorpion would sting him and he would die. The scorpion argues, quite logically, that if it stung the frog, the scorpion too would drown. Seeing the logic the frog agrees to swim the scorpion across the stream. But halfway across the scorpion stings the frog! As the frog feels his muscles begin to convulse he asks the all important question,WHY? As the scorpion struggles in the water he says he could not stop himself even if it meant he lost his life. Why, because I am a scorpion!



Advisors are trained that they are "hunters" who live off the results of their sales efforts. They work hard to find customers and get the assets transferred to their firms. As hunters, the expression is that you "eat what you kill". That translates to you earn the income you generate. More is always better and as a great hunter they have earned the income. They begin to believe that you are lucky to have somebody like them advising you. Surely they deserve to make top level income for the hard work and effort they put into investing your money. As the hunter mentality sets in they are praised by their employer for increasing revenue and achieving ever higher revenue goals. But if they fail to make the goals, they are just average hunters, no longer a part of the elite circle of top producers.

The problem is that the advisor lives in the world of the scorpion. They do not charge the highest fees to hurt the client, they charge the highest fees to maintain their position in their organization. The client becomes a means to an end and that end is to maximize revenue. How do they sleep knowing they have charged so high a fee? They sleep like babies! Their can be no guilt or shame in a scorpion acting like a scorpion!

So, the next logical question is why do investors keep letting the scorpions hitch a ride? I guess we wouldn't if we knew they had the stingers. How do you protect yourself from being a frog?

Try telling your advisor straight up that you do not want any DSC commissions charged to your purchases. In fact, tell your advisor you will pay them a flat pre-negotiated fee or move to a new advisor. If you belong to a group that has access to salaried advisors take a good hard look at the benefits of an advisor who is not commission driven. Your advisor will tell you to avoid salaried advisors as they are not up to the calibre he is. Indeed, those salaried advisors are not worthy of being called hunters!

Fighting fees.....soismike
p.s. The he and she are interchangable. Scorpions come in both sexes.

SIMPLY TOO COMPLEX

Most portfolios are simply too complex. Unfortunately many investors are guilty of thinking complexity is a good thing! ITS NOT. having a portfolio that has exotic products can almost always ensure the portfolio has excessive fees. Even getting past that fee hurdle, the complexities of investing will generally subtract from performance not add to it.
I find that Ken Hawkins of Second Opinion Investor Services generally is the writer that best puts his fingers on the key issues and does it in a way we can all understand.......so here's Ken from his latest Investopedia article.
soismike

Many investors find themselves with a portfolio that is too complicated to understand, hard to manage and difficult to change. In fact, some investors' portfolios contain so many mutual fund and principal protected notes (PPN) that they match the complexity of billion dollar pension plans, but without the expertise and resources required to manage them properly. Individual investors, especially those who invest in mutual funds, should strive for simplicity in portfolio construction. Koichi Kawana, a designer of botanical gardens, says "Simplicity means the achievement of maximum effect with minimum means." This could also be applied to an investment portfolio. See the link for the rest of the article.

http://www.investopedia.com/articles/basics/08/simplify-investing.asp?Page=1

THE MEAN CAN BE VICIOUS

FUND RETURNS, REVISION VERSUS REVERSION OR THE VICIOUS TRUTH ABOUT THE MEAN

Did you ever wonder why that hot fund you bought is suddenly a dog? The fact that it has happened so frequently makes you start to think the market is personally trying to make you the world’s worst investor. You can relax, there is a good chance it’s not you that is the problem.

When you look at Mutual Fund advertising you can begin to understand the primary reason why investors almost inevitably buy the wrong funds at the wrong time. The reason of course, is that you do not really buy mutual funds; somebody sells them to you. Whether you read about the fund in the paper, saw the marketing at your bank, or had it recommended by your advisor, there is a good chance the seed was planted through a sophisticated marketing program.

That most marketing programs promote yesterday’s success is not important to the marketing machine; they need “outstanding returns” to put in big bold letters above the tiny warning about past returns not guaranteeing future returns. In fact, the warning should state that past returns are likely to foretell a weaker return in the future. Mutual fund companies know it, the advertising companies know it, and your sales person knows it! It’s really basic mathematics!

In statistics it is referred to as “reversion to mean”. That basic statistical rule suggests that over time the returns on markets, securities and funds will move toward the average. If a fund had a great 2007 then there is a great chance it will have a sub par 2008. If the fund had a great 2006 and 2007 then there is still a great chance it will have a sub par 2008. Knowing this basic rule, it would seem that promoting a poorly performing fund is just as likely, if not more likely, to produce superior results in 2008.

If you need proof Just look at the world’s indexes by country. Hong Kong was the top country in 1991,92 and 93 and just as you and I figured it out it went to last place in 1994. In 1994 Japan was number one and in 95,96 and 97 it was in last place. In 1999 it was back to first place. The U.S. was last in 1993 and second best in 1995,97 and 98 but careful because as you jumped in 98 the U.S. was headed for last in 2003,04 and 05. If you followed the industry marketing you jump in at the end of the bull and you sell out in frustration at the bottom of the bear market. The fund companies and advisors however take their cut in good and bad markets so they were not hurt nearly as bad as you.

What does the smart money do? The smart money is often called contrarian because it refuses to chase last year’s winners. The smart money also avoids the bubble stocks because they invest on sound fundamentals, not on marketing noise. Retail customers however invest by listening to the marketing campaigns. If everybody is getting into energy then I better call my advisor and get some energy stock. If everybody is buying REITS I better get some too. If everybody is buying Nortel I better get some too. To make the urge to chase hot securities seem legitimate you have the marketing supported by buy side analysis and seemingly independent sourses like Business News Network and the national papers with buy side articles telling you the top securities every week, month and quarter. How can all these folks be wrong?

Reversion to mean is vicious because it is relentless. What goes up does indeed come down and most often it does so shortly after you bought it. The smart money leads on the way up and the suckers follow as the security turns negative. Unfortunately in the security markets, retail investors are often played as the suckers.

How do you beat this cruel reality of the markets. You have two choices. You can find a great contrarian manager and hope their returns do not revert to the mean, or you can buy the indexes and accept the mean returns as a fair return on your equities. The indexes of course are not exciting, but they are cheap to own . Best of all in a well diversified portfolio you can accept the markets random emotional turmoil without wondering if you are the smart money or the sucker.

A lot of good will happen if you stop chasing last year’s winner and just accept that reversion to mean will balance your returns over time. You can play the market but you cannot beat the market by looking in your rear view mirror.
soismike

fee"dumb" 55

FEE-DUMB 55


WHEN IT COMES TO FINANCIAL PRODUCTS, TRUTH IN ADVERTISING IS A SPEED BUMP THAT RARELY SLOWS THE MARKETING MACHINE!

LET’S LOOK ATA FEW OF THE GREATEST MARKETING PROGRAMS IN FINANCIAL HISTORY! IN A PREVIOUS RANT WE DISSED THE CURRENT MARKETING SLOGANS OF THE BIG BANKS BUT WE DID NOT LOOK BACK AT SOME OF THE BIGGEST WINNERS IN CANADIAN HISTORY!

“FEE-DUMB 55”: AN INNOVATIVE PROGRAM OF MUTUAL FUND AND SEGREGATED FUND SALES DESIGNED TO ENSURE YOUR ADVISOR IS INDEPENDENTLY WEALTHY BY THE TIME THEY ARE 55 YEARS OF AGE!

The real cool part about this marketing program is the fact that it was the type of marketing that would naturally appeal to people nearing retirement; and yet that is the segment that it could do the least to assist. Unless you suddenly win a lottery at age 45, you will be hard pressed to find freedom from financial worry at age 55.

In fact this advertising should have been focused on graduating students who, depending on student loans, might be able to survive the high fee mutual fund market and retire at age 55. In fact a student who graduated at 20 and put $1,000./yr in an RRSP earning 6% would have a not very significant $125,000 to retire on at age 55. That is actually less than $50,000 in today’s dollars. So if you wanted to retire at 55 and visited your high fee sales person at age 40 you better be a mega income earner or have a great pension plan before you arrive.

In fact this campaign may single-handedly disappoint more Canadians than any in history. Retiring at 55 is not possible for most of us and even less possible if you have been paying 2.5% MERs!

Another great financial marketing scheme is being played our as we speak! Manulife is turning investing on its head with Income Plus! We can understand that a lot of blood has rushed to the investors head! How else do you explain an investment that is sold as a “guarantee” that will help you sleep at night; but has so many confusing twists and turns that it can keep you up at night just trying to figure out the odds you can ever reset and make a profit above what you put in!
At the end of the day one of the most common warnings comes to mind: if it is too complicated for investors to understand then the person selling it is making a huge commission. As with most “guaranteed” products, you pay a huge price to avoid an unlikely future loss over the life of the investment.

These two marketing schemes stand out as great examples of marketing to the unlikely dream on the one hand and the unlikely fear on the other! Greed that you can find a quick easy way to retire early and fear that the market will suddenly crash just as you retire! Both fear and greed can cause investors to look past fees and the skeptic might even think the ads count on that!

Let me know what marketing scheme is catching your eye these days!

Put Your Advisor on a Diet

Diversification Drift: The Diabetic Portfolio Syndrome

Imagine if you will a person on a strict diet who is working in a candy shop! Moderation is the key, and every day they remind themselves to be disciplined! It can’t be easy and inevitably most will fall off the wagon!
Well advisors can fall into the same trap! They know that equities need to be constrained to reduce the risk in your portfolio, but gosh they are hard to resist. They just look so good with a gooey analyst buy rating spread over the top!

The key to every great portfolio is to get the asset mix right! Nobody even argues that fact any more as history has proven the impact of asset allocation on portfolio volatility. Asset allocation is the primary reason why good advisors start with a financial plan. From the plan you can determine the rate of return needed by a client, and from that you can build an asset allocation model. In fact almost every investor can dig up an old account set-up and find an asset allocation model they received from their advisor long ago!
I challenge you to do so, and when you find it if you are over-weighted in equities please send me a nickel…..forgive me, I will have to write quickly as I am expecting a deluge of coin soon and might be retiring by the end of the week!

So why does it happen? Why would advisors increase the riskiest component of a portfolio above the agreed to targets! Well, advisors are only human. They are bombarded daily with equity recommendations from their bosses, their research departments, BNN, the newspapers and even from clients looking for the next Google! Combine that with the sugar high of big fat commissions and trailer fees and it is a wonder investors ever even know what a bond is! Equities are the sizzle; bonds are the roughage.

Slowly but insidiously, the equity component rises in the portfolio. Fortunately rebalancing should prevent the damage from being too severe or long lasting. Alas, rebalancing is a lot like exercise. It might be good for you, but somehow it keeps getting pushed to the bottom of the “to-do list”. That same old account set-up you found may well list the rebalancing schedule that hasn’t happened and the semi-annual face to face meeting that was not deemed necessary. All these non-events contribute to allowing the equity assets to become the fat kid of the asset class!

Probably my favourite ongoing example of equity drift occurs when I look at an E. J. statement. The statement lists the target for every asset class in the account;and beside that percentage is the actual weighting in the portfolio. It is amazing that clients don’t seem to rebel at the discrepancy from what the E.J. statement recommends and what the advisor actually has them holding!
Now I am sure not every E.J. Advisor is recommending clients be over-weighted in equities and it is probably just my small sample that distorts the fine work they do. I will say the E.J. statements at least show the recommended asset weighting which is more than many of the big brokers do!

So what is an investor to do? Put your advisor on an equity diet. And like any good dietician, have them check in for a semi-annual review to ensure they have not bulked up by nibbling on too many IPO’s or equity buffets. It may be your advisors diet, but the impact of too many equities will damage your portfolio long before your advisor shows any symptoms!

SOISMike
p.s. Beware structured notes which claim to be roughage but are filled with sugary equities and laced with fees!

Darwin Meets Investment Advice!

THE EVOLUTION OF ADVICE!

The more articles you see on how “advice” is sold, the more you want to run for the hills! I think Jonathon Chevareau has been trying to get to the meat of the matter with his recent articles on how different advisors charge fees, but sheeeeesh, should it be this tough?

Perhaps we need to take a trip back to a simpler time when trading stocks was the purview of the elite (i.e. you and I were not invited into the game)

Step 1: Back before Darwin, Brokers sold stocks to wealthy people who paid big commissions for the right to own companies…..you and I bought GICs and looked at the rich with awe and envy!

Step 2: That was good into about the early 1980’s. Then we demanded the right to play in the market; but being simple people we were not likely to understand the complexity of buying one stock! So the smart people set up little baskets of stock we could buy (mutual funds….even sounds a little socialist) at a modest fee. Since we were indeed quite simple, they decided not to bother us with the cost of owning these…they would use hidden fees and trailer fees we wouldn’t have to see for fear it might confuse us!

Step 3: As we paid these high fees without complaint the dollars rolled in and brokers split into two groups, the old guard serving the rich and Mutual Fund Salespeople to milk….er service the rest of us!

Step 4: Then along came a tough challenge for the industry, “discount brokers”! That allowed the mutual fund crowd to get their feet wet in stocks without paying the old guard their full stipend! It also caused fee leakage from MF’s into the DB’s (discount brokerages).

Step 5: Ever on the lookout for ways to make those fees, the smart guys started to stoke up the marketing machines and overwhelm the new investors with new products that they could buy. Soon discount brokers were the home of the money machines known as “day traders”! The average guy/gal thought it they read enough on the internet, watched enough ROB TV, and read the huge ads in the newsprint (think RRSP time); we could do it faster, better, and more frequently than the old guard brokers! Of course our dreams were quickly dashed when the “tech wreck” showed most of us we really were not that good at finding winners!

3b. (love my new math) So we had to back track and return to the MF guys, tails between our investing haunches, and buy more funds. However, we were a more educated bunch now. We knew the cost of a trade and we did not like the MERs on those funds any more!

6. (we are making progress again) Now the field began to divide up depending on our aptitude, level of over confidence/ability,and willingness to do our homework. A few who did not lose their shirts stayed on in the DB channel, those who lost total confidence went to GIC’s, some went back to the traditional broker but now the trade prices had to come down and even “buy &hold” became popular! Through it all, the rich stayed rich (big surprise) but with common folk now in stocks, more of the rich went to Portfolio Managers (fancy schmansy and an entry level deposit requirement to keep us out). Of course many, poorer but wiser, remained with the funds even though the heady days of fantastic gains seems to have gone away!

7. (we’re getting to the end) The deal breaker, earth shaker, and transformational change that occurred next actually began with but a whimper. Out of the U.S. came Index Funds”! They were cheaper than MF’s, they typically outperformed most other funds, and you did not need to pay an advisor! The marketing machine of the “buy side” kicked into high gear and the battle continues to this day! Brokers created new complex products that you had to have; index linked notes, structured products, hedge funds….i don’t know what they do but all the “smart money” is buying them! Heck, they even have this phenominal deal where they keep your money like seven years then guarantee they will give it all back!!!!!!

Finally: Love or hate MF’s or Equities or Bonds or Income trusts….the fact is investors today have more choice than ever! The real issue is the smoke screen of competing products, different fee structures, different types of advisors (fee-based,fee-only,commission sales and trailer based) and a marketing machine that changes the landscape daily with new commission schemes disguised as new products.

Now: What are we to do? Well, do what you understand! Regardless of what channel you decide to invest in WATCH YOUR FEES, ask questions, do not buy what you do not understand! Do not look for the friendliest advisor, look for the cheapest advisor and then monitor your account to make sure it is going up at least as much as the relevant benchmark indexes!

The Future: Planning advice will be bought separately from the securities selection advice! Overall strategy and planning decisions come from one advisor and decisions on what to buy or sell come from another totally separate source. One will not be allowed to impact the other, and like any good balanced approach, each keeps the other honest!

…..at least that’s how I see it all evolving! soismike

CHURN BABY CHURN CTV IGNITES A FIRE

CHURN BABY CHURN…..BROKERS ARE MAKING PROFITS BUT THE CLIENT ISN”T GETTING NO BUTTER!

I congratulate the CTV for having the guts to light a fire under the brokerage business and expose the total disregard that can exist for your money! But, alas, don’t wait for anything to change anytime soon! Too many people are making too much money pretending to be working for you!
Lets track down how all these evil deeds might be able to take place even in the biggest nanny state (province technically) in the nation, Ontario! It is as simple as following the money that leaves the customer account and figuring out where it ends up!

Ø Your broker wakes up in the morning and says “should I spend hours researching the stock universe for a truly undervalued stock for my loyal customers……or should I pick up the brokerages list of “action stocks” I should be pushing….er recommending”. Assuming I go with the list I can always claim I only recommended the stock after diligent research including logging onto my company website and reading the list! This effort is rewarded by soliciting a sale and earning a few hundred bucks for myself and the mother corporation!

Ø For those following at home, try to picture about 10,000 brokers sharing the same morning exercise and multiply by about $200. per….hmmmm quick math gives me about $2 million and its not even coffee time yet!

Ø Now the math gets tougher because we need to balance debits and credits….I learnt that during my week as a teller! That means client accounts must go down by $2 million as well. So when you get up in the morning and have your coffee, you have already helped the economy grow….and by economy we do mean the brokerages/banks in this example!

Ø Now the bad part for your broker is that they need to split the commission with the parent corporation so your broker has only actually made $100. from your account this morning…although you of course have lost an additional $100 to feed the bank/brokerage.

Ø Of course the neat part for the broker is its only the morning and they have about 200 other pigeons…..er I mean customers…they can repeat their efforts with in the afternoon.

Ø Now comes the tricky part….the trades are reviewed for ‘suitability” to, you know, protect your interests from some stupid trade that might not be necessary. Now who provide this quality control check in the brokerage world? It would be the branch manager. The branch manager is an experienced broker who has learned all the tricks and can spot a poor trade with his/her eyes closed. For doing this diligent job the branch manager receives compensation. Now think back again to the $100. that the brokerage/bank has made. Would you be surprised to hear that the manager was in on the skim and might make an income based upon how much revenue is generated by the broker? This override on revenue generated should be just the incentive to keep the manager from actually opening those eyes we discussed!

Ø Thankfully the companies all have hard working and honest compliance folks who truly do keep a diligent eye on what trades are taking place. Now the skeptic might ask who are they looking to protect….customers or brokers? You see, if too much money is skimmed (think of Vegas) then the authorities (security regulators) might actually look real close at what is going on. Rule #1 is do not kill the goose!

Ø Now you the customer might eventually get upset and begin to see what is happening. Your complaint goes to the branch manager, who then evaluates your complaint with great concern. The focus is clear: might this complaint be big enough to harm the “goose”? Fortunately, the little guys known as clients are rarely of a size to do any significant harm to the goose. So your complaint is actually a request to the broker to potentially lower his/her income in return for which they will get an angry broker and lots of paper work.

Ø Now we are back to multiplication…..if the goose is exposed to too many complaints it may actually actually get sick. The branch manager (goose keeper) will, if push comes to shove, choose the goose over the individual broker! That’s because the system only works if the customers remain ignorant of the skim. If a dozen small complaints roll up to a regulator there is once more a potential risk to the goose.

Ø Hold on though! The industry has a secret weapon up their sleeve. The regulator is funded by the brokerage/bank. Indeed the full circle is now complete. Your money funds the broker, the branch manager, the compliance team, and the regulator! The only person not profiting would appear to be…..you!

I know this has been a long exercise, but remember, it’s only 10am. This industry still has the bulk of the day ahead of them! At a collective $2mm a pop, we should be thankful that the stock exchange does not share the 8-8 philosophy of the green bank!

Disclaimer: I really do want to point out that not all 10,000 brokers in the above scenario are churning accounts. The fun part of the game is you don’t know which ones are churning and which ones are working hard for their clients! A BIG clue can be found in your monthly statement! The better brokers are moving to a flat percentage fee where high trading is less of a concern for clients. If you make more than 10 trades a year maybe you should be talking with your broker……if they are back from Tuscany!
I think I am beginning to see why they are called brokers…….when they are done, we are broker! soismike

Its time to get "active" about being "passive"!

MANAGEMENT STYLES?
OK, so a money manager tells you that he can beat the benchmarks on a regular basis. You check the facts and low and behold.....not true! Most fund managers cannot beat the index with any more predictability than I can predict the flip of a coin; well actually they are not nearly that good! I can probably predict the coin 50% of the time while recent stats suggest about 85% of fund managers did not make the benchmark over the last 3 years .

When a manager buys and sells securities in an attempt to beat the benchmark, that is called active management. If the same manager bought the index fund and held onto the index for the year, then we would say they did not try to beat the benchmark and are a "passive" manager.
Now, as guys/gals we know that "passive" is not generally a positive trait in people....we think of passive as being, well, wimpy! We want to be considered "active" which certainly sounds healthy and positive and a much better verb than passive.
To those who love "active"management it is as simple as the lottery philosophy; you can't win if your not in the game! Passive will never beat the benchmark! It will just outperform active funds about, oh say, 85% of the time! And did I mention it costs a lot less to own the passive index?
So for some time the debate has raged about "passive vs active"! But, of course life is not that simple! Money managers. realizing the inherent value in diversified low cost indexes, started to use them in an "active" fashion. Now the "passive" product is being actively managed to beat the indexes that they track! Huh? Well, actually, it does make sense if you can forecast which indexes are going to go up or down the most, and switch out of the dropping index and into the rising index! Of course, if you can't then it is a bunch of active trading that fails to beat the benchmark just like the active stockpicking did.
So how do we label our money managers?

1- active/active manager> actively manages stocks which are an active security
2- active/passive managers> actively manages indexes which are a passive security
3- passive/passive> buys and holds index funds with periodic rebalancing
4- buy and hold> buys stocks which are active securities but is passive in managing them

So there are a lot of ways to manage money and you need to know which your advisor is focused upon! I therefore highly recommend you get "active" about how your money is managed, don't be 'passive" about the results, and when it comes to fees, actively pursuing passive products will generally reduce your fees!
....time for a rest, I've had an active day!
soismike

Portfolio Complexity: The toxic cake!

Wow, do you ever wonder how an industry with so many smart people can get itself into such a huge mess? Having met Purdy Crawford, I know he is extremely bright and experienced and a great choice to sort out the ABCP issues in Canada. So is it not amazing when he takes months working with a hand picked selection of bright minds, and then acknowledges they have no idea what the ABCP is worth today! I guess that qualifies as complex!

Asset Backed Commercial Paper is one of the best examples of smart people outwitting themselves. It all starts with simple assets like a mortgage, but a straight mortgage can only generate so much profit for the smart folks. So from the mortgage comes mortgage backed securities, then comes a complex bundling process that is like baking a cake. When the recipe is right, the individual ingredients cannot be easily distinguished but the finished product looks and smells great! Unfortunately, as with baking, a little of the toxic stuff can be mixed into the investment bundle and perhaps not be fatal. Maybe we use a few ingredients that are past there "best before dates", who will know or care, right. Well, in a great kitchen the chef would notice and of course in the investing world the rating agencies would know. Quick comment: trust your chef before your rating agency, the chef is not paid by the flour mill!

Not surprisingly, it would appear that there is a limit to how much of the ingredients can be toxic before the cake is poisonous. And to bring this long analogy to an end; the cakes have all been baked, nobody knows how much of the ingredients are toxic, and there are very few investors lined up to sample the outcome! The smart guys in the kitchen can't tell the good cakes from the bad and it would appear the bakeries sold enough cake to feed the world!

So what have we learned: The old adage still holds true....you can't have your cake and eat it too!

As for complexity in your portfolio....beware the advisor selling baked goods! Check the ingredients before you scoop up the icing! For a more rational and clear understanding of portfolio complexity, check out the 3rd issue of the Second Opinion Newsletter .

soismike
==================================================================

Simplifying Your Investment Portfolio Ken Hawkins
“Perfection is achieved, not when there is nothing more to add, but when there is nothing left to take away”Antoine de Saint-Exupery
IntroductionA well diversified and uncomplicated portfolio is almost always better than one that is overly diversified and too complex. This is especially true for individual investors with limited time, analytical tools and expertise. Despite this, many investors find themselves with portfolios that are too complicated to understand, hard to manage, and difficult to make changes with confidence. This is especially true for investors that hold too many mutual funds and invest in too many complex structured products


http://www.secondopinions.ca/resources/issue_3_03.htm

Great advice on managing your mistakes!

Ken Hawkins falls into the category of great people who's advice I respect! I think the attached comments from a recent Investopedia article by Ken are a great reminder to all investors....you can't just wish away your mistakes! Ken gives a great breakdown of what we do wrong, why we do it, and how to stop yourself from doing it!
Enjoy!
soismike
==============================================================
The Art Of Cutting Your Losses by Ken Hawkins (Contact Author Biography)


One of the most enduring sayings on Wall Street is "cut your losses short and let your winners run". Sage advice, but many investors still appear to do the opposite, selling stocks after a small gain only to watch them head higher, or holding a stock with a small loss, only to see it worsen.

No one will deliberately buy a stock they believe will go down in price and be worth less than what you paid for it. However, buying stocks that drop in value is inherent to the nature of investing. The objective, therefore, is not to avoid losses, but to minimize the losses. Realizing a capital loss before it gets out of hand separates successful investors from the rest. In this article we'll help you stand out from the crowd and show you how to identify when you should make your move.
(click the link below for more....)

http://www.investopedia.com/articles/stocks/08/capital-losses.asp

by Ken Hawkins (Contact Author Biography)Ken Hawkins is a financial writer and vice president of Second Opinion Investor Services http://www.secondopinions.ca/, an investment consulting firm that provides unbiased and independent investment advice. His experience spans the investment world of the private client investor as well as the world of the institutional investor representing pension funds, asset management companies, mutual funds and investment counselors.

Who needs another blog?

I guess that is a question that every blogger asks when they begin the process of cluttering the Internet with their thoughts. As a grey beard I never really felt this Internet thing would catch on....but apparently I was wrong. I now find myself searching the net regularly for information or advice on everything from cooking to gardening to my pathetic golf game.
So why the "UnbiasedPortfolio"?
Working in the wealth management field I have found myself on many sites about investing and financial planning. What is interesting is how often I disagree with the information I read, even though it is presented as an incontrovertible fact! In fact, it quickly became apparent that I must have a weird perspective on things because I disagree with a whole lot of what is said by "experts"! What I soon noticed was that my level of disagreement was often directly connected to whether I was reading information from the "sales" side of the business. Years spent with a large financial company has perhaps jaundiced my view of "free advice" and commission sales people who "put the client first"! Suffice to say the first lesson I learned was when somebody is putting me first, the first thing I need to do is grab my wallet and hang on tight!

So a couple of things for the world to consider:
- no your not wealthier than you think you are!
- no banking is not this comfortable and there is no green arm chair to sit in!
- changes made last week won't put your child through university!
- when a bank "puts you first" they charge a hefty monthly fee to the millions of other people they are also putting first!
- if your partner is holding up a sign to the banker there is a good chance half your assets just left your account!
- news flash....you are unlikely to pay 2.5% MER on Mutual Funds and still retire to France or Italy!
Sorry if many are disappointed by these crushing realities!....but thats my Unbiased opinion!