Kimmunications

Lessons from the investment bank disaster

I saw last week that Merrill Lynch and Citigroup were in the news again for the exotic mortgage-backed investments that have helped to screw up the credit markets.  Merrill sold off nearly $31 billion of the investments for just 22 cents on the dollar. Citigroup is expected to write down $8 billion because of its involvement in these crazy investments.

Lots of analysts and reporters are talking about how these losses reflect the trickiness of the financial markets and how these collateralized debt obligations were risky ventures from the start. But I don't think that's really the lesson to take from these announcements.

It didn't take a genius to see what was happening. The big investment banks created a bubble, not unlike the tech bubble of a few years back. Everybody knew that eventually the bubble would burst and that things would get ugly. Everybody knew these investments were risky. But the investment banks ran into them head-on. Why? Because of their compensation system. There was the potential to make huge sums of money in commissions, so they were incentivized to take on huge amounts of risk. 

The investment banks also felt bullet-proof. They figured that they were too big to fail, and that the government would bail them out if they got into trouble. In other words, you and I would be on the hook if things went south.

A money manager at one of these investment banks has an incentive to take as much risk as he can with other people's money. He gets paid for gathering assets, and the more assets he brings in, the more he gets paid. The way to bring in more assets is to show outstanding performance over a short period of time and get publicity in the major financial magazines. The way to show outstanding performance in the short term is generally to take on excessive amounts of risk.

By taking that extra risk, the money manager puts his clients in position to lose a lot more down the road -- but the manager doesn't care. Why should he? He doesn't get penalized as a manager for the losses his clients get; he gets paid for the assets he brings in.   

This shows the systemic problem behind Wall Street's compensation structure. Whether you're talking about these exotic investments such as CDO's or the way that fund managers handle your funds, it doesn't matter. Wall Street types are incentivized to put their interest ahead of yours, and they do not suffer the same consequences as you do when you lose money.

These managers are paid handsomely and are widely regarded as the best in the business. They're supposedly geniuses. But if they can screw up their own companies so bad, do you really want them managing You, Inc.? 

The moral is clear. When Wall Street appears in genius mode, raking in huge profits on mysterious products and complex trades, the secret isn't genius at all. It's that hubris is running wild, and so is risk. And whether it's tomorrow or five years hence, risk will jump from the shadows, knife in hand, to cut genius down to size.

-- Shawn Tully, editor-at-large, Fortune Magazine

If you've been reading my blog or newsletter for a while, you probably know that I have six principles underlying my investment philosophy. Number One is "Most investments are designed to make Wall Street rich, not you," and everything else just cascades down from that.

I think the credit and liquidity problems we're seeing now is a fallout from the greed on Wall Street, and it's a prime example of why I advocate managing your own money. You are uniquely qualified to do it, assuming that you are properly educated. The good news is that it's not hard to learn. It's not a big mystery that takes years and years to decipher.

Even if you choose to have someone else manage your money, you still need to be educated. A properly educated investor is subject to the least amount of conflict-of-interest and can better distinguish between a good investment and a clever sales pitch.

Educating investors is what I do, and helping people succeed is what I love. If you're ready to take the reins of your own portfolio, or if you just want to be a more educated investor so you can make better, more informed decisions, let's chat. Give me a call at 214-245-5236, 1-888-6SNIDER, or send me an email.

SOURCES:
1. Story, Louise, "Write-Down Is Planned at Merrill," The New York Times, 29 July 2008. [accessed 30 July 2008]
2. Dowell, Andrew and Ed Welsch, "Merrill Deal May Cause Banks to Revalue Debt," The Wall Street Journal, 30 July 2008. [accessed 04 August 2008]
3. Tully, Shawn, "Wall Street's Money Machine Breaks Down," Fortune, 12 November 2007. [accessed 01 August 2008]

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Kim Snider is the President and Founder of Snider Advisors, an investment adviser registered with the SEC, focused on teaching individual investors a sensible, long-term investment approach focused on maximizing cash flow. For more information on Snider Advisors or the Snider Investment Method, please visit snideradvisors.com. Her book, How to Be the Family CFO: Four Simple Steps To Put Your Financial House in Order, will be in bookstores October 1, 2008.

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 888-6SNIDER to request the Snider Investment Method® Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

No Skin in the Game

I saw this quote on the wall at the grocery store the other day:

"'Tis an ill cook that cannot lick his own fingers."
– William Shakespeare, Romeo and Juliet

I always thought the quote was about cooking. But maybe the Bard was also trying to warn us about mutual fund managers.

According to a report from Morningstar, almost half (46%) of the U.S. stock mutual fund managers studied haven’t invested a dime in the funds they manage. And it gets worse from there, says Morningstar’s Russel Kinnel:

Fully 59% of foreign-stock funds have no ownership, 65% of taxable-bond funds have no ownership, 70% of balanced funds put up goose eggs, and 78% of muni funds lack ownership.

The data Morningstar used cover 6,000 funds. In 2004, the SEC began requiring fund managers to disclose their personal holdings, partly as a response to several scandals in the mutual fund industry. (There were so many scandals around 2003, I can’t even begin to list them all. Wikipedia has a good account, though.)

The SEC only requires managers to disclose the range of their holdings, and they’re pretty broad ranges:

• $1 - $10,000
• $10,001 - $50,000
• $50,001 - $100,000
• $100,001 - $500,000
• $500,000 - $1 million
• < $1 million

No matter how broad the ranges, though, these disclosures can give us an idea of how much skin the manager has in the game. Too often, the manager has nothing at stake. Kinnel continues:

There are really only two excuses for not owning a fund you run. First, if you run a single-state municipal-bond fund for a state other than the one you live in, it doesn't make sense to own that fund as you won't benefit from the tax breaks. Second, managers who are citizens of foreign countries have a good excuse if their country bars investment in U.S.-domiciled funds.

A number of foreign-stock funds are run by foreign citizens and that may account for the ownership difference between U.S.-stock funds and international-stock funds.

For managers who run niche funds or run a lot of funds, there's good reason for them to be at the lower end of the ranges, but not at zero. The number of managers showing no faith in their process is staggering. With the two exceptions I spelled out, I can't think of why anyone should invest in a fund that its own manager doesn't invest in. True, higher investment levels aren't a guarantee of success or an ethical manager but at least they show that managers believe in the funds and they pay some of the costs and taxes that the rest of shareholders do.

Amen! This is yet another example of how Wall Street doesn’t have your best interests at heart. If their interests aren’t aligned with yours, how can you trust them? If they don’t trust themselves with their own dollars, what makes you think you should trust them with yours?

As for my husband and me, the bulk of our total investable assets (excluding our equity in real estate and our business) is in the Snider Investment Method®. The remainder includes our emergency fund, of course; some money in qualified retirement plans; money needed for something specific within the next two years; or accounts that are too small to be invested using the Snider Investment Method®. All of that money sits in a savings account, money market funds, T-bills, or laddered CDs. We would own U.S. Treasury bonds and TIPS as well, but at the moment we don’t.

Everyone has a different situation, so your investment objectives and needs may differ from mine. Still, you should know that when it comes to investment methodology, I eat my own cooking. Can your advisor say the same?

SOURCES:
1. Kinnel, Russel. “Managers’ Investment Secrets Revealed.” http://news.morningstar.com/articlenet/article.aspx?id=241183&page=/OwnershipArticle (accessed 08 July 2008)
2. “2003 Mutual-Fund Scandal.” http://en.wikipedia.org/wiki/2003_Mutual-fund_scandal (accessed 08 July 2008)

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Kim Snider is the President and Founder of Snider Advisors, an investment adviser registered with the SEC, focused on teaching individual investors a sensible, long-term investment approach focused on maximizing cash flow. For more information on Snider Advisors or the Snider Investment Method, please visit snideradvisors.com. Her book, How to Be the Family CFO: Four Simple Steps To Put Your Financial House in Order, will be in bookstores October 1, 2008.

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 888-6SNIDER to request the Snider Investment Method® Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

Hidden Cameras and Annuity Salesmen

I've been fielding a lot of questions lately about equity-indexed annuities. Someone here in Dallas is advertising an annuity product that he says guarantees a 7 percent annual return with no downside risk.

Of course, that oversimplifies what the product actually is, which is an insurance contract with a payout value tied to a stock market index like the S&P 500. Equity-indexed annuities are really no better than their close cousins, variable annuities, and they're sold in much the same way.

Set aside for a moment that there are much better investment vehicles out there. My biggest problem with these annuities is the way they're sold. These products are frequently on the SEC and FINRA watch lists because they're aggressively sold to inappropriate investors, especially seniors.

Chris Hansen, the Dateline reporter famous for his hidden-camera investigations, recently focused on the annuity business. What he found is disturbing, awful, and not at all surprising.

See for yourself:

http://www.msnbc.msn.com/id/21134540/vp/24108012#24108012

Play close attention to the way these guys give themselves fancy titles that don't mean anything and make promises that just aren't true. Also check out the "Annuity University," where salespeople are taught how to hit seniors' fear, anger and greed buttons and how to deflect questions about the products' liquidity and safety.

What disturbed me most, though, is how these scumbags try to buy credibility. They can pay $2,500 to have their name and photo printed on a book they didn't write. They can have their picture on the cover of a fancy-looking magazine, right beside Fed Chairman Ben Bernanke. And they can read a script for a phony national radio show and give out the audio CDs to potential customers.

This obviously struck a nerve with me, as I have a book coming out in October (which I did write myself), numerous articles on the web and in print (ditto), and a real radio show where we're live and taking calls from real people almost every week.

The ways these guys distort the truth to convey a sense of credibility show why the industry has such a bad reputation. If these guys will lie to you about their credentials, what else do you think they'll lie about?

People want to know who they're really dealing with. They want truth and honesty. If you're a commissioned salesperson, fine -- tell me that up front so I know what I'm getting into. The problem with the financial services industry is that there's so much incentive for advisors to confuse and mislead their investors. People deserve much more respect than that.

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Kim Snider is the President and Founder of Snider Advisors, an SEC Registered Investment Advisor, focused on teaching individual investors a sensible, long-term investment approach focused on maximizing cash flow. For more information on Snider Advisors or the Snider Investment Method and how to stop enriching your investment advisors at your expense, please visit snideradvisors.com. Her book, How to Be the Family CFO: Four Simple Steps To Put Your Financial House in Order, will be in bookstores October 1, 2008.

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method® Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

 

Financial Advisor Red Flags - Part 2

Last week, I listed six red flags to watch out for when dealing with a financial advisor or broker. To recap, they were:

1. Invoking a dead relative in an effort to keep your account
2. Recommending variable annuities when they're not appropriate -- such as in an IRA
3. Recommending you move money out of your 401(k) or stop contributing. Also: recommending that you borrow from your 401(k)
4. Constructing a portfolio for you with an expected annual return of less than 10%
5. Recommending only mutual funds, especially those that are only available through his/her company
6. Accepting a commission from products they sell

The post was getting long, so I stopped there. This week, I'd like to continue where we left off with more red flags, some of which were suggested by readers like you. Again, these are in no particular order.

7.  Suggesting that you borrow from your home equity to invest

I am not an advocate of taking a loan for the specific purpose of investing. This includes taking out a home equity loan to play the arbitrage game many salesmen are suggesting these days.

An arbitrage is when you try to take advantage of a price or interest rate differential between two markets. For example, you take out a home equity loan at, say, 6 percent and invest the money in a mutual fund with an expected return of 10 percent.  If successful, you would profit from the 4 percent spread between the loan and the mutual fund.

Salesmen will claim that this strategy is low-risk or even risk-free, but it isn't. What happens if the mutual fund doesn't return 10 percent? What if it returns only 5 percent? Or if it loses money? Compound interest works against you and you stand to lose a lot more than you bargained for.

Also, you can't forget about the fees, commissions and taxes involved in such a strategy. Even if there's a positive spread, these can severely cut into your returns. For me, it doesn't seem worth it.

8. Assuring you that an investment cannot lose money.

An employee of mine showed me a postcard she received from a financial advisor near her neighborhood. He advertised a historical annual return of almost 15 percent with "no known history of loss." The implication is that he can deliver high returns with no risk. Sounds like the perfect investment, right?
RED FLAG! There is no such thing as a risk-free return above what is guaranteed by the U.S. government. It's a basic principle of economics: reward is the profit for risk. As an investor, your job is to manage the trade-offs between risk and reward. A risk-free investment such as a bond will give you about 4-5 percent. If you want more than that -- and most of us do -- you have to be willing to take on a little more risk.

9. Claiming he/she can turn a small amount into a large amount

I heard an advisor on the radio the other day claim he could get his clients a 500 percent return with very little risk. He suggested that he could get that return through a combination of techniques, including investing in real estate.

Is he saying that real estate is low risk? Millions of homeowners, particularly along the West Coast, would disagree! Since the recent housing bubble burst, home prices across the country have been declining steadily. In the top 10 metropolitan areas, home prices declined more than 13 percent since last year, according to the Case-Shiller Home Price Index. Different markets are performing differently, but nowhere are prices ratcheting higher right now. Common sense tells me this claim of a risk-free 500 percent return is simply bogus.

Another financial advisor-type is claiming that he can show you how to turn $10,000 into $3 million in just a couple of years and that he has a 30-year track record to prove it. I did a little math… if he started with $10,000 30 years ago and did what he says, he'd have billions of dollars by now. I haven't seen his name on the Forbes list of the world's richest people, so something tells me his claim doesn't hold water, either.

When someone makes outrageous claims like these, they're playing to your greed. Just remember that with higher returns comes much bigger risk, and if it sounds too good to be true, it probably is.

10. Claiming he/she can successfully and consistently time the market.

Some advisors love to claim that they can tell you when to get out of the market and when to get back in. They'll tell you they have the tools and the research staffs that nobody else has. What they won't tell you is that all the evidence says it can't be done successfully over the long term. Read my recent post on market timers.

11. Attempting to sell you on a fast-moving trend

A former criminal judge told me about numerous schemes that crossed his bench over the years. One of them involved an advisor who sold fractional shares of oil and gas royalties.

"They will lure an investor in with a higher-than-normal return, playing on your greed. Then they come back again several months later and want you to buy more of that share for an even higher return. The house of cards will ultimately fail, leaving the investor with nothing."
A guy called me up not too long ago and offered to sell me fractional shares in something like this, saying that because of rapidly rising energy prices, now is the time to invest. I told him, "If you're calling me, trying to get me to pitch your oil deals to my clients, this tells me that this is the top of the oil rush, not the bottom."

The more people who are calling you and taking out ads regarding a fast-moving trend, it probably means it's time to get out, not get in. To make money, you have to buy when everyone else is irrationally selling and sell when everyone else is irrationally buying. When the sales pitches are fast and furious, alarm bells should go off.

12.  Offering you professional services for free.

One reader told me he was suspicious when his CPA offered to do his taxes for free. What kind of a CPA does that? In this reader's case, it was because the accountant wanted him to open an investment account through him. The investment account would probably generate more in commissions and fees than he would charge for doing a tax return.

This isn't necessarily wrong, but it is something to be aware of. Look, people in the financial services business -- or any business, for that matter -- always get paid. None of us does this for free. As a customer, you need to know how they get paid. Would you rather pay them up front and know what you're paying for, or would you rather take your chances with hidden fees and commissions? Look for transparency in pricing.

There are, of course, many more red flags to watch out for. Keep emailing me your suggestions, and I'll keep adding to the list.

SOURCES:
1. Glink, Ilyce. "Homeowners react to falling real estate values." The Boston Globe, May 13, 2008 (accessed May 15, 2008).
2. "The World's Billionaires." Forbes, March 5, 2008 (accessed May 15, 2008)

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Kim Snider is the President and Founder of Snider Advisors, an SEC Registered Investment Advisor, focused on teaching individual investors a sensible, long-term investment approach focused on maximizing cash flow. For more information on Snider Advisors or the Snider Investment Method and how to stop enriching your investment advisors at your expense, please visit snideradvisors.com. Her book, How to Be the Family CFO: Four Simple Steps To Put Your Financial House in Order, will be in bookstores October 1, 2008.

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method® Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

Financial Advisor Red Flags

I've been talking with a number of our prospects the last couple of weeks, and the stories they tell of being ripped off by various financial advisors and investment schemes are amazing. The chutzpah of some of these advisors is incredible - I don't see how they can sleep at night when they sell so many investments that are clearly designed to benefit the advisor more than the client.

I thought it would be useful to jot down some of the things to look out for when dealing with a financial advisor or broker. We'll call these Financial Advisor Red Flags. Here they are, in no particular order:

1. Invoking a dead relative in an effort to keep your account.

I met with someone the other day - I'll call her Ann - who gave this egregious example. Her husband was a rapidly climbing young executive before he died unexpectedly. Fortunately, he had life insurance.

Ann said she didn't know anything about investing, so she contacted the salesman who sold her husband the policy. The insurance guy sold her all sorts of insurance products like variable annuities. He convinced her that all these products were in her best interest. But after a couple of years, Ann looked at her investments and realized that they didn't meet all her objectives, so she called up the insurance guy and told him she wanted to pull money out.

Instead of defending the investments he sold her on their merits, he tried to shame her in to staying put. "Your husband trusted me," he said, "and he would be so disappointed in you."

I wish I could say that surprised me, but I've heard stories like this from lots of people. Some of them inherited their parents' financial advisor when they inherited money, and were guilt-tripped when they tried to move the investments somewhere else. Others said their advisor invoked the "but we're friends!" card: "But we've been in Rotary together for 20 years! I thought you trusted me!"

Any time a financial advisor uses a guilt-trip or an emotional plea to try to keep your account, that should be a big red flag.

2. Recommending variable annuities when they're not appropriate - such as in an IRA.

I've written a lot about the problems with variable annuities. They cost too much, they rely on terrible mutual funds that underperform the market, the list goes on. (You can read up on the problems with variable annuities here.) But my primary objection is that they're appropriate for only a small portion of investors. Most of us would be better off in something else.

I get particularly mad when I hear about an advisor selling someone a variable annuity inside their IRA. An IRA is already a tax-advantaged vehicle. A variable annuity is tax-advantaged, too - it makes absolutely no sense to have one tax-advantaged investment inside of another.

3. Recommending you move money out of your 401(k) or stop contributing.

This is financial malpractice at its worst. Sure, 401(k) and similar plans have their faults, but for most of us they form the cornerstone of our retirement plan.  Until you leave your employer and are eligible to roll over the money into an IRA, you probably should stick with your 401(k) plan. And if your employer matches part of your contributions, that's free money you'd be leaving on the table by shifting your savings elsewhere.

It's also a red flag when an advisor recommends you borrow from your 401(k). Treat your retirement funds as sacred. If you need cash to deal with an emergency, pretend that 401(k) money doesn't exist. If you borrow from your 401(k), you're robbing yourself of the power of compounding and exposing yourself to penalties if you leave your job before the loan is paid off.  Read more about 401(k)s here.

4. Constructing a portfolio for you with an expected annual return of less than 10%.

Many advisors still ascribe to the old way of thinking, that the best way to ensure your money lasts as long as you do is with a typical 60/40 portfolio (60% stocks, 40% bonds). But this construction is too conservative, and its expected annual return is only 8%. That 8% may give you a high probability you won't run out of money, but it almost assures you won't be able to buy anything with the money you have left.  In other words, the 60/40 portfolio doesn't take into account inflation and taxes.

To pay yourself 4% of your portfolio each year in retirement (the generally accepted "safe" withdrawal percentage), keep up with the historical rate of inflation and pay Uncle Sam at a marginal tax rate of 25%, you have to earn a 10% return. The formula is your withdrawal rate plus inflation divided by one minus your marginal tax rate, or (4 + 3.5)/(1-0.25). If you want to withdraw more or if your tax rate is higher, you'll have to earn an even higher return.

So a double-digit annual return is your goal. If your advisor builds a portfolio for you that is designed to return less than that, you should look for another advisor.

5. Recommending only mutual funds, especially those that are only available through his/her company.

I don't like mutual funds as a rule. I really don't like actively managed mutual funds because their high fees virtually guarantee over time that you will underperform the market itself. So mutual funds are bad enough - but conflict-of-interest from your broker or financial advisor makes it even worse.

A groundbreaking study by Daniel Bergstresser and Peter Tufano of the Harvard Business School and John Chalmers of the University of Oregon found that mutual funds sold by financial advisors badly underperformed the funds selected by investors on their own. The study is titled "Assessing the Costs and Benefits of Brokers in the Mutual Fund Industry," and you can read more about it here. You can also listen to my interview with one of the authors here.

A lot of financial advisors will try to steer you toward proprietary funds that are only available through their company. For example, an Ameriprise advisor may try to steer you toward RiverSource mutual funds, which are only available through Ameriprise. It's not because these funds are the best performing. It's because the financial advisor's employer pays him or her to sell the firm's product. It's another example of conflict-of-interest and is a reason to avoid commission-based advisors. For that matter, let's make accepting commissions its own flag:

6. Accepting a commission from products they sell

Any advisor who takes a commission off the products they sell you has a conflict of interest. You can't tell whether the product he recommends is really in your best interest or if he is recommending the product because it pays him well.

If you do use a financial advisor, your best bet is to go with a "fee-only" advisor, one who doesn't get paid commission on the products they recommend. That's the only way you can be sure to avoid the conflict-of-interest.

This post is getting pretty long, so let's stop there for now. I have lots of other red flags to watch out for, and I'll post those later on. If you have a suggestion for a red flag, send me an email. I will compile your suggestions for a future post.

Lack of a financial education hurts the super-rich, too

Conventional wisdom holds that the ultra-wealthy have many more investment advantages than you or I. After all, they have access to highly selective hedge funds. It’s an exclusive club where the stakes are high and the rewards are out of this world.

Or that’s what they want us to believe.

The big hedge funds claim to offer much higher returns than what the normal investor can get through mutual funds. That’s why the buy-in is so high. But it turns out, hedge fund performance isn’t much better than that of run-of-the-mill mutual funds. What’s more, the incentive programs given to the managers leave hedge funds open to fraud and chicanery.

As with so many problems on Wall Street, this has to do with the compensation system. The manager of an ordinary actively managed mutual fund may take a fee of 1-2%. That’s bad enough, but it’s chump change compared to what the hedge fund manager gets. The typical fee arrangement for a hedge fund manager is usually 1 or 2% of the assets PLUS 20 percent of the returns that exceed some benchmark. So let’s say a fund has $200 million in assets and has a benchmark rate of return of 7%. After the first year, the fund was up 10%, or worth $220 million. The manager would earn $4.4 million for the management fee, plus $1.3 million for beating his benchmark (20% of the 3% extra gain).

You can imagine how this incentive arrangement just invites manipulation – and leaves hedge fund investors exposed to tremendous risk.

According to a study from the University of Pennsylvania's Wharton School:

…[I]t is very hard to set up an incentive structure that rewards skilled hedge fund managers without at the same time rewarding unskilled managers and outright con artists. Furthermore, any incentive scheme that does not directly penalize underperformance can be gamed by the manager so that his expected fees are at least as high, relative to expected gross returns, as for the most skilled managers.

The authors show how an enterprising hedge fund manager can use the derivatives market to generate what look like above-average returns. By placing highly leveraged bets on unlikely events, the manager can generate enormous amounts of cash. If his bets are right, the fund investors are very happy. If he's wrong, the fund collapses and the investors lose almost everything. Either way, the manager stands to make a fortune regardless of how the fund performs. This is a process the authors call “piggy-backing.”

In mutual funds and hedge funds, the term “alpha” is used to explain the part of a fund's performance that isn't explained by market forces. In other words, it's the result of the manager's supposed skill. By piggy-backing, an unskilled manager can fake alpha. By writing a number of covered calls using his investors' money as collateral, “it allows an unskilled manager to mimic a target series of excess returns without having the slightest idea about how a skilled manager would actually generate them.” [emphasis in original]

Dean P. Foster, one of the authors of the study, gives an example of this strategy at work:

An enterprising man named Oz sets up a new fund with the stated aim of earning 10 percent in excess of some benchmark rate of return, say 4 percent. The fund will run for five years, and investors can cash out at the end of each year if they wish. The fee is the standard '2 and 20': 2 percent annually for funds under management, and a 20 percent incentive fee for returns that exceed the benchmark.

Although he has no investment track record, Oz has a smooth manner, a doctorate in physics and many rich acquaintances. He raises 100 million and opens shop. He then studies the derivatives market and finds an event on which the market places fairly long odds, say 9:1. In other words, it costs .10 to buy an option that pays 1 if the event occurs and 0 otherwise. The nature of the event is unimportant: it might be a large fall in the stock market, Florida getting hit by a Category 5 hurricane or Russian President Vladimir Putin dying before the end of the year.

Next Oz writes some covered options on this event and sells 110 million of them in the derivatives market. This obligates him to pay the option holders 110 million if the event does occur and nothing if it does not. He collects 11 million on the options. To cover his obligations in case the 'bad' event occurs, he uses the investors' money plus the proceeds from the options to buy 110 million in one-year Treasury bills yielding 4 percent, which he deposits in escrow. This leaves 1 million in "pocket money," which he uses to lease some computer terminals and hire a few geeks to sit in front of them, just in case his investors drop by.

The probability is ninety percent that the bad event does not occur and Oz owes nothing to the option holders. With a gross return (before expenses) of 15,400,000, the investors are thrilled, and so is Oz. He collects 2 million in management fees (of which he has only spent 1 million), plus a performance bonus equal to 20 percent of the 'excess return', namely, 20 percent of 11,400,000. All in all, Oz nets over 3 million for doing absolutely nothing.

Foster says Oz can repeat this scheme next year. If his bets continue to pay off, he'll attract more investors and pocket more money. If the fund collapses, Oz can simply close the fund early and start a new one next year.

This scheme is not illegal, but it is risky – risky for his investors, but not for himself. In no scenario will Oz actually lose money. Actually, the more risk he takes with this investors' money, the more he stands to profit. That's the way his incentive structure works. You may get screwed if the fund collapses, but he walks away with millions.

This is yet another example of how Wall Street’s compensation system puts the interest of brokers and fund managers ahead of the investor. No matter how much money you’re working with, unless you know what’s really going on, you’re just asking to be taken advantage of.

That’s why it pays to learn as much as you can about how Wall Street really works, and why you ultimately should be in control of your own investments. Wall Street is set up to take advantage of the little guy, even if that little guy has millions and millions of dollars.

SOURCES:

1. Foster, Dean P. and H. Peyton Young, “The Hedge Fund Game: Incentives, Excess Returns, and Piggy-Backing.” March 2008. http://www.brookings.edu/~/media/Files/rc/papers/2007/1114_hedge_fund_young/1114_hedge_fund_young.pdf (Accessed April 23, 2008).

2. Foster, Dean P. and H. Peyton Young, “Hedge Fund Wizards,” Washingtonpost.com, December 19, 2007. http://www.brookings.edu/opinions/2007/1219_hedgefunds_young.aspx (Accessed April 23, 2008).

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Kim Snider is the President and Founder of Snider Advisors, an SEC Registered Investment Advisor, focused on teaching individual investors a sensible, long-term investment approach focused on maximizing cash flow. For more information on Snider Advisors or the Snider Investment Method and how to stop enriching your investment advisors at your expense, please visit snideradvisors.com. Her book, How to Be the Family CFO: Four Simple Steps To Put Your Financial House in Order, will be in bookstores October 1, 2008.

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method® Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

March Mutual Fund Madness - Part One

I spent several days this week in New York and Chicago meeting with reporters from the Wall Street Journal, Dow Jones News Wire, Smart Money, The Street.com and others.  (This is a picture I took, with my cell phone camera, of the New York Stock Exchange. Look to the right at the guy with the helmet, flak jacket and rifle. The military-like security was kind of unsettling.) Anyway, as I made the rounds, talking with reporters about Snider Advisors and the Snider Investment Method, I had the opportunity to give them my take on the problems with traditional investments.

We talked about traditional cash flow investments like bonds, preferreds and dividend paying stocks - none of which pay enough. We talked about the reverse compounding problem with a capital appreciation portfolio. I gave Janet Paskin, from SmartMoney, an unscheduled earful on variable annuities.

But looking back, it occurs to me, I never even talked about one of my favorite whipping posts - actively managed mutual funds. In fact, I can't think of the last time I wrote about the systematic fleecing of unsuspecting mutual fund owners.

What has gotten in to me? I must be getting soft! You know what? I have two hours to kill on this flight. How about we haul them out - just for old times sake?

First of all, mutual funds cover a pretty broad spectrum. There are funds that invest in stocks, bonds, money market funds, REIT's - all kinds of stuff. For now, let's limit the discussion to funds that invest in stocks.

There are closed end funds which trade on the exchanges, similar to a stock, and then there is what we think of as the more traditional fund, where you purchase your shares from the mutual fund company, either directly, or through a broker. Within that category, there are actively managed funds and passive funds or index funds.

An actively managed fund is one where the fund manager is picking stocks, based on whatever criteria he or she uses, in an attempt to outperform the market. An index fund just holds the stocks in the index it is trying to mimic and only changes those stocks when the stocks in the index are changed. Other than that, they rebalance on a constant basis to make sure the fund reflects the weightings of each stock in the index, and that is all that is done.

My beef is with actively managed, equity mutual funds. I will tell you right off the bat that I am not a fan of actively managed mutual funds. In fact, people kid me. You know how companies have tag lines that go with their company name, like “Built Ford Tough” or “Like A Rock”? People tease that my company tag line should be “We'd Rather Stick Pins in Our Eyes than Put Money in a Mutual Fund!”

The problems with actively managed funds fall into three broad categories: 1) Lack of control; 2) Lack of transparency; and 3) Lousy performance. I will outline each of these three areas briefly and then expand on each over the next few weeks.

Too often I see people who are like leaves - just floating along in the current. Wherever it takes them is where they will end up. This is no way to manage your investments. If you care about reaching your financial destination, I believe you have to grab hold of the rudder and steer. With mutual funds, you completely give over control to someone else.

You do not control what stocks the fund invests in or whether the fund even sticks to its stated investment objective. This is known as style slip. You don't control who is managing your money or what they are investing it in.

You also don't control when the fund makes taxable distributions. This makes planning difficult and in certain situations, this can cause you to pay unnecessary taxes or penalties.

Transparency is the second problem. In fact, it is Wall Street's biggest problem. But I won't go down that rabbit hole for now.

You don't really know what your mutual fund owns. It generally only reports the top holdings and often well after the fact. Many mutual funds actually invest in exchange traded funds but few include that information when they report their holdings.

The combination of style slip, also known as closet indexing, globalization, and lack of transparency in fund holdings, makes it difficult - if not impossible - to create a truly diversified portfolio. You would be amazed at how correlated, if not actually duplicative, the holdings of your various funds really are.

And speaking of those exchange traded funds inside a mutual fund - why don't we hear more about that? The fund buys an exchange traded fund that mimics the index. That does two things. It adds an undisclosed layer of costs - the management fee of the ETF. But what should really burn investors is the fund manager continues to charge you active management fees.  The fund is basically charging you for work it did not do! What the heck is that about?

Also, did you know that the way mutual funds are required to report their returns, doesn't tell you how much an investor in that fund would have made or lost? Their return numbers tell you how much the stocks in a funds portfolio went up or down - but they don't tell you how the fund's investor's fared. Often, that is a very different story depending on the timing of the investment.

More disconcerting, you don't really know what you are paying for management. There is no line item showing the debit for fees. They are hidden. And don't count on the prospectus to clue you in.

There are three layers of costs that do not have to be disclosed in the prospectus: transaction, market impact and spread costs.  Academic studies indicate these costs can add an additional 2% to the stated management fee.

I probably wouldn't get my hackles up over these fees if the performance of these portfolio managers offset the costs, but they don't. According to Morningstar, the average domestic equity fund with a track record of at least 15 years, trails the S&P 500 by 2%. So what are we paying them for?

Does 2% matter? Oh my gosh does it matter! Do the math.

Let's take an average actively managed mutual fund with an expense ratio of one and a half percent, which is cheap compared to many mutual funds. Let's compare that with a low expense strategy that has a hypothetical expense ratio of .2 percent. If we apply that to a $250,000 investment and assume that both can earn 10% compounded over the next 20 years, the difference is almost $378,000.

Now consider your required rate of return. To pay yourself 4% of your portfolio each year in retirement, keep up with the historical rate of inflation and pay Uncle Sam at a marginal tax rate of 25%, you have to earn a 10% return. The formula is the withdrawal rate plus the rate of inflation divided by one minus your marginal tax rate, or (.04 + .035) / (1 - .25) = 10%.

If your required rate of return is 10% and your mutual funds return 2% less than their benchmark indexes because of the drag from fees, can you afford to invest in mutual funds? 

Bottom line - you can do better.

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Kim Snider is the President and Founder of Snider Advisors, a SEC Registered Investment Advisor, focused on solving the problem of retirement income for long-time planners, savers and investors who still find themselves wondering if they will have enough. For more information on Snider Advisors or the Snider Investment Method and how we may be able to help you make your retirement savings go farther than you thought, please visit snideradvisors.com.

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

You Can Do Better

Let's look at some facts:

• 2/3 of all actively managed mutual funds return less than the market itself in any given year.
• The funds which outperform the market are different from year to year.
• The raw returns of equally weighted mutual funds (net of all expenses) for 1996 to 2002 were 6.626% for investors working on their own and 2.924% for funds chosen by advisors.
• Management fees cost the investor approximately 2% a year.
• All but about 13% of investment advisors are not paid by you. They work for commissions from the companies whose products they sell. If they don't meet their sales quota, they are fired.

So let me ask you a question - what are you paying them for? These numbers tell us the majority of investment advisors do not add value to the process - they destroy value. Does it matter? You bet it does.

There is a completely practical reason to learn to manage your own money. Let's look at the cost of a money manager over time using the results of the BCT study which puts the return of the self-directed investor at 6.26% and the advisor at 2.924%.

Imagine it is 1996 and you and your neighbor both have $200,000 portfolios. Your neighbor manages his own portfolio. You turn yours over to an advisor. At the end of 2002, you have $244,707. Your neighbor has $305,928. That's 25% more money.

If we extend those numbers out into time, the differential becomes even more pronounced. After 10 years the differential is 38% and after 30 years, your neighbor has $761,481 more than you!

Your financial advisor would love for you to continue to buy into the myth that you can't possibly be a successful investor unless their steady hand is at the helm. I beg to differ. The data just clearly refutes that lie.

Your financial advisor would love for you to continue to buy into the myth that managing your own portfolio requires hours and hours of time that you don't have. I beg to differ. The data clearly refutes that lie too.

Whether you turn your money over to a financial advisor or manage it yourself, you are solely responsible for whatever situation you find yourself in - not your broker, not your CPA, not your spouse - you.

Turning it over to a financial advisor almost guarantees two things: 1) you will have significantly less than if you do it yourself; and 2) you will be turning over control of your financial future to someone who, by definition, has to be concerned about their own financial future.

The data is clear. You can do better. That is why we teach you to how to do it yourself.

SOURCE:

1. Bergstresser, Daniel B., Chalmers, John M.R. and Tufano, Peter, "Assessing the Costs and Benefits of Brokers in the Mutual Fund Industry" (January 16, 2006). AFA 2006 Boston Meetings, Forthcoming Available at SSRN: http://ssrn.com/abstract=616981

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Kim Snider is the President and Founder of Snider Advisors, a SEC Registered Investment Advisor, focused on solving the problem of retirement income for long-time planners, savers and investors who still find themselves wondering if they will have enough. For more information on Snider Advisors or the Snider Investment Method and how we may be able to help you make your retirement savings go farther than you thought, please visit snideradvisors.com.

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

Will the real financial advisor please stand up?

I was talking with a friend the other day. We were talking about the scoundrels and scallywags of the financial services industry. He told me a story about his Dad. When his Mom died, his Dad received some money from a life insurance policy. It wasn't a tremendous amount of money by some standards, but for his elderly father, it was a lot. According to my friend, his Dad turned the money over to a "financial advisor" who churned the account, buying and selling stocks, until there was very little left.

 

This is a common mistake. Dollars to doughnuts his Dad didn't turn the money over to a financial advisor. I would bet you he turned it over to a broker. What? Aren't they the same thing you ask? Absolutely and unequivocally no!

 

A study, commissioned by the U.S. Securities and Exchange Commission from the RAND Corporation, finds the majority of Americans do not understand the difference between the different people we commonly refer to as "financial advisors."

 

Scott Burns, the popular syndicated columnist, published the following breakdown in a recent article on the subject:

 

Cerulli Associates says you can find people called financial advisers in six major places. Each place represents a channel of distribution. Here are the basic numbers:

 

• National full-service brokerage. There are 69,000 advisers at national full-service brokerage firms such as Merrill Lynch, Smith Barney and UBS.
• Regional full-service brokerage. There are another 14,000 at the smaller regional brokerage firms such as RBC Dain Rauscher or Morgan Keegan.
• Independent broker/dealers. There are 98,000 at independent broker/dealers such as Raymond James Financial and Mutual Service Corp.
• Bank brokerage. There are nearly 16,000 at bank brokerage operations such as Wells Fargo and Bank of America.
• Insurance broker/dealers. Insurance broker/dealers add another 34,800 at firms like AXA advisors, NYLIFE Securities and Mass Mutual Investor Services.

 

Add them all up, and you’ve got 232,000 salespeople who work for their firm, not you. Another 23,000 are registered investment advisors. But nearly 10,000 of those are also broker/dealers included in the 98,000 count above.

 

That leaves about 13,000 registered investment advisers.

 

In other words, of all the people who may call themselves financial advisers, about 5 percent are registered investment advisers alone.

 

Semantics, you say? Not hardly. Why do you think you hear so many horror stories, like mine, of the person who entrusted their money to a so-called financial advisor only to see it frittered away? Because most of the people we mistakenly call financial advisors are nothing more than salespeople who are paid a commission to sell the products that make them and their firm the most money. That is usually the exact opposite of what is going to make you the most money.

 

An article in a leading industry trade journal, written by Dan Wheeler, a former stockbroker, highlights the problem:

 

Unfortunately, too many people think that Wall Street brokerage firms are there to provide investors with good advice designed to help them reach their financial goals. On the surface, this perception makes sense. After all, stockbrokers work for enormous firms that employ portfolio managers, economists, analysts, and other market watchers. That appears to put the Wall Street broker in an ideal position to tap into all that knowledge and deliver rock-solid advice backed by enormous research and insight.

 

The belief out there is that the financial services business is made up of professionals. A professional by definition is someone you hire because of their expertise—a doctor, accountant, lawyer, and so forth. By gaining access to that expertise, you receive something of value: better health, a lower tax bill, or a large legal settlement, for example. The relationship between a professional and a client is such that the professional is given incentives to help the client succeed.

 

The financial services industry spends huge sums each year—more than $700 million on magazine advertising alone—to persuade investors that they provide professional advice. The reality is that Wall Street is not in the business of providing objective, professional advice. Actually, Wall Street is in the manufacturing business. Like any other manufacturing business, the objective is to develop products that will sell, and so the firms hire salespeople to “move the products.”

 

Of course, there is nothing inherently wrong with creating and manufacturing products and paying a sales force commissions to sell them. Most commerce functions this way. Investors, however, should not be looking to a manufacturer and its sales force for objective advice. In short, the business that much of the financial services industry is in is the wrong one for investors.

 

I believe, for reasons I think are obvious, that your best bet is on yourself. You are the only person with no conflict of interest. Learn to manage your own money. Don't believe the Wall Street smoke screens that only an expert can do it or that it takes too much time.

 

Wall Street treats you like a mushroom - they lock you in a dark room and feed you ... you know what. Break out into the light. Take control of your financial future.

 

SOURCES:

 

Burns, Scott. “What “Financial Adviser” Means 95 Percent of the Time - Registered Investment Advisor.” assetbuilder.com 29 Feb 2008. 13 Mar 2008 <http://assetbuilder.com/blogs/scott_burns/archive/2008/02/29/what-financial-adviser-means-95-percent-of-the-time.aspx>.

 

Hung, Angela et al. Investor and Industry Perspectives on Investment Advisers and Broker-Dealers. Santa Monica, CA: LRN-RAND Center for Corporate Ethics, Law and Governance, 2007. 13 Mar 2008 <http://www.sec.gov/news/press/2008/2008-1_randiabdreport.pdf>.

 

Wheeler, Dan. “House of Games - Investment Advisor Magazine.” Investment Advisor Magazine Oct 2004. 13 Mar 2008 <http://www.investmentadvisor.com/article.php?article=4243&pagenum=1>.

 

 

Kim Snider is the President and Founder of Snider Advisors, a SEC Registered Investment Advisor, focused on solving the problem of retirement income for long-time planners, savers and investors who still find themselves wondering if they will have enough. For more information on Snider Advisors or the Snider Investment Method and how we may be able to help you make your retirement savings go farther than you thought, please visit snideradvisors.com.

 

Snider Advisors makes no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments, including the Snider Investment Method™ are subject to risk, including possible loss of principal.

 

Protecting seniors from predatory practices

Chances are, you are over 65, have a loved one over the age of 65, or both. Financial services firms are targeting older Americans because of the tremendous opportunity they represent for these firms. Older Americans control record amounts of wealth in the United States and where there is bait, there will be sharks.

 

Regulators are particularly concerned about predatory practices aimed at seniors. These practices fall into four broad categories:

 

• Recommending products or services that are not appropriate given the person's individual situation;
• The use of false designations which imply special expertise in retirement and senior issues;
• High-pressure sales seminars aimed at seniors;
• Diminished capacity and the financial abuse of seniors by caregivers.

 

Suitability

 

Regulations require brokers and registered financial advisors to always place the customers best interest ahead of their own. Before recommending “the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable” for that customer, based on “the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs.”

 

Unfortunately, financial advisors often ignore this rule by selling products inappropriate for the customer because they pay a high commission. The Financial Industry Regulatory Authority (FINRA) is the largest non-governmental regulatory agency for securities firms doing business in the United States. FINRA's examiners have been focusing specifically on recommendations to seniors that involve:

 

• Products that have withdrawal penalties or otherwise lack liquidity, such as deferred variable annuities, equity indexed annuities, some real estate investments and limited partnerships;
• Variable life settlements;
• Complex structured products, such as collateralized debt obligations (CDOs);
• Mortgaging home equity for investment purposes; and
• Using retirement savings, including early withdrawals from IRAs, to invest in high risk investments.

 

FINRA has repeatedly stated that variable annuities are generally considered to be long-term investments and are therefore typically not suitable for investors who have short-term investment horizons, like seniors. FINRA has stated in various regulatory bulletins, that this is true even of some variable annuities that offer riders specifically designed for seniors, including those offering guaranteed life benefits.

 

FINRA has also held forth on the lack of suitability of variable life settlements, which are often improperly aimed at investors over the age of 70; and taking out home equity for investment purposes. FINRA also warns against recommendations that investors use retirement savings, in some cases by making early withdrawals from IRAs pursuant to Section 72(t) of the Internal Revenue Code, to make unsuitable alternative investments.

 

In spite of these rulings, I continue to see these investments being sold to seniors. You don't have to dig hard to find them either. I hear stories from my clients every day. If you or your loved one is over the age of 65 and an advisor recommends any of these products or strategies to you, chances are, he or she is taking advantage of you. I admit there are exceptions but they are extremely rare.

 

Misleading Credentials

 

Several state securities regulators have adopted rules aimed at protecting older investors from misleading professional designations and credentials. In Massachusetts, for example, new regulations govern use of credentials and professional designations that use words such as "senior," "retirement" and "elder" in combination with words such as "certified," "advisor" and "specialist" to imply an expertise in advising senior investors. Most regulatory agencies, government and non-government alike, consider anyone 65 years of age or older "senior." Nebraska and Washington have followed suit.

 

This was necessary because there has been a rash of these designations that have sprung up over recent years with little or no transparency as to what they actually mean. In fact, the largest of these, The Society of Certified Senior Advisors, which offers the "certified senior advisor" designation, will begin requiring its CSA's to disclose that they may have no particular expertise when it comes to financial issues affecting seniors.

 

Beginning June 1, financial advisors in Massachusetts, can use only senior designations that have been accredited by a national accrediting agency. Nebraska maintains a list of "approved" designations. The North American Securities Administrators Association (NASAA), which represents state securities regulators, plans to develop similar guidelines by the end of the year and recommend their adoption to other states.

 

Similarly, FINRA found that some third-party vendors are marketing ghostwritten books on senior investing to registered representatives as tools to establish credibility. Basically, the advisor buys the book and then puts their name on it as the author.

 

Rules, such as NASD Rule 2210 and NYSE 472 prohibit firms and registered representatives from making "false, exaggerated, unwarranted or misleading statements or claims in communications with the public". So does the Investment Advisor Act, a federal law. FINRA has stated that representing yourself as an author of a book you didn't write, to confer some level of expertise you don't really have, is misleading and may violate state and federal law.

 

High pressure sales seminars

 

Many financial services firms, including ours, use sales seminars. But regulators are particularly concerned right now about the so-called "free-lunch seminars" that target seniors.

 

SEC Chairman Christopher Cox said the agency is scrutinizing brokers and advisers who conduct meetings over free meals at "fancy hotels and restaurants." The effort will begin in Florida in the coming weeks, Cox said today at a conference in Washington hosted by the Consumer Federation of America.

 

"If we find that instead of a legitimate sales seminar and a free meal, seniors are being exposed to pitches for unsuitable products, with high-pressure sales tactics and wild claims about projected returns, and no disclosure of the actual risks of the investment, we'll move in hard and fast," Cox said.

 

The initiative is part of "a comprehensive national strategy for protecting older investors" that is being carried out by SEC field offices, state and local regulators and law enforcement, said Cox, 53. NASD enforcement chief James Shorris, named to the post yesterday, said his agency will also make protecting elderly investors a priority.

 

I have to admit, some of the findings of this sweep are scary to a legitimate firm like ours because it is difficult to tell the difference. For example, a Yahoo article says:

 

While their promoters paint the "free lunch" seminars as educational sessions, sometimes promising that nothing will be sold, "they are designed to sell — either at the seminar itself or later," said Lori Richards, director of the SEC's Office of Compliance Inspections and Examinations. "They're not educational events."

 

The investigation conducted by the SEC, state regulators and FINRA found the use of scare tactics to get seniors to question their current investments, claims of fantastic returns with no risk, and "ringers" in the audience who would stand up and offer testimonials of how much they had earned.

 

For one, we don't target seniors - our demographics mirror the general population. But as the number of seniors in the population increases, so will the number of seniors served by us. It seems that we must now err on the side of caution to avoid being painted with the same brush - probably not a bad idea anyway.

 

We have called our free sales events, "educational seminars" but we have never said we aren't selling anything because we obviously are. The sub-title of our events is "An introduction cash flow investing and the Snider Investment Method™." What we do say is you won't be subjected to a high-pressure sales pitch, which you won't. We try to respectfully give you the facts and then leave you alone.

 

But while we don't try to get anyone to sign up on the spot, we do sometimes offer a discount if you sign up for a paid workshop within seven days. When our classes are not full, encouraging someone to sign up for an earlier class seems like a wise business decision. Is that high pressure? I'd like to hear your thoughts.

 

The one that really sets my teeth on edge is the one about the "ringers" in the audience. This should really make some of our students who routinely show up to talk with others pretty mad. We have never, ever paid someone for their testimonial. Anyone who shows up at our marketing events is a client who paid to learn the Snider Investment Method™, is using it, and wants to tell others. They get nothing in return.

 

The last information session we did in Frisco, there was a woman in the audience who I didn't even recognize as being one of our graduates. During the Q&A, she asked me if she could stand up and tell her story. I didn't ask her to be there. I didn't ask her to stand up. She just did - and I appreciated it. I am grateful to know that what I taught her made a meaningful difference in the quality of her life.

 

I know some firms may use shills or "ringers." I don't know how they sleep at night, but I know they do. So how does someone differentiate between a legitimate customer who is there because they really believe in the product and a shill? How does someone distinguish between a legitimate firm using a seminar to sell a legitimate product to people for whom it is appropriate from a sleaze ball who doesn't care about anything other than generating the highest possible commission? Again, I'd like to know your thoughts. You can leave them in the comments below.

 

At the end of the day, I guess that is the regulator's concern as well. So from my perspective, and that of any other legitimate firm who wants to use seminars to educate potential customers about their products or services, we should be thankful the regulators are trying to clean this area up. If successful, attendees can feel confident the material being presented is accurate and they will not be subjected to any high-pressure sales pitch.

 

My very real concern though, is that in the process, some legitimate firms like ours may get painted with the same, very broad brush.

 

Diminished Mental Capacity and Suspected Financial Abuse

 

The last issue regulators are concerned about is diminished capacity and financial abuse by caregivers. This is obviously a non-regulatory issue and has nothing to do with a firm like ours - except that we have the potential to spot it and take actions to protect the client.

 

What can you do?

 

The first thing is to make sure you or any family members have a will, a living will and a durable power of attorney in case of incapacity. That will save you from going through the court system if a loved one loses the mental capacity to make decisions.

 

The second is to begin a dialog with aging family members about their financial situation as early as possible. Don't wait until the last minute. A conversation now about whether your parents have long-term care insurance, for example, may lead them to let you in more on their finances as you go along.

 

Third, offer to accompany them on appointments with financial advisors - especially if you have any doubts about their capacity to make sound financial decisions. The elderly are much more susceptible to fraud or just being taken advantage of.

 

Finally, educate yourself on financial matters. You not only need it to protect yourself, but you may also need it to protect those who once protected you.

 

SOURCES (direct quotes are indented):

 

1. Financial Industry Regulatory Authority. "Seniors" Regulatory Notice 07-43 September, 2007.

 http://www.finra.org/RulesRegulation/NoticestoMembers/2007NoticestoMembers/P036815

 

2. "Mass limits use of senior credentials"; Boston Globe; May 17, 2007.

http://www.boston.com/business/ticker/2007/05/mass_limits_use.html

 

3. "States re-evaluating who should be licensed"; Financial Advisor; September, 2007.

http://fa-mag.com/issues.php?id_content=2&idIssue=125&show=fronline

 

4. Annys Shin. "SEC targets free-lunch scams"; WashingtonPost.com; March 24, 2006.

http://blog.washingtonpost.com/thecheckout/2006/03/sec_targets_free_lunch_scams.html

 

5. Marcey Gordon. "Free lunch seminars can entrap seniors"; Associated Press; September 10, 2007.

http://www.boston.com/business/ticker/2007/05/mass_limits_use.html

 

2. Bruce Fraser. "Role Reversal"; Financial Advisor; September, 2007.

http://fa-mag.com/issues.php?id_content=2&idArticle=1568

 

 

Kim Snider, Kim Snider Financial Communications, Chronim Investments and/or Snider Advisors make no representation that the information and opinions expressed are accurate, complete or current. The opinions expressed should not be construed as financial, legal, tax, or other advice and are provided for informational purposes only. Call 866-952-0100 to request the Snider Investment Method™ Owner's Manual, which includes a description of the Snider Investment Method, investment objectives, risks, suitability and other information. Please read and consider carefully before investing. All investments are subject to risk including possible loss of principal.

 

Bad Profits

You may have heard that A.G. Edwards is merging with Wachovia. When finalized, this deal will make Wachovia the second-largest brokerage firm behind Merrill Lynch. But is another example of bad profits. Many A.G. Edwards clients are going to get screwed in the deal. Many A.G. Edwards clients will end up moving their accounts or paying higher fees and making smaller returns.

 

Big full-service brokerage firms are trying to move their customers away from a commission-based model and into so-called managed accounts which charge a percentage of assets (typically 1% to 3% annually) instead of a commission on each transaction.

 

An article, in this weekend's edition of the Wall Street Journal, noted:

 

	Wachovia, the Charlotte, N.C. bank, has a large business in managed accounts and is expected to encourage A.G. Edwards clients - the bulk of whom are in traditional brokerage accounts - to switch.

 

A fee based on assets is all well and good if the account is truly managed, but for the most part, they are not.

 

The reason to pay a fee is for valuable advice - advice you cannot get elsewhere. But all brokers give basically the same self-serving advice. This is evidenced by the recent court ruling that a broker cannot hold himself out to be a financial advisor.

 

Brokers are salesmen. Salesmen get paid commission on the products they sell. Financial advisors should be paid fees for their advice.

 

You may be thinking its semantics, but it is not. There are real implications for investors. Most people will pay far less in commissions than in fees, even at the bloated commission rate charged by full-service brokerage firms. Moving to a fee-based structure will cost more but you don't get anything more in return - in fact, you may actually get less. Which is exactly why the brokerage firms are doing it.

 

In a conference call with analysts, the head of Wachovia, told them: