Greetings!
Here is your newsletter for March 2010, including a review of a New York Times article on the regulation of financial advisors, and a piece on the value of portfolio rebalancing.
I am still scheduling Q1 review meetings for the duration of March, so if you have not yet made an appointment please contact the office at your convenience.
To provide a friend with an electronic issue of this edition, you may click on the button below.
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Risk v. Reward, Good Advice, and Portfolio Rebalancing
The Risk-Reward Correlation
The spectrum of risk and reward looms large in almost all we do; on the level of investment management and conversation, it is the key factor that determines portfolio composition.
On an emotional level, countless studies have shown that investors prefer avoiding losses to securing gains, which partially explains why volatile financial markets can make us feel so anxious. Helping to balance these emotions is the mark of competent financial planning and advice.
The Value of Good Advice
To understand the value of appropriate advice, it helps to recognize the cost of inappropriate advice.
Bad advice panders to human emotions by exploiting greed and fear, which can lead to the pursuit of high returns in the good times with little attention to risk, and fleeing from risk in the bad times with no regard for return.
History has shown this to be a recipe for failure.
Good advice stresses the virtues of discipline and patience, which means more than simply sticking to a buy-and-hold strategy. Among other factors, it involves creating an Investment Policy Statement which aligns your investment program to your individual needs, utilizing low cost investments, and rebalancing periodically to maintain your asset allocation objectives and provide control over the risk contained within your portfolio.
The Rebalancing Process
Rebalancing is the process by which we periodically adjust your portfolio, selling down the stronger performing asset classes and rotating the proceeds into the poorer performers, in order to maintain your target asset allocation. Put another way, it is the process of selling high and buying low. This is not a timing strategy; it is a means of managing portfolio risk while sticking to the original investment plan.
But just as a lack of rebalancing can throw a portfolio out of whack and undermine the original financial plan, rebalancing too frequently can be costly, including exposure to potentially higher short-term capital gains tax rates and trading costs. The issue is often dealt with by creating a "hold range" within your portfolio. For example, if the target is a 60-40 stock-to-bond allocation, we would allow a 5-10% buffer range, within which there is no need to rebalance. In this way we can achieve a practical equilibrium between the need to maintain the broad asset allocation on the one hand, and minimizing the potential costs associated with rebalancing on the other.
Unlike the actual movement of fixed and equity assets, all of these decisions are within your control. Paying attention to the risk-reward correlation, pursuing appropriate advice, and rebalancing intelligently are all methods that can improve investment results over time.
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Proposed Financial Regulation would Require all Financial Professionals to Act as Fiduciaries
You may be familiar with the television commercial that shows a man and a woman on a beach somewhere, reveling in the success of their retirement plan. Except that it's not a husband and wife as the spot would have you presume; instead it is the woman and her brokerage firm financial advisor.
A recent New York Times article by Tara Siegel Bernard, reporting on a bill that has been put forth in the Senate, points to the commercial as an example of the lengths to which traditional brokerages will go to illustrate that they are trusted advisors, not merely investment salesmen who are more interested in closing sales than in giving advice.
In the nomenclature of financial advice, advisors fall under two general categories: a) those who are fiduciaries, and b) those who follow what are called suitability guidelines.
As required by the Securities and Exchange Commission, fiduciary advisors (including Milestone) are obligated to put their client's interests before their own, known as the fiduciary rule. In contrast to this, advisors and brokers who follow suitability criteria must simply provide advice they believe is suitable for the individual client, without regard to whether or not it is also in the best interest of the advisor.
As momentum builds for the inclusion in financial overhaul regulation of stronger fiduciary requirements, many advisors formerly employed by large brokerage firms have a lot to say about this. One of them, David Armstrong, who "learned a lot about being a good salesman" as a Merrill Lynch advisor, says that "the amount of training I sat through to properly evaluate investment opportunities was almost non-existent relative to the training I got on how to sell them."
One of the conundrums of suitability criteria is that when advisors are paid for selling investments which may be in their clients interests but which also provides them with incentives, it invites conflict of interest. One example of this is "revenue sharing", an arrangement made between brokerage firms and mutual fund companies whereby the fund companies agree to share a portion of their revenue with the firms that promote their products. (Morgan Stanley and Merrill Lynch disclose these relationships; UBS and Wells Fargo Advisors declined to comment for the article whether or not they do.)
Senator Christopher Dodd has recently proposed requiring that all brokers and financial advisors operate as fiduciaries. (Apparently, this will require an act of Congress.) Unfortunately, the legislation is stalled and may ultimately be watered down, as Senator Tim Johnson is proposing an 18-month study of the investment advisory industry, which would replace the legislation proposed by Dodd. About this, Kristina Fausti, a former S.E.C. lawyer said: "In my opinion, the Johnson study is a stalling tactic that will either substantially delay or totally prevent a strong fiduciary standard from being applied."
One suspects that those in Congress who are opposed to any new regulations are supporting elements of Wall Street who see a negative impact to their bottom lines, when brokers who formerly were paid to bring money into their firms suddenly have to put the clients best interest before their own. (Guy Moszkowski, a securities industry analyst for Bank of America Merrill Lynch, said that the impact of a fiduciary standard to a firm like Morgan Stanley could cost the firm as much as $300 million of this year's expected earnings.)
Investors who employ fiduciaries can take heart that their interests must legally be placed before those of their financial advisor. Moreover, working with fee-only advisors can add another layer of objectivity.
As for those who work with advisors acting under suitability guidelines, they will have to draw their own conclusions.
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Milestone Financial Advisors, LLC
Ten Key Portfolio Considerations: |
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- Reduce Expenses
- Diversify Systematically
- Seek to Reduce Taxes
- Think Long Term
- Maintain Discipline
- Maintain Prudent Cash Reserve
- Own Low Cost Funds
- Maintain Asset Allocation
- Add to Portfolio Systematically
- Connect Goals to Investments
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