Dirty Tricks Brokers Use to Get Your Business

There really is no great secret on successful investing for long

The New York Stock Exchange, the world's large...
Image via Wikipedia

term goals. You do not have to know everything about investing to succeed, but you do need to know the right things. There is an academic method to developing a diversified portfolio, custom fit to each individuals situation. This goes against the Wall Street model that strives to keep investors in fear that they need Wall Street to guide them in ever changing directions.

Misleading tiltThere is significant research supporting the value of tilting the stock portion of a portfolio towards small and value stocks. Tilting towards these riskier asset classes can increase expected returns, albeit with increased risk. However, there are periods of time when large and growth stocks outperform small and value. For example, in 2011, large cap stocks outperformed small cap stocks.

By tilting the stock portion of a portfolio towards the asset class that outperformed in the past year or two, advisers can make it appear they have the ability to increase returns in the future. Don’t be fooled. If your adviser is recommending a tilt towards any asset class, ask to see long term data supporting this recommendation.

Using long term and lower quality bonds

By using long term (maturity dates more than 5 years) bonds, and bonds with ratings below investment grade, brokers and advisers can make it appear they are generating higher returns. Many investors don’t understand these returns come with higher risk. Historically, according to research done by Dimensional Fund Advisors, long term bonds are more volatile than shorter term bonds, but have not provided consistently greater returns. The same research indicated that bonds lower in credit quality have earned higher returns, but there is a greater risk of default.

You would be better advised to limit your bond holdings to maturities of five years or less and to insist that all of these holdings be rated investment grade or higher. You can increase your expected return (and your risk) by allocating a greater portion of your portfolio to stocks, assuming that would be suitable for you.

Using short term returns

Short term data can be extremely misleading. Some brokers and advisers cherry pick funds for inclusion in a recommended portfolio that have impressive three year returns. The implied message is that these funds are likely to outperform in the future. You can find a discussion of the benefit of longer term data here.

You should insist on seeing at least a 10-year history of returns and preferably longer.

There’s an old Chinese Proverb that says: “If you must play, decide upon three things at the start: the rules of the game, the stakes, and the quitting time.”

You now know some of the rules of the game.

This is how most brokers compete and it does not involve the truth.

Please comment or call to discuss.

  • Their Confidence Is Killing Your Returns II (401kplanadvisors.com)
  • Diverisification Is Your Buddy (401kplanadvisors.com)
  • Asset Allocation Basics (sethigherstandards.com)
Enhanced by Zemanta

Leave a Reply

Your email address will not be published.