Lessons You Can Learn From This Wealthy Investor

Brokers and agents are trained to feed your fear. This typically results in inappropriate products designed to enrich the brokers and agents and not you.

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Mistake No. 1: The DeBerrys no doubt felt that brokers had an expertise that would assist them in growing their fortune. They would have been better advised to seek the services of a Registered Investment Advisor who focused on their asset allocation and recommended only a portfolio of low management fee stock and bond index funds in a suitable asset allocation.It is easy to learn from this mistake. Don’t deal with brokers.

His broker at Morgan Keegan invested his funds in four, proprietary bond funds, including its Select High Income Fund, C shares, its High Income Fund, its Strategic Income Fund, its Multi-Sector High Income fund and its Advantage Income Fund.

Mistake No. 2: Never purchase proprietary funds. They are aggressively sold by brokers because they often have a financial incentive to do so. The brokerage firm wants to keep the management fees. Proprietary funds frequently underperform their Morningstar assigned indexes. I recently did an analysis of the performance of the proprietary funds of three of the largest and best-known banks. The majority of them failed to achieve the returns of their benchmark index over a 15-year period.

Mistake No. 3: The DeBerrys were attempting to use bond funds to increase their returns. There is a common misconception about bonds. Investors believe they are “safe.” When you seek higher yields from bond funds, you are taking additional risk. The bonds may be lower rated, increasing the risk of default. The maturity date may be long-term, giving you the risk caused by fluctuating interest rates. There is no free lunch. You would be better advised to take risk by adjusting the amount of your portfolio you allocate to stocks, and limiting your bond holdings to short term (less than a five-year duration), very high quality, bond index funds, which will act to smooth out the short term volatility of your stock holdings. Vanguard’s Total Bond Market Index Fund (VBMFX) would be a good choice for the bond portion of your portfolio.

The DeBerrys invested $8 million in these funds. According to their Statement of Claim (from which all facts in this blog were derived), they lost more than $7,550,000.

In a Consent Order dated June 22, 2011, the SEC and the Financial Industry Regulatory Authority announced that Morgan Keegan and Morgan Keegan Asset Management had agreed to pay $200 million to settle fraud charges related to subprime mortgage-backed securities. They were accused of causing false valuation of subprime mortgage-backed securities in five funds managed by Morgan Asset Management from January 2007 to July, 2007. The SEC’s order found that Morgan Keegan “failed to employ reasonable pricing procedures and consequently did not calculate accurate ‘net asset values’ for the funds. Morgan Keegan nevertheless published the inaccurate daily NAVs and sold shares to investors based on the inflated prices.”

Two Morgan Keegan employees agreed to pay penalties for their alleged misconduct, including one who was barred for life from the securities industry.

The DeBerrys held four of the five funds that were the subject of the SEC and FINRA proceedings.

The DeBerrys filed an arbitration claim with FINRA seeking to recover their losses. Because they had an account with a FINRA member, they were required to resolve all disputes in an arbitration administered by FINRA. In light of the SEC and FINRA orders, you would think this arbitration would be a slam dunk.

Working with a broker, non-fiduciary, you are taking more risks than you may realize. Seek the advice of a fiduciary adviser, someone who will state in writing that your interests come first.

Please comment or call to discuss what a fiduciary adviser means to you.

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