Scrutinize Broker Ads Carefully

The Wall Street bullies continue to confuse and deceive investors with their ‘cute’ ads. Many people will be swayed to believe that the bullies have their best interest in mind. The Wall Street bullies want you to continue trading because this is their primary source of income. They will never recommend a prudent portfolio and help you remain disciplined to your strategy. Fire your broker and hire an investor coach. Wall Street bullies like ETrade need traders to continue trading. Don’t empower them.

E-Trade (Photo credit: San Diego Shooter)

For clients who elect its “Managed Investment Portfolio,” E*TRADE charges a maximum annual net advisory fee of 0.90 percent on assets up to an account value of $100,000. Its fees decline on a sliding scale as assets increase in value. For assets over $1 million, its fee is 0.65 percent.Most of the funds recommended by the E*TRADE representative were actively managed funds where the fund manager attempts to beat a designated benchmark. The average expense ratio of those funds was 0.72 percent. A comparable passively managed portfolio would have lower expense ratios, ranging from 0.20 percent to 0.47 percent. Higher expense ratios reduce returns.

The funds in the E*TRADE portfolio paid 12b-1 fees of 0.15 percent. These are marketing fees often paid to intermediaries for selling the fund. These fees are included in the expense ratios of the funds. The payment of 12b-1 fees gives brokers an incentive to sell those funds and may create a conflict of interest. Passively managed funds typically pay no 12b-1 fees.

Three of the mutual funds recommended by E*TRADE charged front-end loads, which is a commission or sales charge applied at the time of the initial purchase. These loads lower the size of the investment. Passively managed funds typically do not charge front-end loads.

What are the chances that an actively managed portfolio will outperform a less expensive, passively managed one? Exceedingly small. My colleague Larry Swedroe wrote a blog post addressing this issue. He found that, based on the assumptions set forth in his blog, the probability of a portfolio of 10 equally-weighted actively managed funds, rebalanced annually, successfully generating “alpha,” was a minuscule 0.055 percent over a 10-year period.

Most importantly the E Trade account will provide a facilitator not an adviser. If you hire an investor coach you will have someone to guide you through the tough times.

Please comment or call to discuss how this affects you and your family’s financial future.

Posted via email from Curated 401k Plan Content

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Comparisons to Other Mutual Funds Can Be Misleading

Marketing gimmicks in the financial services industry are rampant. Many investors are realizing that they cannot trust wall street as evidenced by the outflow of fund from actively managed funds and inflow to passively managed funds.The main street solution is to own equities, gloablly diversify and rebalance.

Mutual Fund Playas
Mutual Fund Playas (Photo credit: greggoconnell)

Since 100 percent of its retirement funds beat their 5-year Lipper average, investors could believe that T. Rowe Price has found a way to consistently “beat the market”. Is this accurate?Not if you understand how the use of benchmarks can be misleading.

Lipper mutual fund averages are benchmarks that measure the performance of funds in a given category against other funds in that category. The fact that all of the retirement funds managed by T. Rowe Price beat their Lipper averages means they were better than the average performance of the other funds measured by Lipper. While interesting, it tells you nothing about how those funds performed against their benchmark indexes.

Morningstar assigns a benchmark index to each mutual fund it rates. This is the index against which the performance of a given fund can be measured. These indexes are assigned by the Morningstar fund analyst team, based on its Morningstar category. It is the index the Morningstar analyst team believes is the most appropriate benchmark for the Morningstar category.

The performance of a fund against its appropriate index is a more accurate way to evaluate the performance of a mutual fund. Think of it this way. If the average 8th grader can run a 100 yard dash in 20 seconds and your child took 40 seconds, you might be concerned. However, if the only information you had was that your child was better than the average in his class (and the average in his class was 45 seconds), you might believe he was in great shape.

Using data from Morningstar (for example see here), Index Funds Advisors calculated the returns for the five-year period ending December 31, 2011 of the T. Rowe Price Retirement funds against their analyst assigned benchmark. This was the same period used by T. Rowe Price to measure performance against the Lipper average. We measured the performance of all 33 T. Rowe Price Retirement Funds. The results were surprising. None of them equaled (much less beat) their Morningstar analyst assigned benchmark. Underperformance ranged from 0.84 percent to 1.73 percent (annualized). Only twelve of these funds are available for direct purchase by individual investors.

The marketing machine of the major mutual fund families are continuously looking for ways to peddle their funds. Most of these methods are misleading to investors. Armies of lawyers for these funds make sure the wording of the marketing pieces will get their firm into court.

Please comment or call to discuss.

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Headline Risk Is a Lame Excuse for Active Managers

Active vs Passive
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Active managers need to convince you that they will beat the market going forward because they cannot prove they beat it in the past.

Active managers were quick to explain their underperformance. Mark Lamkin, the CEO and “chief investment strategist” at Lamkin Wealth Management, blamed his underperformance on “headline risk,” noting: “Nine of the last 11 years my active strategies have beaten the market, and I’m underperforming this market. It’s all headline risk.””Headline risk” is the possibility that a negative news story will adversely affect the price of a stock.

I tried to verify Mr. Lamkin’s claim that his active strategies have “beaten the market” in nine of the last eleven years and was unable to do so. His firm does not publish the results of its portfolios on its web page. I called his office and asked for additional information but received no response.

Analyzing the significance of claims that a fund manager or advisor “beat the markets” is not uncomplicated. You need to understand how much risk the manager took and whether the benchmark used for comparison is an appropriate benchmark, comprised of a proportionately weighted mix of stocks and bonds.

Mr. Lamkin’s lament about “headline risk” is troublesome. Unexpected news is a reason for under performance by active managers, but it is not an excuse that active managers should use to explain their inability to “beat the markets.” Tomorrow’s news drives stock prices. Active managers don’t know tomorrow’s news. They can’t anticipate what they don’t know. “Headline risk” is one of many reasons why active managers historically have underperformed the markets and are likely to continue to do so in the future.

According to a mid-year 2011 study by Standard and Poors, Over the past three years, 63.96% of actively managed large-cap funds were outperformed by the S&P 500, 75.07% of mid-cap funds were outperformed by the S&P MidCap 400 and 63.08% of the small-cap funds were outperformed by the S&P SmallCap 600. Passive management trumped actively managed in nearly all major domestic and international stock categories.

Finding an active manager who beats the market is a matter of luck. You have no idea if the active manager presented will beat the market going forward.

Please comment or call to discuss.

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Their Confidence Is Killing Your Returns

English: Eugene Fama receiving the inaugural M...
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There is a scientific method of building a risk adjusted gloablly diversified portfolio. Trying to find the next hot asset class or stock or fund manager is a futile exercise. To succeed in reaching your long term financial goals you must remain disciplined to a prudent strategy.

At the request of a prospective client, I proposed a risk adjusted portfolio, consisting of low management fee, passively managed stock and bond funds. I tilted the portfolio towards small and value stocks, consistent with the research of Eugene Fama and Kenneth French. Their research explained the relationship between risk and return for stocks. It is known as the Fama-French three-factor model. Distilled to its essence, the Fama-French three-factor model holds that a portfolio tilted toward small and value stocks (which increases risk) has a higher expected return than a portfolio without this tilt, over the long term. You can read more about the Fama-French three factor model here. In my recent book, The Smartest Portfolio You’ll Ever Own, I recommended portfolios of index and exchange traded fundsat different risk levels that investors could implement themselves. These portfolios are based on the research of Fama and French.My prospective client showed my recommendations to a friend who is a well-known financial advisor. He derided them as “possibly” suitable for those who wanted to preserve wealth, but not to grow it. In order to grow wealth, he advised retaining his firm because of its ability to time the markets and “customize an individually tailored portfolio of stocks and bonds.”

The research supporting my recommended portfolio is extensive and is summarized in the bibliography to my book. His advisor friend provided no research validating his approach to investing, but he made up for the lack of data with his air of infallibility and aura of expertise.

We all want to know what will happen next. Who will be the best ‘stock picker’? There is a scientific method to developing you portfolio for superior long term results.

Your comments are welcome or as well as your calls.

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