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Financial Opinion and Insights

Smart Investors Think Long Term – And Know What Questions To Ask

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

According to a Morningstar study I saw that was conducted in 2010, the odds for those trying to `time the market’ didn’t look too good – and I doubt they’ve improved much – but there are still a lot of financial tv shows picking stocks for all of us.  Are they doing us a favor? 

Anyway, the study I saw analyzed the cost of market timing using the S&P Index over the 10-year period of 1990-2009 inclusive, which comprised 5,044 trading days.

An investor who stayed invested during the entire period would have experienced an average annual return of 8.2%.  Hmmm, didn’t that include the period of the 2008 market meltdown?   But, I digress.  Here’s what the study found:

· Missing only the 10 best days reduced that percentage to 4.5% – almost in half!

· Missing only the 20 best days meant realizing only a 2.1% average annual return for the entire ten-year period!  Returns were cut in half again… and 75% less than the investor who stayed invested!

· Missing the 30 best days meant an average annual return of only 0.1% – for the entire 10-year period!!!  It’s worth noting that those 30 best days may not—and probably didn’t—run consecutively, which makes it even more problematic.  Can YOU guess those 30 days—in advance?

· Missing the 40 best days meant a return of –1.8% as an average annual return for the entire 10-year period; and missing the 50 best days took that percentage down to –3.5%

Other studies I’ve seen show that individual investors do underperform indexes by a wide margin!  The reason seems to be because they react to current events.   One CFO I talked with told me he constantly sees people ‘get out’ after drops only to be left there during rebounds!

Why do they do this?  Maybe because they simply don’t have an investment discipline.  It becomes too easy to react to headlines.   The next time someone tells you they manage their own portfolio, ask them, “If you had a choice of ten managers – nine professional institutional money managers and yourself, would you pick you?  Would anyone else?”

Oh, well.   But, choosing an advisor can be dicey, too.   Smart investors, however, do ask smart questions. 

Here’s a sample set of screening questions you can use.   Ask your potential advisor to answer them in writing before you begin your discussions.   For example:

  • Are you a registered investment advisor, a registered representative, or both?

       Note:  A registered investment advisor (RIA) works for fees.  A registered representative works on commission.   Some `advisors’ are `dually’ registered.   A registered representative (broker) is free to operate under a `suitability’ standard while an RIA is legally required to work under a `fiduciary’ standard, which means the client’s best interest must be paramount.   `Dually-registered’ representatives will often adopt the fiduciary standard for the planning process, then adopt the `suitability’ standard when it comes time to select investments.  Under that standard, an investment may not be in the client’s best interest; but, if it’s suitable, it passes.

  • Do you work for fees only, commissions only, or a combination?

       Note:  If a combination, you want a breakdown on each.  When does the `fiduciary hat’ come off and the ‘suitability hat’ (commissions) go on?  Some adopt fiduciary status for planning but switch to the ‘suitability’ standard when it comes to the investment process.

  • Do you accept fiduciary status and are you willing to put it in writing?

       Note:  If your candidate isn’t willing to accept fiduciary status in writing – for both planning and investments – one has to wonder just what you’re paying them for.  Chances are it might be simply product sales.

  • Who provides the reporting on my account?

       Is it his own firm?  That’s not necessarily bad, but it’s worth knowing.

  • What firm will serve as custodian of my assets?

       His own firm again?  Again, not necessarily bad, but again worth knowing.  If it’s one thing all the `bad guys’ have in common, it seems to be the lack of an independent custodian.  If a firm has custody of your assets, does the managing internally, and also provides the reporting, where are your checks and balances?  Where is your independent verification?   All those so-called sophisticated investors who lost money to Bernie Madoff and every other crook could have asked this simple question.

  • Are the managers you recommend in-house managers or outside managers?

His own firm again?  Hmmm.  Be careful.  Sometimes a ‘proprietary’ solution won’t transfer so easily if you decide to move to another advisor.  When was the last time an `in-house’ manager was fired in order to use an outside manager?  Thankfully, this isn’t as much of an issue today as it used to be – I don’t think; I’ve been away from that environment for some time now.

Spotting a good advisor shouldn’t be too hard:  A good one will focus on you and not the markets.  S/he will talk about process and risk management and take time to learn about your issues and concerns.

A bad advisor – or worse, a rogue – will focus on investments, returns, and markets.  And, s/he’ll love if you should ask, “What kind of return do you get for your clients?”  That’s a question Bernie Madoff loved to hear.   Only novices and `marks’ would ask it.

Smart investors take a high-level view of portfolio makeup, knowing an 80-year old retiree has a financial and risk profile completely different from a 45-year-old high-earner who’s trying to accumulate assets for the future. 

Remember, success isn’t about being brilliant; it’s about being smart –  and the definition of smart is not being dumb.

 

Jim

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Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.