Smartphones and other portable devices allow the user to stay connected from even the most remote locations.  Social networking sites like Twitter and Facebook have amplified the chatter to a level that no one would have dreamed of at the beginning of the millennium.

A troubling byproduct of this flood of information is the ease with which extreme messages are being propagated.  From cable news shows to the blog-o-sphere, we are being bombarded with ideological beliefs that are driven mostly by emotion and have little use for facts.  During turbulent times especially, irrational views can become pervasive because they touch emotional nerves that otherwise would not be as sensitive.

A Ratings Game

Avoid Extremes

Larger than life persona’s on both ends of the spectrum do their best to keep us all in a constant state of anxiety because they know that if we are provoked enough we will continue to tune in.  The name of the game is ratings, because higher ratings translate into higher advertising revenue.

Glenn Beck and Michael Moore are polar opposites on the political sphere, but they have more in common than either one of them would care to admit.  The challenge they face is trying to blend editorial content within a format that is meant to entertain.  They both endeavor to create an emotional response in their audiences by enhancing certain aspects of the subject matter while leaving important details out that would possibly cause a different reaction.

Motivation that was born of their formative experiences is altered by a cycle of capitalistic one-upmanship that can distort even the purest of intentions.

Unfortunately, blurring of the lines between truth and fiction in the information landscape is all too common, and often the consequence for the consumer is drawing a conclusion without having heard the full story.

Separating Fact from Fiction

Keeping fact separated from emotion is an important part of our job and something that we spend a great deal of time doing.  A healthy dose of skepticism is necessary, as we have found that even the most respected source of information can often be influenced by their biases.

We employ various methods, such as quantitative research, to enhance the opinions and analysis gathered from our trusted sources.  We also talk to people in our industry as well as our clients to get a perspective as to how others are experiencing the economy.

There is no easy solution to charting the course that we feel will provide the best opportunity for success.  By remaining consistently disciplined in a long-term approach to investing, we believe that we can gain an advantage by filtering out the noise.

Photo Credit : truthout.org

Deflation Fighter?

Gold’s average annual return (using average monthly price) from 1980 through 1986 as it followed the inflation rate down is a negative 10%; from 1980 to 2005 it is a negative 2%.  Meanwhile, gold didn’t hit its average monthly high again until over twenty five years later when it began its recent bull run in 2006.  Since 2006, gold has averaged a return of over 17% per year.  However, inflation has hardly been out of control during this time and, in fact, the prevailing fears currently facing the markets are those of deflation.  So how is it that a commodity that has a history of being used as protection against inflation is suddenly a haven in a deflationary environment?

Yosemite Sam’s Investment Choice

Gold is also a reflection of the overall faith (or lack thereof) in the economic and political system. Issues such as the European debt crisis, the Gulf oil spill, persistent joblessness, a housing crash hangover, etc. have created a sense that the problems we face are too big and might lead to widespread economic collapse.  Currencies will tumble in value in a collapse scenario, so the hedge with gold is that you will have protected your ability to trade for goods and services through the relative stability of its value.  That, in effect, is the bet that is being made by those who are pushing gold up into stratospheric territory.  The gold bet in 1980 didn’t break even for another twenty five years (even longer when adjusted for inflation), it will be interesting to see how well today’s gold bet plays out.

The Dreaded Check Engine Light

Check that Engine!

One of the more standard ways your car will alert you of a problem is by triggering the check engine light.  Usually once illuminated, the check engine light can be decoded by running a diagnostic test on the car.  When we first meet with clients, we’ll often hear the statement, “I want to make sure I’m doing all I can with my investments.”  By running our version of the diagnostic test each quarter, we spot tune-ups and efficiencies that otherwise may be missed.  Our checklist includes:

• Handling required minimum distributions
• Identifying opportunities to fund more tax advantaged accounts (Roth IRA’s, IRA’s or qualified plans)
• Verifying funds will be available for short-term cash needs
• Minimizing transaction fees
• Evaluating if a lower cost investment could fill the role of a current one
• Determining if any accounts can be transferred for cheaper or better investment options
• Considering if any other account openings or transfers would be beneficial (college planning accounts/life insurance/1035 exchanges/annuities)
• Keeping investment allocations in line with your risk capacity and our investment themes

Some of these items occur every year and some every quarter.  Staying on top of each one keeps your portfolio in good working order.

Photo Credit: Robert Couse-Baker

This is the third and final installment of our “Behind the Scenes” series.  It is our hope that this series gave our clients a more transparent look at our business so they can better understand the diligence we employ with each client review.

Reverse Your Emotions

Don't Panic!

Successful investing requires turning emotions on their head.  When most people are nervous is the time to see opportunity, and when most people are fearless is the time to be scared.

The stock market did worse during the 2000’s than it did in the 1930’s! Do you remember how you felt in September of 2002?  Or even last February 2009? These periods are when many people were giving up on the stock market.  Fear had brainwashed their rational decision-making skills. If they would have realized in 2002 that their investments were about to go on a multi-year bull market ride, would their fear have been as pronounced?

On the other hand, people’s attitudes of early 2000 and October 2007 were ripe with optimism and fearlessness.  This is a direct contrast to the fear and pessimism that are now dominant.  Optimism makes people overpay for opportunity, while fear makes them overpay for safety.

It’s important to recognize that we will continue to have economic scares in the future (as we always have in the past).   Economic Cycle Research Institute had a recent write-up about the lag effect in people’s perception after a recession.

Take Inventory of Your Short-Term Holdings

What percentage of your investments are in safe areas?  The basic rule of thumb is to have 3-6 months of your living expenses in a safe place with little risk.  This allows you some breathing room for the money you have invested in the markets.  Knowing that you have a cushion of cash and bonds to access for your everyday expenses gives riskier investments time to ride through the stock market dips.

*Photo Credit: pasukaru76

Watch Out For Potholes

Photo Credit : me and the sysop

Unfortunately, with an investment portfolio we don’t always hit a pothole or get a steering wheel shake to let us know it’s time for realignment.  In fact, when investors do begin seeing bad returns, it often leads them to make bad choices with their investments resulting in costly mistakes. We have become well aware of this natural human tendency which is why we rely heavily on our research themes.  By conducting our investment review process quarterly, we can review client portfolios and realign according to our research themes if necessary. During our analysis, we monitor how closely the client’s current investment mix matches our long-term investment strategy.  We also measure the level at which our clients’ stocks are positioned within the allocation ranges we establish during our initial planning work.  If the stock percentage is above or below the range, we know an adjustment should be made.

Mental Accounting

Photo Credit: gutter

Many investors have a tendency to bucket their investment accounts.  They assign different purposes for their accounts which in turn require different investment strategies for each account.  For an investor to reach their optimal portfolio return, we feel it’s vital to have a coordinated investment strategy across all investment accounts.  Qualified plans give us the best example of this philosophy.  Many investment choices offered in 401k’s and 403b’s are limited compared to what you might be able to access in other accounts.  In a 401k, there may be a great international fund choice but only average domestic choices.  In this scenario, we may want to use the attractive international investment for all the funds in the 401k and surround it with more quality choices in other accounts where we have more investment selection.

I’ll Owe More in Taxes?!?

Photo Credit: krossbow

Don’t let the tax tail wag the investment dog.  In other words, there are times when heavy realized gains in a holding could lower the motivation to sell if you were strictly looking at the scenario from a tax perspective.  However, if this same security represented 75% of the portfolio and was comprised of one individual stock, the concentration risk would most likely outweigh the desire to hold on to the stock to avoid incurring a large capital gain.  Decisions such as these take careful evaluation and can only truly be assessed by taking the “big picture” into consideration.

Other Factors

Our investment review process allows us to assure our client’s portfolio is in good working order. To accomplish this, we also consider specific factors such as a client’s age, family relationships, tax considerations, risk levels, and the latest notes and communications with the client to assure we are not missing any potential improvements that could be made to their overall investment situation.  Our investment review process helps us take great care in assuring our client’s investment mix matches their risk preferences. Do you have a review process for your investments?

This is the second part of a 3-part series we’re calling “Behind the Scenes.” It is our hope that this series will give our clients a more transparent look at our business so they can better understand the diligence we employ with each client review.

Photo credit to Michael (mx5tx)

UNDER THE HOOD

In order for a car to stay in good working order, regular maintenance is required.  For investments, our routine maintenance checks occur regularly as we apply our review process to client portfolios on a quarterly basis.  If you popped the hood on our system, you would first notice the engine, our unique research process.  To keep this engine running at a high level, each member of our investment team spends time uncovering their own individual research in order to keep the bearings well-oiled.

We regularly conduct monthly meetings in which we discuss and debate our opinions to develop overarching economic themes and strategies.  These strategies are derived from multiple thought-provoking writers, money managers, and trusted economic researchers.  We also employ several statistical models of our own which are the basis for our estimate of the markets fair value.  After running through likely scenarios and or debunking biased theories, we craft our own strategic calls that we feel hold the most potential for future returns.  Several examples of questions we investigate while making these assumptions include:

• What is a healthy balance for splitting assets between US/Foreign holdings?
• Based on market valuations, which position should we be targeting in your allocation ranges?
• What specific sectors are likely to benefit going forward?
• How long of a maturity and what grade of quality should we be targeting with our bond holdings?
• Do large or small companies possess more potential return?
• Is any particular asset class over or undervalued?

AVOID IMITATIONS

When you encounter a maintenance issue with your car, there can often be ancillary problems that crop up if you try and make the fix with an imitation part.  To have the most confidence, you would prefer to replace with a part made by the manufacturer of the car for the best performance long-term.

The second leg of our unique research process is very similar as we are searching for specific funds to make a client’s portfolio run more efficiently. We run multiple screens in hopes of discovering quality funds that could potentially earn their way into our preferred fund rotation.  These funds go through a rigorous 18-point qualification test which helps us to judge if they deserve the right to be discussed in our Security Selection meetings.  These meetings, which also take place once a month, are where we peel the onion on funds we are considering for usage in our client portfolios.  We do our best to put a fund through the ringer, by evaluating everything from how the manager is compensated, to judging the culture of the mutual fund business.  Once a fund makes the initial cut, we try to find reasons why not to include it in our preferred list.  Several questions usually develop at this stage that gives us a reason to interview someone at the fund company.  Only after this type of meticulous analysis do we upgrade a fund to be used in our client portfolios.

This is the first part of a 3-part series we’re calling “Behind the Scenes.” It is our hope that this series will give our clients a more transparent look at our business so they can better understand the diligence we employ with each client review.

photo credit: saturnism

What if you never again had to prepare your tax return? Or pay someone to do it for you?  The catch is that the IRS would be the ones who prepare it.  Sound a little scary?  The Bipartisan Tax Fairness and Simplification Act of 2010 introduced in the Senate has a provision for just that scenario.

http://www.theatlantic.com/business/archive/2010/02/will-the-new- tax- reform-bill-kill-h-r-block/36605/

HOW TO LOSE MONEY IN THE TOP-PERFORMING FUND

by Bob Veres

An article in the December 31st issue of the Wall Street Journal makes a point that many of us in the financial planning world have long suspected. It says that the CGM Focus fund was the top performing mutual fund, by far, over the past ten years, generating an annualized return of more than 18% a year since January 1, 2000.

photo credit: aresauburn

Now here’s the punchline: the average investor in this top-performing fund lost an average of 11% a year over the same ten-year period.

How is it possible for investors to lose their shirts in a fund that posted outsized returns?

Most planning professionals know the fund’s manager, Ken Heebner, as a swing-for-the-fences investor, somebody prone to huge runups and equally scary drops.

A Chicago-based investment research firm called Morningstar – whose data is used by most financial advisors — calculated what is called the “dollar-weighted” return of the CGM Focus fund, which gives a picture of what investors in the fund actually experienced.

If you had bought and held Ken Heebner’s portfolio throughout the 2000s, you would indeed have received returns of 18% a year. But the fund was so up and down that investors were alternately panicked and selling out or optimistic and crowding back in.

The article says the most dramatic example came after the fund was up 80% in 2007. Investors flocked in, putting $2.6 billion into the CGM portfolio — just in time to catch its equally-dramatic 48% drop through the end of 2008.

There have been credible studies showing that the average investor underperforms the market, and this illustrates exactly how it happens. Right after an investment generates strong returns, people tend to jump on the bandwagon — and then they experience the subsequent return to reality.

When an investment is struggling, people tend to abandon it, and miss out on its recovery. Missing the upside and catching the downside, consistently, is human nature, perfectly understandable behavior.

But it inevitably leads to dismal investment results — as it did for the battered, unhappy, money-losing investors in the best-performing mutual fund of the 2000s

WHY WE PASSED ON CGM IN 2007

Bob Veres’ commentary illustrates why we were not recommending CGM in 2007 when it was generating so much excitement. That same sentiment is why we are currently emphasizing funds like Allianz NFJ Dividend Value Fund, which may not be popular at the moment, but have proven to outperform after periods of lackluster results.

ALLIANZ NFJ DIVIDEND VALUE, PNEAX

The following is an excerpt from an interview with Ben Fischer, portfolio manager of NFJ Investment Group, on the recent performance of Allianz NFJ Dividend Value Fund:

(The Full interview can be found at www.AllianzInvestors.com)

Q: Why haven’t the financials in the portfolio fully participated in the rally?

A: You need to remember that NFJ seeks to invest in low-priced stocks with attractive fundamentals. NFJ believes that many of the benchmark constituents that have driven recent index performance have not done so because of their fundamentals. In fact, many of the stocks that improved the most were those that declined most precipitously in 2008.

Further, among financials, it is the very lowest quality stocks that have delivered the best performance since the market bottom on March 9.

While we are not limited to investing in only high-quality names, our process does prevent us from owning the lowest quality names. This positioning has served our shareholders well in the past, and will do so over the long term.

Q: Your Morningstar rankings have been affected. Explain a bit about that.

A: Morningstar rankings can be useful, but must be understood in context. Growth has significantly outpaced value year to date. In that environment, a deep value manager like us will likely underperform relative to its Morningstar peer group.

Further, deep value funds like NFJ Dividend Value will lag traditional and relative value peers. In addition, given the way the rankings are weighted, one-year performance has a greater effect on longer-term rankings, so any performance lag over, say, four months, will have an unusually significant impact on three- and five-year rankings.

Q: Has the portfolio ever lagged its benchmark and Morningstar peers in the past?

A: Yes, in the late ’90s, when growth outpaced value, the portfolio lagged both its benchmark and peer group. Again in 2003, when lower quality names outperformed, the fund lagged the benchmark and its peers.

However, both of these periods were followed by periods of outperformance.

Q: What are you doing to protect your shareholders in this environment?

A: We are focusing intently on absolute yield. We are also focusing on the cushioning effect of dividends.

To the latter point, though dividend cuts by many companies have been well publicized, among the Fund’s holdings, raises have actually outnumbered cuts three to one. Only eight of 45 holdings have reduced payouts over the past year, and the median holding still pays more than it did one year ago.

We have also emphasized companies with no looming debt maturities or pension plan concerns. We have highlighted companies that have recently hiked their payouts, even in the midst of the current economic malaise, as NFJ views these companies as less likely to turn around and slash their dividends.

Further, in the future, dividends may become rarer, and company managements will probably think twice before instituting standard payout hikes unless they are certain that they can be maintained.

Thus, going forward, increasing dividends may work even better as an indicator of quality and management confidence.

This amendment cuts out a part of the original bill that would have required everybody who gives investment advice to the public to act as a fiduciary.  Senator Johnson wants the Senate to “study” the issue instead.

Why should you care?

The fiduciary standard is a legal concept, but its core idea is not complicated.  To act as a fiduciary means we professionals have to put aside our own financial interests, and also put aside the business/financial interests of any company we work for, and give recommendations that are solely and completely in the best interests of people like you, our customers or clients.

In other words, our recommendations have to be made with only one concern: is this the best thing I (the professional) can do for you, given what I know about who you are and what you want and need?

So what does it mean NOT to be a fiduciary?  Imagine that there were two kinds of health practitioners in the world.  One group functions much like doctors do today: they work out of independent offices, meet with you, diagnose your ailments, prescribe a medical solution that they believe is the very best course of treatment, and you pay them directly for this service.

photo credit - j.reed

The other group of health care providers operates somewhat differently.  They’re employed in the branch office of a large multinational health conglomerate which requires its employees to recommend certain treatments which are most profitable to the company, so long as these treatments are considered to be “suitable.”

These might not be the best treatments, but under a set of very complicated regulations, these less-than-ideal prescriptions are deemed to be legally-defensible ways to address certain medical problems.  These other health care providers are paid by the company according to how many of these treatments they can sell.

Now imagine that these larger companies, because of the very high profits they’re making on these treatments, are able to gain a lot of influence over the process that decides which treatments are “suitable.”  In fact, their executives sit on the governing board of the organization that makes these determinations.

Finally, imagine that something went horribly wrong.  Several of the most popular treatments that these non-fiduciary medical professionals were eagerly peddling to their “patients” were not at all as their companies had portrayed them.  The result: catastrophic consequences, pain and suffering throughout the world.  An enormous mess.

To bring the analogy back to the financial world, these terrible treatments (investments) actually DID bring the global economy to the brink of financial collapse, a mess that required our taxpayer money to fix.  These companies had become so entwined in the system that the government had no choice but to help them recoup the staggering losses they brought upon themselves.

Not surprisingly, an outraged public demanded that this must never happen again.  To the real fiduciary practitioners, the solution is obvious: require everybody to act in the best interests of their customers/clients by imposing a fiduciary standard.  No more shady “suitable” treatments.

We were encouraged when Congress drafted legislation which, among other things, would bring every provider of financial advice under a fiduciary standard.

So here’s why professional financial services providers are angry.  Now that the catastrophic global meltdown, TARP, massive losses in the stock market and the longest recession since the 1930s is beginning to fade from memory, those companies that provide “suitable” non-fiduciary advice have gone back to business as usual–and very quietly, a Senator from South Dakota has now inserted a provision into the reform bill saying that instead of imposing this fiduciary requirement, that instead Congress will “study” the issue.

The Senate has decided to leave fiduciary out of the final bill.  Even the Wall Street Journal is outraged–here’s a link to a strongly-worded column that clearly explains what happened: http://online.wsj.com/article/SB10001424052748703940704575089413832399630.html

And here’s a link to another article which talks about how the legislative process favors the organizations that take the most money out of the pockets of their customers: http://www.financial-planning.com/fp_issues/2010_1/angels-and-demons-2665124-1.html

It would be nice if everybody called their Senator and Congressperson and said that they were just as angry as we are in the professional community.  A groundswell of public opinion might make our elected representatives understand that we haven’t forgotten TARP and all the rest of it.  Right now, the only people lobbying on your behalf are the professionals themselves, and there apparently aren’t enough of us to get the attention of the Congressional representatives who may be looking out for their own interests more than ours.

• This article is written by Bob Veres, publisher of Inside Information.  Inside Information is a journal that keeps financial advisors on the cutting edge of industry news. We found this piece particularly relevant to the heated debate surrounding the fiduciary vs. suitability discussion.

(1) Countries that went away from the gold standard sooner fared much better during the Great Depression than those that held longer (like the U.S.)

(2) Average inflation, under the gold standard, is determined by the pace at which gold is mined

http://www.j-bradford-delong.net/Politics/whynotthegoldstandard.html