Naked Truth Investing: Watch out for these signs on the road to financial perdition

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This is the part of a new series of columns called "The Naked Truth," by retirement expert Dan Solin. Please bring him your questions, in the comments box, and he will answer as many as he can.

The are many minefields for investors who want to save for retirement. Fortunately, the warning signs are clear. If you see any of these signs, you are driving on the road to financial perdition. Stop. Turn around and go in the opposite direction:

1. "This mutual fund has a 5-star Morningstar rating." It still is unlikely to beat an index fund with a comparable risk over the long term.

2. "We provide alpha." "Alpha" is a fancy word that brokers love to use. It means that a stock or mutual fund has performed better than would have been expected given its volatility. There is no evidence that brokers can provide "alpha" over the long term. There is a lot of evidence that brokers add cost and subtract value.

3. "We think this is a good time to get back into the market." There is no evidence that anyone can time the market successfully over the long term with any more consistency than you could attribute to luck.

4. "We think this is a good time to get out of the market." See #3.

5. "The target price for this stock is $___." It doesn't matter what the dollar figure is. The stock is already efficiently priced.

6. "We have a lot of confidence in this fund manager." There is little likelihood that a successful fund manager will repeat her success in the future.

7. "Our analysts think ......" It doesn't matter what the rest of that sentence is. There is precious little evidence that the stock picks of analysts are of any value.

8. "Just sign the Account Opening Statement here. Don't worry about the mandatory arbitration clause." All investors who open an account with a broker who is a member of FINRA give up their right to access to the Courts and to a trial by jury. Instead, they get an arbitration administered by FINRA, the largest non-governmental regulator for all securities firms doing business in the United States. There are several studies (including one I co-authored) that cast serious doubt on the fairness and impartiality of these industry arbitration panels. This means you can't do business with any broker in the United States...but maybe that is not such a bad idea!

What's an investor to do?

Focus on your asset allocation. Use low cost index funds in your portfolio. Open up an account directly with a major fund family like Vanguard, Fidelity or T. Rowe Price... but do not let them talk you into anything other than a globally diversified portfolio of index funds.

Dan Solin is the author of The Smartest Investment Book You'll Ever Read (Perigee Books 2006) and The Smartest 401(k) Book You'll Ever Read (Perigee Books, June 24, 2008). Visit his website at Smartestinvestmentbook.com.

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