DailyFinance.comhttp://www.dailyfinance.comDailyFinance.comhttp://o.aolcdn.com/os/df/2013/img/2-dailyfinance_logo_m.pngDailyFinance.comhttp://www.dailyfinance.comen-usCopyright 2013 Weblogs, Inc. The contents of this feed are available for non-commercial use only.Blogsmith http://www.blogsmith.com/Don't Gamble When It Comes to Your Retirementhttp://www.dailyfinance.com/2011/04/01/retirement-planning-tool-monte-carlo/http://www.dailyfinance.com/2011/04/01/retirement-planning-tool-monte-carlo/http://www.dailyfinance.com/2011/04/01/retirement-planning-tool-monte-carlo/#commentsFiled under: , ,

Most people associate Monte Carlo with gambling and the lifestyles of the rich and famous. As investors, however, you should be familiar with another meaning.

A "Monte Carlo analysis" can be used to determine if you are on track to retire with dignity or more likely to run out of money and spend your "golden years" destitute and dependent on family or the government for your monthly expenses.

In a Monte Carlo analysis, the computer generates a large number of future return scenarios and computes the statistical likelihood of your portfolio surviving to the end of a designated period. The results of the analysis are heavily dependent on the assumptions, so great care must be taken to make the assumptions as accurate as possible.

The assumptions I use in the Monte Carlo analysis include:
  • The beginning portfolio value;
  • The number of years (according to actuarial tables) of life remaining for my client;
  • Future deposits and withdrawals in retirement;
  • Inflation rate; and
  • The distribution of returns for the portfolio selected based on past returns. I use either 83 years of data (which includes the Great Depression) or 50 years of data.
10,000 Retirement Scenarios

The computer generates 10,000 different scenarios of year-by-year returns and calculates the value of the portfolio at the end of each year. The end product is the "portfolio survival rate," which computes the odds of the portfolio surviving. For example, if the portfolio is in negative territory for 1,000 of 10,000 trials, the portfolio survival rate would be 90%. I regard a portfolio survival rate of less than 95% as unacceptable.

You can input your assumptions and obtain a Monte Carlo analysis for your portfolio here. (Full disclosure: The input form was designed, and the reports are generated, by Index Funds Advisors, with whom I am affiliated.)

Sponsored Links
It's not surprising that most investors have no clearly defined goal for their investments. The financial media and "market- beating" brokers and advisors focus on trying to predict the direction of the markets, picking stock winners, and selecting the next "hot" mutual fund manager. Few investors understand no one has the expertise to engage successfully in any of these activities.

Here's the question I ask every investor: Would you find it helpful to understand how to structure a portfolio that will maximize the possibility of your money lasting longer than you and your surviving spouse or partner, for a given level of risk? I have never had a negative response to that question, but I have also never posed it to an investor who had a clue whether he or she was on the right or wrong path towards achieving that goal.

Running a Monte Carlo analysis is not perfect. It is not predictive since it is based solely on long-term historical data. Nevertheless, it is a lot better than the "wing and prayer" that passes for investing "advice" at the office of your retail broker.

Permalink | Email this | Comments

]]>golden yearsMonte Carlomonte carlo analysisretirement mistakesretirement planningretirement savingssaving for retirementDaniel SolinFri, 01 Apr 2011 10:00:00 ESTThe Return of the Dreaded -- and Dreadful -- Stock Pickershttp://www.dailyfinance.com/2011/03/25/the-return-of-the-dreaded-and-dreadful-stock-pickers/http://www.dailyfinance.com/2011/03/25/the-return-of-the-dreaded-and-dreadful-stock-pickers/http://www.dailyfinance.com/2011/03/25/the-return-of-the-dreaded-and-dreadful-stock-pickers/#commentsFiled under: , , ,

Market turbulence and economic uncertainty create fear and anxiety among investors. Unfortunately, many turn to advice freely dispensed by self-styled investment gurus -- who claim they can predict the direction of the markets or pick outperforming stocks. Reliance on this advice can be very harmful to your financial well-being.

One form of stock market crystal ball reading is so-called "technical analysis." This, according to its proponents, is the examination of patterns in the market to identify the current trend, and then looking for patterns that suggest whether that trend is likely to continue or change.

Sharing "a Pedestal with Alchemy"

There's compelling evidence that technical analysis is nonsense. The view of those who study the capital markets, and publish peer-reviewed papers setting forth their conclusions, was nicely summarized by Burton Malkiel of Princeton University, in his seminal book, A Random Walk Down Wall Street. Professor Malkiel concluded that "under scientific scrutiny, chart reading must share a pedestal with alchemy." The concept of using past data to predict future prices has been debunked by the efficient market hypothesis -- which holds that markets are random and efficient. It is tomorrow's news that moves stock prices and markets, not yesterday's. No technical chart can predict tomorrow's headlines.

Stock pickers fare no better, but they keep trying to convince you they have predictive power that will help you to gain outsized returns.The unstoppable Jim Cramer advises you to buy banks, industrials and metals and mining. Should you listen to him?

No Better Than Coin Flipping?

Consider this: A study of 1,446 large-cap blend mutual funds for the 10-year period ending Oct. 31, 2004, found only 35 outperformed the S&P 500 index. Do you believe any individual stock picker is better than these handsomely paid and well-credentialed mutual fund managers?

Sponsored Links
The CXO Advisory Group tracks Cramer's picks, and those of other alleged "stock picking gurus." The overall rating of the stock pickers was 48%. You could replicate these dismal results by coin-flipping or by tossing a dart at a list of stocks. Is this an intelligent way to invest and plan for retirement?

In May, 2009, CXO did an analysis of Cramer's buy and sell recommendations. It concluded his recommendations are not particularly good or unusually bad. While Cramer likes to compare his performance to the S&P 500, the reality is his stock picks are often riskier than those in that index. In a bull market, you would expect higher returns from riskier asset classes.

A study by Barron's may also give investors pause before following Cramer's latest recommendations. It found Cramer's stock picks typically underperform the market. From May to December 2008, the market lost 30%. Investors who followed Cramer's advice would have lost 35%.

"No Such Thing as Stock Picking Skill"

There's something fundamentally wrong about making stock picks and knowing that some investors will rely on them, when there is no data indicating anyone has this expertise. William Bernstein, author of The Intelligent Asset Allocator and other valuable investing books, said: "It turns out for all practical purposes, there is no such thing as stock picking skill." His views are shared by Nobel laureates Merton Miller, William Sharpe and Paul Samuelson, and backed up by hundreds of academic studies.

Yet the charade continues. The same "gurus" who recommended Lehman Brothers, Washington Mutual, Worldcom, Enron and other companies that later filed for bankruptcy continue to tout their skills as investing prognosticators, unashamed and without remorse. They have new "stocks picks" for gullible investors with short memories. They hope their purported "expertise" will convince you to read their blogs, watch their television shows or -- worst of all -- entrust your money to them. I don't mean to pick on Cramer, who is no better or worse than his stock-picking colleagues. However, it is noteworthy that he recommended Lehman Brothers on Aug. 17, 2007, together with other financial stocks. That day, it closed at $58.11. Its most recent close was around 4 cents.

It may be entertaining to read their musings and watch their antics, but it has nothing to do with intelligent investing.


Permalink | Email this | Comments

]]>beating the marketbeating the streetBurton MalkielColumnsinvestinginvesting tipsinvestmentinvestment gurusjim crameroutperformstock market outlookstock pickersStock Pickingstock picksstocksTechnical AnalysisThe Intelligent Asset AllocatorunderperformWilliam BernsteinDaniel SolinFri, 25 Mar 2011 13:00:00 ESTWhite Lies: Five Secrets Your Cosmetic Dentist May Not Tell Youhttp://www.dailyfinance.com/2011/03/24/white-lies-five-secrets-your-cosmetic-dentist-may-not-tell-you/http://www.dailyfinance.com/2011/03/24/white-lies-five-secrets-your-cosmetic-dentist-may-not-tell-you/http://www.dailyfinance.com/2011/03/24/white-lies-five-secrets-your-cosmetic-dentist-may-not-tell-you/#commentsThe allure of a dazzling white smile has hit mainstream America. The annual U.S. cosmetic dentistry market is estimated at around $2.75 billion. According to a survey commissioned by the American Academy of Cosmetic Dentistry (AACD), 600,000 patients every year undergo veneer procedures, costing more than $371 million.

Before you plunk down your hard-earned cash for a smile makeover, here are five secrets your dentist may not tell you:

Secret No. 1: There is no specialty known as "cosmetic dentistry."

Any general dentist can call herself a "cosmetic dentist." Since cosmetic dental procedures are such big ticket items, general dentists have resisted efforts to have the procedures designated as a specialty, which would require certification and training. Patients are left to try to figure out who is really qualified.

Secret No. 2: Not all dentists who perform cosmetic procedures have advanced training.

Not all dentists who hold themselves out as "cosmetic dentists" have significant advanced training in the procedures they will be performing, but such training exists. Meaningful credentials include accreditation by the AACD or extensive training at the Las Vegas Institute for Advanced Dental Studies, the Pankey Institute, the Dawson Academy, the Kois Center or the Spear Education Center.

There are currently fewer than 350 dentists and laboratory technicians accredited by the AACD. Only 53 hold the highest credential of Accredited Fellow.

Secret No. 3: The dental laboratory that makes the veneers is as important as the dentist.

Most likely, the porcelain veneers that will define your smile will not be fabricated at your dentist's office. They are usually sent to outside laboratories specializing in this kind of work. There is a vast difference in the quality of work done by these labs. According to Bob Clark, president of Williams Dental Laboratory, a high-quality lab will employ technicians with training similar to the training required for highly qualified cosmetic dentists, and will work in close partnership with the dentist.

Chester Garcia, CEO of daVinci Dental Studios, notes that his lab uses advanced CAD/CAM software and FDA-approved materials to ensure veneers meet exacting standards.

Patients considering cosmetic procedures should be as focused on the lab as they are on the dentist.

Secret No. 4: Your cosmetic dentist may be using a foreign or non-certified laboratory.

Many dentists use laboratories located in China or in other foreign countries. These laboratories offer far lower prices than U.S.-based labs. The lower cost isn't always passed on to patients. Furthermore, foreign labs may not use FDA-approved materials. Some crowns and bridges manufactured abroad have been found to contain lead. The American Dental Association and the Center for Disease Control and Prevention, however, are not concerned. They believe the "trace amounts" of lead are "extremely unlikely to cause adverse health effects."

Sponsored Links
James Kessler, DDS., the Chairman of the Department of Education at the Pankey Institute, is opposed to the use of foreign labs. He believes close, personal communication with the lab technician is very important. He is also concerned about the quality of materials used by some foreign labs.

If your dentist is using a foreign laboratory, you have a right to know. Just because he sends his work to an address based in the U.S. doesn't necessarily mean it's not being outsourced to China or Mexico. If this is a concern, ask your dentist to show you "point of origin" and "list of materials" used for your lab work. This information should be maintained in your patient records, although in most states it is not required to be.

Some of the same issues can be present even when U.S.-based laboratories are used. Government regulation of both domestic and foreign dental laboratories is almost non-existent. The exceptions are Florida, Texas and South Carolina, which require certification for dental technicians and laboratories.

Bennett Napier of the National Association of Dental Laboratories advises patients to ask if the lab their dentist uses is a Certified Dental Laboratory or a DAMAS (Dental Appliance Manufacturers Audit System) accredited laboratory or is certified by the International Organization for Standardization (ISO). You can check a directory of certified technicians and laboratories by city and state here. You have a right to insist your lab work is done at a certified laboratory by certified technicians.

Secret No. 5: There are risks to having porcelain veneers placed on your teeth.

The advantages of porcelain veneers are compelling. A beautiful smile can be a confidence booster, with significant benefits. But there are risks you should know before making this important decision.

The veneers can be damaged or worn down over time, and may need to be replaced. This will cause both inconvenience and additional cost. Dr. Kessler notes that many patients believe veneers will last a lifetime, which is often not true.

By reducing the tooth structure, the tooth is more vulnerable to trauma or sensitivity. In extreme cases, root canal therapy may be required. New advances in cosmetic dentistry can reduce or eliminate this risk. Tara Hardin, DDS, a leading cosmetic dentist in Mason, Ohio, uses Emax veneers, which are custom made in the dental laboratory and bonded to teeth. Dr. Hardin notes the biggest advantage to Emax is their high strength and durability, which permits them to be produced in very thin layers, requiring little or no tooth preparation. According to Dr. Hardin, "no-prep veneers" usually involve no drilling and "we don't even need to numb patients for this procedure."

There are many cases of poorly performed cosmetic dentistry. Scott W. Finlay, DDS, an Accredited Fellow of the AACD, says that veneers can break off or be placed in the wrong position, affecting speech or giving the appearance of "bucked teeth." The burden and cost of repairing this work can be substantial.

While cost isn't technically a risk, the procedure is very expensive. Dr. Finlay advises patients to expect to pay a qualified cosmetic dentist from $1,500 to $2,500 per tooth. "Cheap" can be very expensive. A cosmetic dentist charging $800 a tooth is probably not using a first class laboratory and may be inexperienced. You could be very disappointed with the results.

Permalink | Email this | Comments

]]>cosmetic dentistrydental caredentiststeeth whiteningwhite teethWhiterTeethDaniel SolinThu, 24 Mar 2011 09:00:00 ESTRebuffing Warren Buffett: Japan Is Not a 'Buying Opportunity'http://www.dailyfinance.com/2011/03/21/warren-buffett-japan-buying-opportunity/http://www.dailyfinance.com/2011/03/21/warren-buffett-japan-buying-opportunity/http://www.dailyfinance.com/2011/03/21/warren-buffett-japan-buying-opportunity/#commentsFiled under: , ,

It's pretty daunting to take on the Oracle of Omaha. Warren Buffett, the billionaire investor and chairman of Berkshire Hathaway (BRK.A), recently stated that the extraordinary events in Japan offer a "buying opportunity." Buffett believes the massive earthquake could prompt a new bout of stock buying.

Is he right? Should you overweight your portfolio with Japanese stocks and take advantage of this "opportunity." I don't think so.

Sponsored Links
A real "buying opportunity" exists when stocks are mispriced. Six billion investors are looking at the price of Japanese stocks. They know every public fact about these stocks. They are well aware of the devastation and uncertainty caused by the earthquake and the instability of the nuclear reactors in Japan. They also understand the rebuilding and government stimulus that is likely to follow in the ensuing months and years. The collective wisdom of these traders has determined that the current price of Japanese stocks is a fair price, taking into consideration all of this news.

In his excellent book, The Wisdom of Crowds, James Surowiecki demonstrated that diverse crowds looking at the same data typically make an accurate assessment. That's precisely what is happening with the determination of the price of Japanese (and all other) stocks and bonds.

There is no "buying opportunity" if Japanese stocks are fairly priced. Investors will not earn above-average returns by investing in these stocks without taking above-average risks. It is the amount of risk undertaken by investors that determines the amount of return.

The Nikkei 225, a stock market index that consists of 225 of the largest publicly traded companies in Japan, increased from 10,000 in 1985 to over 38,000 in December 1989. Investors in Japanese stocks made a bundle if they bought the index early in that decade. Since then, it has been quite a different story. The Nikkei 225 closed at 9,206 on March 18, 2011. The past twenty years has hardly been a "buying opportunity" for investors in Japan.

Prepare to Wait

The current level of uncertainty in the Japanese economy has caused the prices of Japanese stocks to fall. Buyers of those stocks should understand they are taking on the risk of that uncertainty. Over the long term, investors are likely to earn a return that will reward them for stepping in at a time where others were fearful. This reward is unrelated to speculation about the price of Japanese stocks. It is directly related to the current risk of those stocks.

If you decide to take the plunge and buy Japanese stocks, the high risk of those stocks means you should be prepared to wait a long time to reap those expected returns. If you are investing for a short-term killing, you are likely to be disappointed.

The markets are unforgiving. They extract a price for the possibility of high returns. That price is "risk." "Risk" is a two-way street. High risk can mean high returns, but it can also mean significant losses. Just ask anyone who bought the Nikkei 225 since December of 1989.

If you are considering the purchase of Japanese stocks, remember this: Someone will be on the other side of that trade. Don't assume you know something they don't.


Permalink | Email this | Comments

]]>buffettColumnsjapan earthquakejapan stocksJapanEarthquakeJapanStocksnikkei 225Nikkei225warren buffettDaniel SolinMon, 21 Mar 2011 11:15:00 ESTHow Signing 'Standard' Agreements Can Bankrupt Your Small Businesshttp://www.dailyfinance.com/2011/03/10/how-signing-standard-agreements-can-bankrupt-your-small-busine/http://www.dailyfinance.com/2011/03/10/how-signing-standard-agreements-can-bankrupt-your-small-busine/http://www.dailyfinance.com/2011/03/10/how-signing-standard-agreements-can-bankrupt-your-small-busine/#commentsFiled under:

How Signing 'Standard' Agreements Can Bankrupt Your Small Business I am often asked by friends who know my background as a lawyer to review "standard" agreements for their small business. I've learned a lot from these experiences.

The agreements in question are typically drafted by high-powered lawyers for large companies. They're one-sided and intended to protect those companies' interests, while reducing or eliminating your legal rights altogether. These lawyers know that most people just sign on the dotted line, without reading or understanding the ramifications of an agreement.

To illustrate the problem, let's consider the agreement I was asked to review recently by a friend who runs a dental practice. My dentist friend was considering signing up with a professional employer organization. PEOs permit companies of all sizes to outsource their human resource, employee benefits, payroll and workers' compensation responsibilities. The PEO establishes a "co-employer" relationship with the employees of the client company, and contractually assumes certain employer rights, responsibilities and risks. The arrangement is typically known as "employee leasing."

There are pros and cons of this business model. I didn't weigh in on the merits (although I had many concerns). My role was simply to review the proposed agreement with the PEO.

It was quite a shocker. Here were some of the most onerous provisions:

1. The agreement automatically renewed from year to year unless the dentist gave notice within a set time prior to the end of the year. Most small offices are not set up to provide a notice of non-renewal, so they would be stuck for another year whether they wanted to renew or not.

2. The fees could be changed at will by the PEO, if its "overall cost of business" increased. This provision would permit an arbitrary increase in fees at any time at the whim of the provider.

3. The dentist was required to "indemnify" the PEO against any lawsuits relating to the agreement, even if the lawsuit was caused by the negligence of the PEO. "Indemnification" means the dentist would be responsible not just for any judgment, but also for the legal fees incurred by the PEO. In my view, no one who understood this clause would agree to it.

Sponsored Links
4. The dentist waived all rights to recover for "consequential" damages (those that were a consequence of the misconduct of the PEO), but there was no similar limitation on the amount of damages the PEO could recover.

5. The PEO could assign the agreement to any other company of its choosing, but the dentist could not re-assign it to anyone without the consent of the PEO.

6. If there was a dispute between the PEO and the dentist, the dentist would be required to go to the state where the PEO was based, and would have to pay the PEO's legal fees if the claims asserted by the dentist did not prevail.

7. The dentist was required to sign the agreement "under penalty of perjury." The PEO was not. This requirement could expose the dentist to criminal liability.

I explained to my friend that, whatever benefit she thought she was getting from the business arrangement with the PEO, it was more than offset by the additional liability imposed by this agreement. She agreed and entered into an arrangement with another human resources outsourcing firm (not a PEO) that required no written agreement.

You need to understand you are often better off with no agreement rather than an agreement of this type. If a "standard" agreement is imposed on you, it's worth the expense to have an attorney review it. Some of the liabilities hidden within these "standard" agreements can bankrupt you.

Permalink | Email this | Comments

]]>arbitrationautomatic renewalboilerplateColumnsfeeslawyersliabilityperjuryprofessional employer organizationsmall businessstandard agreementstandard contractDaniel SolinThu, 10 Mar 2011 10:00:00 ESTMotley Fool's Patented Stock-Picking System: Should the Fools Believe?http://www.dailyfinance.com/2011/02/22/motley-fools-patented-stock-picking-system-wisdom-crowds/http://www.dailyfinance.com/2011/02/22/motley-fools-patented-stock-picking-system-wisdom-crowds/http://www.dailyfinance.com/2011/02/22/motley-fools-patented-stock-picking-system-wisdom-crowds/#commentsFiled under: , , ,

Popular investing site The Motley Fool has patented technology it believes has the potential to predict stock performance.

The technology is called Motley Fool CAPS. It works by tapping "the collective brainpower" of more than 170,000 individual investors who rate 5,600 stocks from "one star" for the lowest ranking to "five stars" for the highest ranking. Since its inception in 2006, the five-star-rated stocks have beaten the S&P 500 index by 51 percentage points.

The rankings held up consistently down the line: Four-star stocks beat the performance of three-star stocks. Two-star stocks equaled the performance of the S&P 500, and one-star stocks underperformed the S&P 500 index by 31 percentage points.

A study by Harvard University's Kennedy School of Government gives added credibility to the CAPS system. The well-credentialed authors of the working paper found "consistent evidence" that CAPS stock picks were predictive of future returns and that the excess returns of those picks were "statistically significant."

One Mighty Smart Crowd

These findings conflict with the efficient market hypothesis, which asserts no one can accurately predict future stock returns. The basic tenet of that theory is that publicly available information about a stock is instantly incorporated into its trading price, resulting in a fair price.

The CAPS system takes the contrary view: It holds that the collective view of Motley Fool readers is able to identify undervalued stocks that are likely to outperform in the future.

The argument that large numbers of people can make remarkably accurate estimates has support. It's set forth in James Surowiecki's excellent book, The Wisdom of Crowds. Surowiecki found that, under the right circumstances, crowds can make estimates that are more accurate than the individual estimates of experts.

But the problem with relying on this as support for the CAPS system is that there's an even larger crowd that looked at the same stocks ranked by Motley Fool readers: the entire pool of hundreds of millions of investors. They concluded that the price of those stocks -- and others -- were fair, and that none of those stocks was undervalued.

Which "crowd " is right? My money is on the bigger crowd.

Why Not Start a Five-Star Fund?

Investors in the U.S. can pick from more than 8,000 mutual funds staffed by fund managers and research analysts who are the best, brightest and most highly trained finance professionals in the world. They have huge budgets and can access supercomputers to crunch data. Their mandate is to pick stock winners and beat their designated benchmarks. But only 5% of these pros succeed, and many of their funds go out of business.

Sponsored Links
Accepting the CAPS stock-picking methodology as effective assumes that mostly untrained Motley Fool readers have better stock-picking skills than these investment pros and that their judgment is superior to that of the larger crowd of investors looking at the same data. Those are major leaps in logic.

If a mutual fund adopted the CAPS stock picks and achieved excess returns over a sustained time period, the CAPS methodology would have far more credibility. The Motley Fool is the fund manager of two funds, The Motley Fool Independence Fund (FOOLX) and the Motley Fool Great America Fund (TMFGX). Neither fund's portfolio is based on the stock rankings of its readers.

If the Motley Fool really believes in the CAPS methodology, it should start a mutual fund based on its stock picks, solicit investors for that fund and report its returns. Think of the possibilities. It could go long on the five-star stocks and short the one-star ones. It would be putting its reputation -- and the funds invested by its readers -- solidly behind its patented system.

Until then, investors would be better off focusing on their asset allocations and investing in a globally diversified portfolio of low-cost index funds, in asset allocations suitable for them.


Permalink | Email this | Comments

]]>beat the marketColumnsefficient market hypothesisHarvardinvestment adviceKennedy SchoolMotley FoolPredictionsSP 500standard and poorsStock Pickingstock pickswisdom of crowdsDaniel SolinTue, 22 Feb 2011 10:55:00 ESTInvestors Are Keeping Their Eyes on the Ball. . .But It's the Wrong Ballhttp://www.dailyfinance.com/2011/02/14/short-term-investors-mistake-stock-market-timing/http://www.dailyfinance.com/2011/02/14/short-term-investors-mistake-stock-market-timing/http://www.dailyfinance.com/2011/02/14/short-term-investors-mistake-stock-market-timing/#commentsFiled under: , , ,

There's a frenzy of stock buying going on now, because no one wants to be left out of the stock market recovery.

To some extent, this enthusiasm is warranted. The long-term data fully support investing in stocks. From 1926 through 2010, the average annualized return of the U.S. stock market has been almost 10%.

However, it's short-term data that's fueling the current rush into stocks. The rapid recovery of the stock market has put most "buy and hold" investors back in the black, granting them a full recovery from the market crash that began in 2008. So much for those who claimed that buy and hold was dead.

No Risk, No Reward

All that euphoria, however, is proof that investors have short memories for the risks associated with overexposure to stocks.

Sponsored Links
Investing in stocks is a double-edged sword. The profits can be worthwhile, but buying equities always involves uncertainty about returns and a risk of losses. Most investors view the risks as negatives, but they are actually positive forces: It's only by accepting the uncertainty and the risk that investors get compensated with higher returns.

The problem with most investors is they want the returns of stocks with the risk of the bonds. When stocks tank, as they did in 2008, those investors dumped their stocks and fled to safety. Now that the markets are in recovery mode, we're seeing the opposite trend. But investors who move in and out of stocks, trying to predict short-term trends, receive only a fraction of the returns reflected in long-term market data.

There have been four periods since 1926 when the stock market had two or more consecutive years of negative returns. If you aren't prepared to hold on during those periods, you should have no exposure to the stock market. I tell my clients not to have any stock market exposure if they will need 20% or more of their invested assets within five years.

Keep Your Eye on the Right Ball

Investors who are betting on a recovery are engaged in what I call "wrong ball investing." No one can predict the short-term direction of the markets. Market prices are determined by tomorrow's news, and none of the pundits confidently predicting the continuation of the stock market recovery have read that news yet.

Your investing decisions should not be based on a belief that the stock market will continue its upward trajectory in the near term. It might, or it might not. Instead, you should be determining your asset allocation -- the division of your portfolio between stocks and bonds -- and investing in a globally diversified portfolio of low-management-fee stock and bond index funds. I have a good asset allocation questionnaire on my website: smartestinvestmentbook.com.

By following this advice, you'll be able to withstand the inevitable short-term volatility in the stock market and enjoy the long-term historical returns stocks have delivered. That kind of investing is keeping your eye on the right ball.

Permalink | Email this | Comments

]]>asset allocationbondsbull market forecastBuy and HoldColumnscrashequitieseye on the ballInvestingLong term investingmarket timingportfoliorallyrecessionreturnsriskshort-termstock marketstock market outlookstocksuncertaintyDaniel SolinMon, 14 Feb 2011 11:30:00 EST10 Investing Facts You Probably Don't Know -- but Shouldhttp://www.dailyfinance.com/2010/11/30/10-investing-facts-you-probably-dont-know-but-should/http://www.dailyfinance.com/2010/11/30/10-investing-facts-you-probably-dont-know-but-should/http://www.dailyfinance.com/2010/11/30/10-investing-facts-you-probably-dont-know-but-should/#commentsFiled under: , , , , ,

Individual investorThe securities industry spends hundreds of millions of dollars a year in advertising, but that doesn't mean the general public is getting the straight scoop. Nor does the blanket coverage from the financial media ensure that the public is shielded from misinformation. So, as you contemplate investing for the New Year, here are 10 facts you probably don't know (but should):

1. This wasn't the "lost decade": All the talk about the "lost decade" is complete nonsense. Investors who bought and held a globally diversified portfolio of low-cost stock and bond index funds did just fine. Dividing that portfolio into 60% stocks and 40% bonds, while not suitable for everyone, is an average asset allocation and is routinely used by defined-benefit retirement plans. The annualized return for that asset allocation for the past decade was approximately 6%. Investors in a portfolio of 100% stocks, invested in the same globally diversified manner, had an annualized return of almost 8%. But, yes, it was a "lost decade" for those who invested all of their assets just in the S&P 500. I don't know why anyone would do that. I also don't understand why any "expert" would use that index as a benchmark for the entire market. It isn't.

2. "Great" companies can be lousy investments: Consider Lehman Brothers, WorldCom, General Motors, Conseco and Chrysler. Companies that are "great" one day can tank the next. There's no way to tell who's next.

3. The S&P 500 Index is very unstable: While most investors understand that companies enter and exit the S&P 500 index periodically, few understand just how unstable it is. In the 41 years from 1957 to 1998, only 74 of the original 500 companies were still in the index.

4. Most investment clubs underperform the market: An extensive study of the performance of 166 investment clubs showed 60% did worse than the market. There are many reasons for joining an investment club, but superior investment performance shouldn't be one of them.

5. Mutual fund out performance can be explained by luck, not skill: This is the big one. When mutual funds tout their great performance over the past five years, they want you to believe their fund managers have superior stock-picking skills. Not true. A recent study found no evidence of skill in the performance records of over 2,100 funds. The study's ramifications are profound. If outperformance is based on luck, there'is no way to predict the next lucky fund. Investors should avoid all actively managed mutual funds and invest in a globally diversified portfolio of low-cost stock and bond index funds instead.

6. Most investors should not hold individual bonds: Most investors would be far better off selling their individual bonds and buying a low-cost, short- or intermediate-term bond index fund. They would get greater diversification, superior management of their bond portfolio, more liquidity and lower cost. A study by Vanguard summarizes these advantages.

7. Most investors should not hold individual stocks: An individual stock has the same expected return as the index to which it belongs, but it can have up to twice the risk. That's because holding an individual stock entails risks that are unique to that stock, like corporate dishonesty or the death of a key executive. You can get the same expected return, with less risk, by investing in the index. Same return, less risk. You would think it would be a "no-brainer." Yet investors, egged on by their brokers and looking for the next monster stock, continue to gamble with their money by investing in individual stocks.

Sponsored Links
8. Warren Buffett does not "beat the market": I'm a huge fan of Buffett. Most investors believe his company, Berkshire Hathaway (BRK.A), has consistently beat the market. Not true. The index with approximately the same standard deviation (a measure of risk) as Berkshire Hathaway is the Emerging Markets Value Index. For the 10 and 20 years ending Dec. 31, 2005, Berkshire Hathaway stock underperformed that index. You can see the analysis here.

9. Warren Buffett advises investors to invest in index funds: Over the years, Buffett has repeatedly recommended that investors stick to low-cost index mutual funds. He even prefers them to ETFs, as he explained in an interview on CNBC in May, 2007.

10. Chasing big returns causes the brain to react just like snorting coke: Both activities are addictive. This explains why investors act so irrationally and fall easy prey to brokers and advisers who claim they can "beat the markets." The brokers are drug dealers, and the investors are addicts. You can compare the brain images of investors looking for a big score and drug addicts doing the same thing, here.

The next time you're confronted with an investment decision, take a look at these 10 facts. Then fundamentally change the way you invest.

Permalink | Email this | Comments

]]>asset allocationbond fundsColumnsindex fundsindividual investorsinvestment clubMutual fundsSP 500warren buffettDaniel SolinTue, 30 Nov 2010 10:00:00 ESTTurbocharge Your Investing Returns by Understanding Luckhttp://www.dailyfinance.com/2010/11/08/turbocharge-your-investing-returns-by-understanding-luck/http://www.dailyfinance.com/2010/11/08/turbocharge-your-investing-returns-by-understanding-luck/http://www.dailyfinance.com/2010/11/08/turbocharge-your-investing-returns-by-understanding-luck/#commentsFiled under: , ,

Turbocharge Your Stock Market Returns by Understanding LuckWhat if you could increase your investment returns more than 200% by simply understanding the role of luck versus skill in investing? If ever there was information the securities industry didn't want you to have, this is it.

Several recent studies have demonstrated conclusively that almost every mutual fund that outperforms the market is just lucky. No investment skill is evident. The same can be said for brokers and other "investment pros" who claim to be able to time the markets, pick outperforming stocks or select mutual funds that will outperform other funds.

One study, discussed in an article in The New York Times, looked at the performance of 2,100 actively managed funds over a 31-year period. The highly credentialed authors of this independent study concluded that only 0.6% of the fund managers studied had genuine stock picking ability - a number which is statistically indistinguishable from zero.

Sponsored Links
The article noted: "Professor [Russ] Wermers [of the University of Maryland] says his advice has evolved significantly as a result of this study. Until now, he says, he wouldn't have tried to discourage a sophisticated investor from trying to pick a mutual fund that would outperform the market. Now, he says, 'it seems almost hopeless.' "

A recent study by business professors Eugene F. Fama of the University of Chicago and Kenneth R. French of Dartmouth, Luck versus Skill in the Cross Section of Mutual Fund Returns, looked at the effect of luck in the performance of actively managed funds. When luck was excluded, the authors concluded as follows: "Going forward, we expect the remaining 97% of the active fund universe to perform worse than comparable efficiently managed passive funds."

One More Study: My Own

I recently did my own study and confirmed these findings. I looked at all balanced mutual funds for which I could find performance data for the past 20 years. I wanted to see how these funds performed in both 10-year periods. I found that:
  • 23.33% of them outperformed the median in both 10-year periods;
  • 21.67% of them underperformed the median in both 10-year periods;
  • 55% of them had one period when they outperformed and one period during which they underperformed.
If skill was the core reason a given fund outperformed the crowd during one 10-year period, almost 100% of those successful funds would have repeated the accomplishment in the second 10-year period. The cold, hard fact is they were just lucky.

By random chance, some mutual fund managers will be able to beat the market. Approximately 300 out of 10,000 coin flippers will call 5 consecutive coin flips correctly. They have no psychic powers: They're just lucky.

How to Really Get Lucky With Your Investments

These findings have meaningful ramifications for investors.

A study released by Dalbar in March 2010 found that, during the 20 years from 1990 through 2009, the average stock fund investor earned returns of only 3.17% per year, while the S&P 500 returned 8.21%. On an inflation adjusted return, the average equity fund investor increased to only $108,743 on the value of a $100,000 investment made in 1990, while the inflation adjusted growth of $100,000 invested in the S&P 500 would have been $281,979.

The reason for the poor returns of the average stock fund investor is the inability to distinguish between luck and skill. These investors chase returns, relying on brokers and advisers who tell them they can "beat the markets." They persuade them of their ability to do so by pointing to past returns and implying those returns will persist in the future. They might, if they were based on the skill of investment manager. They don't, because virtually all of those managers were just lucky.

Once you understand the mesmerizing -- but misleading -- attribution of skill to results in which luck was the prime factor, you will fundamentally change the way you invest. By simply capturing market returns, using low-cost index funds in an asset allocation appropriate for you, you can turbocharge your returns.

That's a skill every investor can implement.

Permalink | Email this | Comments

]]>averagebeat the marketbest mutual fundsColumnsEugene F. Famahow to investindex fundsInvestingKenneth R. Frenchlow-cost index fundsluckluckymutual fund managersMutual fundsreturn on investmentroiRuss Wermersskillskillsstock brokersstock marketstock picksstocksStocks to buytop mutual fundsDaniel SolinMon, 08 Nov 2010 10:06:00 ESTJim Cramer on Short-Term Trading: Mad Money or Simply Mad?http://www.dailyfinance.com/2010/10/12/jim-cramer-mad-money-promotes-short-term-trading/http://www.dailyfinance.com/2010/10/12/jim-cramer-mad-money-promotes-short-term-trading/http://www.dailyfinance.com/2010/10/12/jim-cramer-mad-money-promotes-short-term-trading/#commentsFiled under: , , ,

Mad Money's Jim Cramer recommends short-term trading. But studies have shown that 70% of traders who try this lose money.Jim Cramer has a new investment strategy for you: short-term trading. According to Cramer's Mad Money show last week, summarized on the show's CNBC blog, short-term trading can be a good way to make money.

Here's his recipe: Identify stocks in your portfolio that have "flown too high" and "take a little bit off the table," investing that money elsewhere and letting the hot stocks cool off before buying them back at lower prices. Cramer pointed to Chipotle (CMG), Netflix (NFLX) and Salesforce.com (CRM) as examples of stocks that have soared too high,and assured his viewers that short-term trading is a "tested strategy."

In my view, this idea is errant nonsense. How would an investor implement this strategy? Stock prices move in a random pattern, and there's no way to determine with certainty when they have "flown too high" and when to buy them back.

Who Knows the Future?

Take Chipotle as one example: The stock closed at $97.90 on July 30, 2007, marking a big gain from its price of $42.22 on Jan. 26, 2006. Was that time to sell and "take a little off the table"?

If you thought so, you'd have been disappointed when the stock reached $151.88 on Dec. 24, 2007. The shares did fall then, to a low of $39.90 on Nov. 17, 2008, only to surpass their December level to close at $178.60 on Oct 11.

But that's exactly the problem. Future events affect stock prices, and no one knows what those events will be or how they'll affect the price of a stock.

Sponsored Links
How difficult is it to guess? According to a summary of seven studies on day trading, 70% to 80% of day traders lose money. Another analysis, by investment consultant Ronald Johnson, concludes that 70% of the short-term public traders included in the study "will not only lose, but almost certainly lose everything they invest." As he puts it: "Numerous market studies have concluded that accurate market timing is not possible, even for professional money managers."

So Cramer's claim that short-term trading is "tested" is disingenuous. But consider the source: Cramer's employer, CNBC, derives substantial revenue from sponsors -- such as purveyors of trading systems and the securities industry -- that make money when you trade.

Don't be fooled. Cramer's trading advice really is "mad."

I'd encourage investors to heed the admonition of Vanguard founder John Bogle instead. As he told Bankrate.com during an interview about exchange-traded funds last year: "Trading is your enemy, because it's based on emotion."

Permalink | Email this | Comments

]]>Buy and HoldChipolte stock pricechipotleColumnsday tradingInvestingJim CramerMad Moneymarket timingsalesforce.comshort-term tradingStockstock marketstocksToshibatradingDaniel SolinTue, 12 Oct 2010 11:00:00 ESTHow to Protect Your Investments From a Falling Dollarhttp://www.dailyfinance.com/2010/10/03/how-to-protect-your-investments-from-a-falling-dollar/http://www.dailyfinance.com/2010/10/03/how-to-protect-your-investments-from-a-falling-dollar/http://www.dailyfinance.com/2010/10/03/how-to-protect-your-investments-from-a-falling-dollar/#commentsFiled under: , , , ,

How to Protect Your Investments from a Falling Dollar Here's a question I get frequently: It's obvious the dollar is going to crash, so what can I do to protect my investments?

A compelling case can be made for the devaluation of the dollar: The U.S. is experiencing record deficits, the loss of our manufacturing base, slow growth and poor education; there's the conduct of the Fed, which some believe is "devaluing" the dollar; and overseas, we're seeing the strong ascendancy of Brazil, India and China.

Many investors are absolutely convinced the dollar is doomed. Here 's a list of options they want me to implement: Sell the dollar and buy stronger currencies, buy gold or other commodities, hold investments in accounts located in other countries, hedge against the dollar. Do any of those moves make sense?

No.

They're all based on the false premise that currency markets are mis-priced.

Whatever You Know, the Market Knows Too

All these concerns about the dollar are valid. The problem is that those concerns are well-known to millions of investors around the world. My clients don't know anything not in the financial media. All of that information is instantly factored into the price of all currencies.

Sponsored Links
Think about the way the market sets the price of currency and other assets. Traders and nontraders alike (because nontraders have made a decision not to trade), consider all available information, include future uncertainty, and establish a market-based price. Exchange rates are set in the same manner. As such, current prices are fair prices.

This analysis doesn't mean you can't make money speculating on currency or stocks. Prices go up and down. But what will move prices is tomorrow's news, and no one knows in advance what that news will be. Unfortunately, trying to predict the movement of the currency market is a zero sum game (or worse, given transaction costs). Here's something else to keep in mind: If you're so sure the dollar is doomed and you want to bet against it, who's on the other side of that trade? Presumably, that person has a contrary view.

Worried About America? Buy American Stocks?

Let's assume you have looked at the data and are convinced the U.S. economy is headed for disaster. Here's my advice: Buy stock in U.S. companies. Why? Because the buyers and sellers in the market have already priced those assets to reflect all of your concerns. The market has determined U.S. companies are risky assets, and what do we know about risky assets? Over time, the expected return on risky assets is significantly higher than the expected return on safer ones. Want proof?

The returns of the index measuring emerging markets -- the MSCI Emerging Markets Index (EEM) -- averaged 9.98% between 1989 and 2008 . The returns of the S&P 500 Index over the same period were only 8.42%. There's no doubt the companies in the S&P 500 Index were far less risky investments than companies located in countries such as Pakistan, Egypt and Turkey, where reliable financial data is hard to find.

I'm not suggesting you invest a significant portion of your portfolio in emerging markets: Most advisers would limit investments in them to 10% of your portfolio because of their extreme volatility. For example, in 2008, the MSCI EM Index lost 53.33% of its value.

Think Logically, Diversify Globally

Here's another example. From February 1955 to August 2010, the United Kingdom was in a steady decline, much like current predictions for the U.S. economy. During this period, investors in the FTSE All-Share Index (which measures the returns of U.K.-based companies) had an annualized return of 10.7%. The S&P 500 had an annualized return of 9.7%. Investors in the riskier asset reaped greater returns.

There is an intelligent strategy that will protect you against the risk of collapse of the U.S. dollar. It's global diversification, using low-cost stock and bond index funds. Global diversification of your portfolio reduces risk and increases return. A well-diversified portfolio captures the returns of the global economy, and should include the stocks and bonds of more than 12,000 holdings in 43 countries around the world.

Don't engage in risky and discredited strategies, or pay attention to the fear-mongering in the financial media. You'd be much better advised to understand the underlying basis for how prices are set, and the risk inherent in assuming these prices are not "fair."

That's the real risk of betting against the dollar.

Permalink | Email this | Comments

]]>bond fundsColumnsDan Solindiversificationdiversified portfoliodiversifydollar declineDollar depreciationdollar devaluationdollar downemerging marketsfalling dollarglobal diversificationhedging the dollarindex fundsinvestment adviceinvestment risklow costreturn on investmentrisky investmentsROISafe InvestmentsDaniel SolinSun, 03 Oct 2010 06:30:00 ESTTen Wall Street Sales Pitches Investors Should Run Away Fromhttp://www.dailyfinance.com/2010/09/07/how-your-bad-broker-suckers-you-sales-pitch/http://www.dailyfinance.com/2010/09/07/how-your-bad-broker-suckers-you-sales-pitch/http://www.dailyfinance.com/2010/09/07/how-your-bad-broker-suckers-you-sales-pitch/#commentsFiled under: , , ,

Wall StreetI take a dim view of Wall Street. The financial crises that began in December 2007 exposed an industry that couldn't manage the risk of its own portfolios, much less provide accurate, objective advice to its clients. Yet 85% of individual investors continue to invest with brokers who claim to add value by "beating the markets," even though the overwhelming data indicate the opposite is true.

Here are 10 Wall Street sales pitches that should make you run for the door.

1. We offer free access to our extensive stock research: Their research may be "free," but it's overpriced if it induces you to rely on it and trade. Information about every stock is instantly disseminated. Tomorrow's news moves stock prices, and no analyst can anticipate tomorrow's news. Stock prices are random and unpredictable. Unless he has inside information (which is illegal), the views of one analyst are unlikely to be any more accurate than the views of his counterpart at another firm. All "research" about stocks is not only useless, it's misleading.

2. We offer low-cost trades: Low-cost trading encourages more trading. More trading increases your costs. Higher costs mean lower returns. One study compared the returns of frequent traders to those who traded less frequently. The frequent traders had lower returns.

3. We provide estate planning advice: Many brokers and life insurance companies offer estate planning advice, but it's typically a loss leader to bring in your assets. The big money for these individuals is in the recurring fees for managing your funds. You don't want an estate planner who has an interest in selling you products, much less one who may insert a provision in your will appointing the planner to manage your assets after your death. You'd be far better advised to retain an experienced estate planning attorney.

4. We are very conservative: The same brokers who encouraged their clients to buy tech stocks (which collapsed in 2000), have had a major conversion recently. Now, it seems every broker touts "conservative" credentials. Really? Ask them if they were conservative prior to the crash in 2008 and stayed out of the markets during the 2009 market rally. Being "conservative" or "aggressive" is irrelevant, since no single investment strategy is right for everyone. You need an adviser who will ensure your asset allocation is suitable for you.

5. We focus on the stocks of excellent companies: Excellent companies like Lehman Brothers, Bear Stearns, General Motors, Chrysler, Enron and Washington Mutual? At one time, most "experts" thought these companies were "excellent." We all know how those stock picks turned out. What's more, no data indicate the stocks of so-called excellent companies outperform the S&P 500 index. Indeed, for the five-year period from Oct. 1, 2002, to Sept. 30, 2007, even the most "excellent" of excellent companies, Berkshire Hathaway (BRK.A), significantly underperformed the S&P 500 index. Berkshire Hathaway stock returned 59.72%. The S&P 500 index was up 104.07%.

6. We can put you in managed accounts. Managed accounts, also called "wrap" accounts, are great -- for your broker. He gets fees averaging 1.17% a year for endorsing your check over to an "exclusive" fund manager. When you add the cost of the investments, total fees can exceed 2% a year. Big fees. Little work. No wonder brokers love these accounts. But they're a bum deal for investors. There's no evidence these "top" fund managers do any better than their peers at beating their benchmark index, and the performance of their peers is pretty dismal. If you want a managed account, consider Vanguard's Target Retirement Funds. Their total cost is a miserly 0.19%. The historical performance of these funds is superior to the vast majority of actively managed funds (like those in managed accounts).

7. We believe the markets are [fill in the prediction]: For the same reasons that analysts can't predict the future price of a given stock, brokers can't predict the direction of the markets. Late last year, I wrote a article on DailyFinance that detailed some of the terrible predictions of well-credentialed stock market experts. One who really missed the mark was Jeremy Siegel, a contributing editor to Kiplinger's, an author of several leading financial books and a professor at the University of Pennsylvania's Wharton School. Siegel predicted we would avoid a recession in 2008 and financial stocks would outperform the S&P 500. Flush with confidence, Professor Siegel also predicted Hillary Clinton would take the Democratic nomination and Rudy Giuliani the Republican nomination. All predictions about the direction of market are useless and dangerous: Useless because there's no such skill, and dangerous because investors rely on them to their detriment.

8. We think you should get out of that mutual fund and into this one: Why? If past performance doesn't predict future returns, why are you being told to move to a fund with stellar past performance? If your broker had the ability to pick outperforming mutual funds (and he doesn't), how did he make a mistake with the fund you're currently invested in? Investors who jump in and out of funds chasing the next hot fund manager end up getting lower returns than those who stay invested in a globally diversified portfolio of low cost stock and bond index funds.

9. We recommend this alternative investment: No data indicates alternative investments or private-equity deals beat the returns of a globally diversified portfolio of low-cost index funds. These investment options share one common denominator: high fees and commissions. That's why they're aggressively sold.

10. We focus on private wealth management: This is a sales slogan, not a viable investment strategy. Based on my experience, many firms that repeat this mantra successfully "manage" to transfer your wealth to themselves.

I know what you're thinking: "What's left? These 10 statements are just about everything brokers offer me. Why should I use them at all?"

Now we're making progress!

Permalink | Email this | Comments

]]>Alternative investmentsbeat the marketbeating the marketbrokersColumnsestate planninglow cost tradeslow cost tradingmanaged accountsmutual fund managersMutual fundsprediction-marketsPredictionsPredictions and Trendsstock brokersStock ResearchstocksWealth managementwrap accountDaniel SolinTue, 07 Sep 2010 10:25:00 ESTA Ray of Hope for Bernie Madoff's Victimshttp://www.dailyfinance.com/2010/08/30/a-ray-of-hope-for-bernie-madoffs-victims/http://www.dailyfinance.com/2010/08/30/a-ray-of-hope-for-bernie-madoffs-victims/http://www.dailyfinance.com/2010/08/30/a-ray-of-hope-for-bernie-madoffs-victims/#commentsFiled under: ,

Bernie Madoff committed massive fraud against his investorsI checked Facebook to see whether U.S. District Court Judge Victor Marrero was listed. He probably isn't allowed to participate in social networking sites. Too bad. I wanted to be his friend.

On Aug. 18, 2010, Judge Marrero issued an extraordinary decision in Anwar v. Fairfield Greenwich, Ltd., which is pending in the U.S. District Court for the Southern District of New York (09 Civ 0118).

Obscene Fees for Little Work

The underlying lawsuit is a class action brought by hapless investors who lost their shirts investing in funds operated by Fairfield Greenwich Group. Fairfield was the most notorious of the "feeder funds" that took money from investors and turned it over to Bernie Madoff for "investment management." We all know what happened to those funds.

Fairfield invested "billions" with Madoff. It was paid handsomely for basically endorsing investors' checks to him. It received about $547 million in "performance fees" and $200 million as a "management fee" between 2002 and 2008. This was the holy grail of the securities biz: Obscene fees for little work.

Confronted with this epic fraud, Fairfield and others who "fed" their clients' assets to Madoff had two choices. The principled choice would be to admit their mistake, make their clients whole, and seek recovery from anyone they could prove misled them. The other would be to lawyer up, claim to be a victim themselves, and engage in a scorched-earth defense intended to defeat the claims of its defrauded clients. Guess which one they chose?

They drew the wrong judge.

A Litany of Red Flags

Plaintiffs alleged that a litany of red flags should have alerted Fairfield (and others) that Madoff was a fraud. These included his use of a one-person accounting firm, no independent custodian, blind acceptance of his fraudulent trade confirmations and others.

The Court summarized the allegations of the Complaint (which haven't been established) as describing Madoff as "a vampire" and "the various [Fairfield] defendants his glamoured familiars who procured the sleeping victims." I don't know who wrote that line, but I envy it.

Judge Marrero skillfully wove through a "virtual minefield of lawyerly defenses" strewn by Fairfield in an effort to get this pesky case dismissed without a trial. He refused to dismiss the vast majority of the claims against Fairfield and even left open the possibility of punitive damages, "given the magnitude of the fraud and the reckless state of mind alleged in the complaint."

We can only hope this decision encourages Fairfield and others to do the right thing and compensate their defrauded clients. That's about as likely as Judge Marrero signing up for Facebook and accepting my friendship invitation.

Permalink | Email this | Comments

]]>bernie madoffBernie Madoff Ponzi SchemeColumnsFairfield Greenwich Groupfeeder fundsfinancial fraudfraud victimmadoff fraud victimsmadoff victimsu.s. district courtDaniel SolinMon, 30 Aug 2010 09:00:00 EST10 Signs Your 401(k) Plan Is a Clunkerhttp://www.dailyfinance.com/2010/08/28/ten-signs-your-401-k-plan-is-garbage/http://www.dailyfinance.com/2010/08/28/ten-signs-your-401-k-plan-is-garbage/http://www.dailyfinance.com/2010/08/28/ten-signs-your-401-k-plan-is-garbage/#commentsFiled under: , ,

what your 401k plan doesn't want you to knowWilliam Bernstein is one of the most respected financial minds of our time. His book, The Intelligent Asset Allocator, should be read by every investor. In an insightful commentary entitled What the Investment Industry Doesn't Want You to Know, Bernstein observes that investors "can only positively impact one aspect of investment performance -- your allocation of assets among broad asset classes." Stock picking, mutual-fund picking and market timing are "irrelevant."

Keep this advice in mind, since it is the primary reason why your 401(k) is probably a "clunker." Here's a checklist of others:

1. High costs: Low costs correlate directly to higher returns. The total cost of your plan should not exceed 1.50%. By "total cost," I mean the expense ratio of mutual funds in the plan, record keeping, custody, administration fees and advisory fees.

2. No investment advice: Advisers to 401(k) plans are well compensated, yet most limit communications with plan participants to "education." Your adviser should give investment advice. Most advisers won't because of the potential liability. If the investment options in the plan were in the best interests of plan participants, they wouldn't have this concern.

3. Revenue-sharing and hidden mark-ups: Brokers and insurance companies typically extract payments from mutual funds that want to be included as investment options. How objective can their advice be if they are receiving these payments? They also mark-up management fees charged by mutual funds. I reviewed a plan that included a Vanguard Target Retirement Fund, which Morningstar reported had an expense ratio of 0.18%. The plan was charged 0.93% for this fund. This difference comes out of your returns.

4. The plan adviser is not a "real" fiduciary: Brokers and insurance companies misuse the term "fiduciary" in describing their obligation to the plan and plan participants. The only real fiduciary is a 3(38) ERISA fiduciary. This kind of fiduciary accepts 100% of the liability for the selection and monitoring of investment options in the plan. I have never seen a 401(k) plan where a broker or insurance company agreed in writing to be a 3(38) ERISA fiduciary. Any other designation of "fiduciary" is meaningless.

5. Retail share classes are in the plan when institutional classes are available: I recently reviewed a plan that had thirteen mutual funds as investment options. All of them were retail shares. Every one of these funds had institutional shares available. What's the difference between the two share classes? The retail shares have higher management fees. Otherwise, they are exactly the same. The only reason to include retail shares when less expensive institutional shares are available is to increase fees and lower returns. This practice is indefensible.

6. The money market fund has high fees: In many plans, the money market fund is the default where assets are placed if the plan participant does not make another choice. The management fees charged by money market funds can really impact your returns. If the money market fund in your plan has an expense ratio higher than 0.25%, it should not be in the plan.

7. The mutual funds in the plan have high fees: Brokers typically populate fund options with high-cost, actively managed funds (where the fund manager attempts to beat a given benchmark). The fees charged by these funds range from 1.5% to 2% (or more). A blend of comparable index funds has fees under 0.50%. The difference comes right out of your returns.

8. Mutual funds in the plan underperform their benchmark: Most actively managed mutual funds underperform their benchmark index. I looked at a plan where over 70% of the funds failed to equal their benchmark. Why are those funds in the plan when low-cost index funds will equal their benchmark 100% of the time (less low expenses)?

9. Funds drop in and out of the plan: A charade takes place at most companies with 401(k) plans. The investment committee meets periodically with brokers advising the plan to decide which funds will be dropped and which ones will take their place. This makes everyone feel they're doing something useful, but it's a useless activity. Past performance is not an indication of future performance. Poor-performing funds may or may not outperform in the future. Stellar-performing funds typically underperform in the following five years. It also ignores a key issue: If the broker really had the expertise to pick superior funds, why is this exercise necessary at all?

10. Many investment options: Many fund options confuse plan participants. Few participants know how to put together a risk-adjusted portfolio in an asset allocation suitable for them. Instead of offering a boatload of funds, your plan should have a limited number of pre-allocated, globally diversified portfolios of stock and bond index funds, ranging from conservative to high risk. Plan participants should fill out a simple asset-allocation questionnaire to determine their risk level. They should then select the portfolio suitable for them. If all 401(k) plans followed this practice, returns would increase significantly.

Permalink | Email this | Comments

]]>401k401k planmutual fund feesMutual fund investingMutual fundsWilliam BernsteinDaniel SolinSat, 28 Aug 2010 06:00:00 ESTHow Fidelity Could Reform the 401(k) Plan System, but Won'thttp://www.dailyfinance.com/2010/08/22/how-fidelity-could-reform-the-401-k-plan-system-but-wont/http://www.dailyfinance.com/2010/08/22/how-fidelity-could-reform-the-401-k-plan-system-but-wont/http://www.dailyfinance.com/2010/08/22/how-fidelity-could-reform-the-401-k-plan-system-but-wont/#commentsAccording to Fidelity Investments, withdrawals from 401(k) plans are on the rise. This is a troublesome sign. The average 401(k) plan balance at the end of the second quarter of this year was a paltry $61,800 -- hardly enough to "retire with dignity."

Plan participants reduced their balances by taking loans or obtaining hardship withdrawals. A staggering 22% of participants have loans outstanding, and 62,000 participants took hardship withdrawals. This doesn't bode well.

Need to Access Cash

You can easily understand the need to access the cash in these accounts. More than 250,000 homes were foreclosed in the second quarter of 2010. Expenses for tuition and the purchase of a primary residence were also cited as reasons for these withdrawals.

Hardship withdrawal rules vary with the terms of individual plans. Typically, payment of medical expenses and primary residence purchases qualify. These withdrawals don't have to be repaid, which is good short-term news, but often shifts the problem from the present to the future, when participants may find it difficult to ever retire.

Loans from 401(k) plans can be very problematic. Obviously, you are diminishing the amount in your account. Less money means less return. If you leave your job, you will have to pay back the full amount of the loan. If you cannot repay the loan as required by IRS guidelines, the loan will be treated as taxable income and a 10% penalty will be assessed. Additional restrictions may be applicable depending on the terms of your plan.

What Fidelity Could Do

As the "nation's No. 1 provider of workplace retirement savings plans," there's a lot Fidelity could do to improve this system. If it wanted to be not only the "No. 1 provider," but also the best provider, it could assume full 3(38) ERISA status and agree to act as a fiduciary to plan participants. This would turn the industry on its head.

Instead of populating its plans primarily with expensive, actively managed funds (where the fund manager attempts to beat a designated benchmark), it could limit investment options to its low-cost, stock and bond index funds. It could offer a limited number of pre-allocated portfolios consisting solely of index funds at varying risk levels. Instead of having actively managed funds in its target date funds, it could learn from its competitor Vanguard. Vanguard's target date funds consist solely of its low-cost index funds.

It could refuse to take "revenue sharing" payments from other fund families as the price of admission to the array of investments offered to plan participants. It could disclose all fees and costs in an open and transparent way.

Fees Impossible to Calculate, Difficult to Justify

It's one thing for Fidelity to lament the sorry state of low balances in 401(k) plans and tacitly blame beleaguered employees. Where's the examination of its own conduct? Fidelity participates (as do other fund families) in a system that practically insures the returns will be significantly less than market returns. It reaps huge fees, which are almost impossible to calculate and are difficult to justify.

Raising the consciousness of plan participants that withdrawing funds from their plan accounts may jeopardize their future retirement is useful. Taking a leadership role in reforming a system that primarily benefits mutual fund families and plan advisers would be far more newsworthy.

Don't count on it.

Permalink | Email this | Comments

]]>401k401k withdrawalsFidelityFidelity fundsFidelity Investmentsmutual fund feesmutual fund managersMutual fundsreforming the 401k systemretirementretirement planningretirement savingsvanguardVanguard FundsVanguard GroupDaniel SolinSun, 22 Aug 2010 12:45:00 ESTYes, Life Insurance Can Be a Smart Investmenthttp://www.dailyfinance.com/2010/08/11/life-insurance-can-be-a-smart-investment/http://www.dailyfinance.com/2010/08/11/life-insurance-can-be-a-smart-investment/http://www.dailyfinance.com/2010/08/11/life-insurance-can-be-a-smart-investment/#commentsFiled under: ,

Graver markerI don't sell life insurance, and I have no interest in any entity that does. However, I am concerned with the lack of planning I see in the financial statements of many investors I advise. One common mistake is that many investors follow this oft-repeated advice: Buy term life insurance and invest the difference.

Suze Orman tells her readers ". . .the only type [of life insurance] you need is term insurance, because it's simple and affordable. Other plans include investing components, but you'd do better to buy the cheaper term policy and invest on your own."

Dave Ramsey says "no way" to buying cash-value life insurance. He also advises buying term.

Not Such a Good Idea

I have a problem with this advice for several reasons.

First, most people who buy term insurance don't "invest the difference." They "spend the difference."

Second, for those who do "invest the difference," there's no assurance their investments will be profitable. Many investors don't understand risk and lose a significant portion of their invested funds.

Third, most term insurance policies lapse without paying out a claim. Premiums for these policies increase as you age, making them unaffordable when you need them most. At that time, you may not be able to obtain any life insurance if you have serious health issues.

The Problem With Insurance Agents

What are the alternatives?

The primary problem with exploring insurance options is the necessity to consult with an insurance agent. Most people don't understand that their insurance agent isn't a fiduciary. The agent has an interest in generating commissions, and that creates a conflict of interest. This can mean an agent won't necessarily present you with the low-cost alternatives that may be in your best interest.

The solution is to not rely on agents. Instead, if you're considering life insurance where the annual premium will be $10,000 or more, you should retain the services of a fee-only insurance consultant. These little-known specialists charge an hourly fee, and they have no interest in any policy you may purchase. They provide unbiased advice and act as your fiduciary.

A competent fee-only insurance adviser should save you many times his fee. Glenn Daily, a fee-only insurance adviser, has a list of other advisers on his website. As he notes, there aren't many of them.

Building Cash Value

I interviewed one insurance adviser, Scott Witt, who's a former actuary for a large insurance company. I asked him to give me an example of a policy that would be a wise purchase but that an insurance agent would be unlikely to recommend.

Witt said a 29-year-old, in excellent health and a nonsmoker, could purchase a cash-value life insurance policy with a death benefit of $1.2 million and pay a premium of $17,000 a year.

Here's the kicker. After only one year, the illustrated cash value of this policy would be more than $15,000. After only five years, the total premiums paid would be $85,000, but the illustrated cash value would exceed that amount. In 20 years, it's extremely unlikely that any additional premiums would have to be paid to keep the policy in force.

At that time, the illustrated cash value would be $584,132, representing an internal rate of return of 4.9% on the amount invested in the policy. This is a higher after-tax return than you're likely to earn by investing in high-quality bonds.

When our hypothetical 29-year-old gets to age 49, she'll have insurance in force of $1.2 million. She can take the cash value out of the policy if she wants, up to the amount of the premiums paid, tax-free (but this would reduce the death benefit). When she dies, the death benefit will be paid tax-free to her beneficiaries. Do you think she believes she made a dumb investment?

Lower Sales Costs = Lower Commissions

Why is your insurance agent unlikely to present you with this type of policy? Because it's a "blended insurance policy," meaning it combines whole life and term into a single policy, resulting in higher cash values. It can do this because of lower sales costs. Lower sales costs mean lower commissions. Now you have the answer.

Several large, highly rated insurance companies sell blended policies, including Northwestern Mutual, Guardian, New York Life and Mass Mutual. According to Witt, these companies have a history of using reliable illustrations, based on recent experience.

No single type of insurance is suitable for everyone. But for some well-advised investors, buying this kind of cash value life insurance can be a very smart choice.

Permalink | Email this | Comments

]]>Columnsinsurance companiesLife Insuranceterm life insurancewhole life insuranceDaniel SolinWed, 11 Aug 2010 17:20:00 ESTHow You Can Beat Jim Cramer's Portfolio for Freehttp://www.dailyfinance.com/2010/08/08/how-to-beat-jim-cramers-portfolio-for-free/http://www.dailyfinance.com/2010/08/08/how-to-beat-jim-cramers-portfolio-for-free/http://www.dailyfinance.com/2010/08/08/how-to-beat-jim-cramers-portfolio-for-free/#commentsFiled under: , , , ,

How You Can Beat Jim Cramer's Portfolio for FreeIt's no secret that Jim Cramer and I have our differences. Our confrontation last year on CNBC's Power Lunch generated a lot of buzz. My basic gripe with him is that he makes it appear that he has some special insight into the markets which is of value of investors. However, I'm unable to find any evidence that's the case, and lots of data indicating it isn't.

So naturally, I was intrigued by this call to action on his web page, thestreet.com: "My charitable trust portfolio was up an amazing 31% in 2009, even when the market was on a wild roller coaster ride. In fact, for years, I've made money in good markets and bad."

This statement is part of a pitch to get subscribers to Cramer's "Action Alerts Plus," which gives you "24/7 access to [Cramer's] portfolio." As an added inducement, if you order "right now," you get a free "Booyah Bull." How tempting!

Curious, I checked to see just how "amazing" Cramer's 31% gain was in 2009. First, I looked at the returns of an all-indexed portfolio offered by our firm, Index Funds Advisors. The Index Portfolio 100 seemed like a fair choice for comparison purposes, because it consists 100% of passively managed stock mutual funds. No effort is made to "beat the markets" with this portfolio.

Buy and Hold Beats Booyah Bull

So, how did the Index Portfolio 100 do in 2009? It was up 39.63 %, net of adviser fees and expense ratios of the funds. (See the full disclosures relating to these returns).

Since access to this portfolio requires retaining an investment adviser, I ran the returns for the Vanguard index funds recommended in The Smartest Investment Book You'll Ever Read, which I wrote in 2006. In it, I advised investors to place 70% of the amount they allocated to stocks into Vanguard's Total Stock Market Index Fund (VTSMX), and the remaining 30% in its Total International Stock Index Fund (VGTSX). These are two low-cost index funds that simply track their respective indexes.

How did this "no brainer" portfolio do in 2009? It was up 31.1%.

With this portfolio, you simply bought and held. No need to watch the financial media or to follow the markets. No frenetic buying and selling. You slept well knowing you had a globally diversified portfolio of stocks (even though an asset allocation of 100% in stocks is far to risky for most investors).

Cramer often uses the S&P 500 index as the benchmark against which he compares his returns. It's the wrong benchmark, because Cramer recommends many small-cap and foreign stocks, which are riskier than the stocks in the S&P 500 index. In a bull market, riskier stocks will yield higher returns. However, anticipating his howls of protest, I will note that the S&P 500 index was up only 26.6% in 2009.

As for Cramer's assertion that he "makes money in good markets and bad", here's my offer: Show me verifiable returns for your charitable trust in 2008 -- by any definition, a bad market -- and I will publish them.

Still, Cramer does offer one thing you can't get with an all indexed portfolio: the Booyah Bull!

Permalink | Email this | Comments

]]>Beat Jim Cramerbeat the marketBooyah bullBuy and HoldCNBCColumnsDan Solinindex fundsJim CramerJim Cramer charitable trustJim Cramer portfolioMad Moneymarket timingVanguard fundsDaniel SolinSun, 08 Aug 2010 06:00:00 ESTWhy New Rules for 401(k) Fee Disclosures Don't Go Nearly Far Enoughhttp://www.dailyfinance.com/2010/08/03/why-new-rules-for-401-k-fee-disclosures-dont-go-nearly-far-eno/http://www.dailyfinance.com/2010/08/03/why-new-rules-for-401-k-fee-disclosures-dont-go-nearly-far-eno/http://www.dailyfinance.com/2010/08/03/why-new-rules-for-401-k-fee-disclosures-dont-go-nearly-far-eno/#commentsFiled under: ,

The Department of Labor has finally issued an "interim final regulation" governing fee disclosure and conflicts of interest in 401(k) plans. Unfortunately, it's too little, too late.

The goal of the new regulation (effective July 16, 2011) is to allow employers and plan participants to finally figure out what they're paying for their 401(k) plan. Currently, there's no obligation to disclose "revenue-sharing" payments extracted from mutual fund families that want to be included as 401(k) investment options. These payments create an obvious conflict of interest between the adviser (who wants to maximize them) and employees (who want to minimize them). Under the new regulation, full disclosure is required.

Only in the perverse world of the securities industry would candid disclosure of fees paid to vendors be considered a victory. In all other areas of commerce, it's not an issue. How would you feel if your car dealer refused to give you the price he's charging for your car?

Advisers Should Be Fiduciaries

The new regulations don't deal with the core problems of this broken system. Disclosing revenue-sharing payments isn't nearly enough. They should be prohibited altogether. Brokers and insurance companies justify them by claiming the fees offset record-keeping costs. However, participants would be far better off paying a fully disclosed, transparent fee for these services, and getting the benefit of objective, nonconflicted advice from advisers to their 401(k) plans.

Advisers should be required to be what's known as "3(38) ERISA fiduciaries," which means they can have no conflicts of interest. But the new regulations focus on disclosure of conflicts of interest. Real reform requires their elimination

If advisers were held to this standard, you would not see retail shares of mutual funds placed in plans where lower-cost, institutional shares of the same funds were available. You would see plans with pre-allocated portfolios of low-cost, globally diversified stock and bond index funds, exchange-traded funds and passively managed funds. Currently, most 401(k) plans have a confusing mish-mash of high-cost, actively managed funds (where the fund manager attempts to beat a benchmark, usually without success). This is great for advisers and mutual fund families (high costs mean big profits), but bad for employees.

The Best Recommendation Possible

Labor Department employees don't have to look further than their own plan to find the poster child for a properly run 401(k). Their plan is part of the U.S. government's mega $240 billion Thrift Savings Plan (tsp.gov), which has extremely low fees, no actively managed funds and pre-allocated portfolios that make it easy for government employees to purchase one fund that's best suited for their investment goals and tolerance for risk. Walter Updegrave, the respected financial journalist for Money magazine described this plan as "one of the best retirement plans around."

But here's the most compelling reason for the Labor Department to look to this plan when issuing regulations intended to improve the lot of employees: The securities industry is opposed to it. As reported by Allan Roth, in an excellent column on this subject, the Investment Company Institute, a trade group that seeks to keep profits of mutual funds as high as possible, published a paper taking shots at the Thrift Savings Plan. If the ICI is against it, it has to be good for employees!

Labor Department employees already have a dream plan. They should give everyone the same opportunity for retirement with dignity.


Permalink | Email this | Comments

]]>401k401k fee disclosure401k feesColumnsfeaturedvideomutual fund feesMutual fundsretirement accountretirement planningretirement savingsThrift Savings PlanDaniel SolinTue, 03 Aug 2010 09:00:00 ESTThe Big 401(k) Rip-Off May Be Endinghttp://www.dailyfinance.com/2010/07/18/401k-rip-off-ending/http://www.dailyfinance.com/2010/07/18/401k-rip-off-ending/http://www.dailyfinance.com/2010/07/18/401k-rip-off-ending/#commentsFiled under: ,

401(k)The end may be in sight for a common investment industry practice that robs millions of 401(k) plan participants of higher returns by choosing funds with expense ratios that are some 40% greater. This is how the rip-off works.

Say you want to buy a new car. You see two Ford Fusions in the dealer's showroom. They're the same in every respect, down to the color. The only difference is the price. One is $5,000 more than the other. Which one would you buy?

Dumb question, right? No one would purchase the more expensive car.

If you're a 401(k) plan participant, you don't get to select the investment options. They're put there by the broker or the insurance company. The adviser to the plan can often select from two classes of shares for each mutual fund -- retail and institutional shares.

As with the cars, everything about these two funds is the same -- except the cost. The retail shares have a much higher expense ratio (the amount deducted by the funds for fund expenses) than the institutional shares. To qualify for institutional share purchases, you typically have to meet a minimum purchase requirement. The minimum varies from fund to fund, but it's typically $500,000.

Kickbacks to 401(k) Plan Advisers

401(k) plans often qualify for the minimum because they can aggregate the purchases from plan participants. Even if they don't qualify, many funds will waive the minimum for these plans because they want to remain as investment options.

The difference in returns to plan participants can be significant over time. In one 401(k) plan I reviewed, there were 13 mutual funds offered as investment options. All of these funds were retail classes. There were institutional share classes available for every one of these funds. The expense ratio of the institutional funds averaged almost 40% lower.

Why would an adviser select higher cost funds when the same funds are available at a lower cost? To find out, just follow the money.

Retail share classes kick back a portion of their fees to the plan advisers. Institutional share classes do not. In effect, it's the plan participants who subsidize these kickbacks (known in the industry as "revenue sharing"). It's also the returns of plan participants that suffer due to this shameful practice.

Decision's Potentially Far-Reaching Impact

A recent federal court decision may stop this nonsense. In Tibble v. Edison International (CV 07-5359), Judge Stephen V. Wilson ruled on a class action brought by participants in Edison's (EIX) 401(k) plan. The case was brought in the District Court for the Central District of California.

Judge Wilson ruled that the selection of three retail share classes for inclusion as investment options in Edison's 401(k) plan violated the company's "duty of prudence" because lower cost institutional share classes of the same funds were available.

In reaching this conclusion, he stated: "In light of the fact that the institutional share classes offered the exact same investment at a lower fee, a prudent fiduciary acting in a like capacity would have invested in the institutional share classes."

The ramifications of this decision could be far-reaching. Judge Wilson concluded the plan participants had suffered significant damages to be determined by computing the difference in cost of the two share classes over the relevant time period and the "lost investment opportunity" caused the participants having less money to invest.

The Edison 401(k) plan is not an anomaly. In well over 90% of the 401(k) plans I have reviewed, retail shares are included as investment options, even though institutional shares are available at lower cost.

Blow Against Excessive Fees

To make a further point, there's no reason why any share class of any actively managed mutual fund (where the fund manager attempts to beat a designated benchmark) should be included as investment options in 401(k) plans. Index funds typically have only one class -- the costs are lower than either the retail or institutional classes of actively managed funds --and they'll likely outperform actively managed funds over the long term.

Nevertheless, if your 401(k) plan has retail funds in it, and institutional funds are available, your employer might be responsible for the difference.

To paraphrase Neil Armstrong, this is a small step for 401(k) plan participants and a big blow against the excessive fees and avarice that's so harmful to participants in these plans.

Permalink | Email this | Comments

]]>401kColumnsedison internationalkickbacksMutual fundsretirement planningretirement savingsDaniel SolinSun, 18 Jul 2010 08:30:00 ESTThe Simple Secret for Surviving in Turbulent Marketshttp://www.dailyfinance.com/2010/07/06/secret-for-surviving-turbulent-markets/http://www.dailyfinance.com/2010/07/06/secret-for-surviving-turbulent-markets/http://www.dailyfinance.com/2010/07/06/secret-for-surviving-turbulent-markets/#commentsFiled under: , , ,

Trading on stock marketI'm not going to make you wait for this advice. It's simple and direct: Pay no attention to Wall Street. I'm not asking you to believe me. Just listen to people who know better and have studied the securities industry.

Steve Eisman is a perfect example. He was the hedge fund manager who made a fortune shorting the subprime market and every other company involved in that debacle. Here's what he had to say about Wall Street, as quoted in Michael Lewis' excellent book, The Big Short:

"Not once in all these years have I come across a person inside a big Wall Street firm who was having a crisis of conscience. Nobody ever said 'This is wrong'. . . . What I learned from that experience was that Wall Street didn't give a s... what it sold."

Eisman saved his choicest words when he explained why he shorted Merrill Lynch stock:

"We have a simple thesis. . . . There is going to be a calamity and whenever there is a calamity, Merrill is there. When it came time to bankrupt Orange County with bad advice, Merrill was there. When the Internet went bust, Merrill was there. Way back in the 1980's, when the first bond trader was let off his leash and lost hundreds of millions of dollars, Merrill was there to take the hit."

Why the Push for Actively Managed Funds?

Eisman couldn't have been more correct. Merrill was definitely "there" when the subprime market crashed. The firm nearly collapsed after losing $50 billion in subprime loans. Its colleagues in the brokerage business didn't do much better. Lehman went bankrupt. Bear Stearns was sold for a fraction of its precrash value. Morgan Stanley (MS) lost billions. The list goes on.

The daily grist of brokers is recommending actively managed funds (funds where the manager attempts to beat a given benchmark) to their clients. Usually, they base their recommendations on Morningstar ratings, past performance or their assessment of the fund manager's investment skill. That there's no support for any of these factors is irrelevant to them.

A recent study obliterated the notion that a five-star rating by Morningstar should influence investors. Among other findings, the study said only four of 248 funds with a five-star rating maintained that rating 10 years later.

Past Performance Is Even More Problematic
.
Another study looked at top-performing funds over a five-year period. Guess how many were able to repeat that performance in the following five years? Less than 10%.

What about the much-touted "investment expertise" of top-performing fund managers? It simply doesn't exist.

A recent study determined that luck -- not skill -- explained outperformance by fund superstars. The well-credentialed authors conclude that investors should ". . . want low-fee, passive funds, unless you feel like paying these active managers the fees for basically not having performance that can be documented."

Of course, all this misses an even more critical point: Why would you entrust your money to firms that can't manage their own?

Passive Management Is All You Need

In turbulent times, you need sound, Nobel Prize-winning, academic-based advice to guide your investment decisions. Wall Street isn't about to give you that.

Here's what you should do: Determine how much risk you can take (you can find free asset-allocation tools on the Web, including a questionnaire on my website, smartestinvestmentbook.com). This will tell you how to divide your assets between stocks (riskier but with better growth potential) and bonds (stable but unlikely to keep up with inflation). Then purchase low-cost, passively managed stock and bond index funds divided according to your ability to withstand risk.

That's it. No broker. No worry every day about the direction of the market or the musings of the "professionals." Sleep well.

Permalink | Email this | Comments

]]>actively managed fundsbroker feesbrokeragebrokersColumnsindex fundsinvesting in turbulent marketspassively managed fundssecrets of investingStock InvestingDaniel SolinTue, 06 Jul 2010 07:30:00 EST