The Fee-Only Alternative to Business as Usual on Wall Street

Traditional Wall Street firms have failed to deliver credible, objective advice.  Their commission-based compensation system irreparably taints the advice process with conflicts of interest and hidden agendas.  But there is a viable alternative to the commission-crazed, churn-and-burn stockbroker.  The independent, fee-only registered investment advisor offers objective advice, superior service, and economical and effective execution

The vast majority of these firms are relatively small, without the marketing clout of the giant institutions.  So, they are not “top of mind” when investors seek out advice.  But they offer a key invaluable advantage: objective advice.  Because a fee-only advisor derives all of his income from fully disclosed fees paid directly by the client, conflicts of interest are virtually eliminated.  There remains no financial incentive that would prevent the advisor from providing the very best advice for each individual.  So, while the advisor may not always be “right” in his counsel, there are no hidden agendas, or conflicts of interest to cloud his vision or taint the relationship.  And, after all, what good is advice if it’s not objective?

The demand for impartial professional advice is enormous and growing.  For instance, since 1989, assets with Schwab’s Financial Advisor Service have grown to nearly a half trillion dollars managed by 5,600 independent registered investment advisors!  Fidelity and Waterhouse are also experiencing exponential growth in similar services, with others entering the fray close on their heels.  Clearly, Americans are looking for unbiased professional advice and an intelligent alternative to Wall Street’s commission-induced conflicts of interest and voodoo-based investment schemes.

The Problem with Hearing it Through the “Grapevine”

My recent post from yesterday talked about how it feels like an eternity when going through a period of negative performance in one’s portfolio.  And how relative pain is remembered more than relative joy during a downturn.  Continuing from that topic: The proverbial “grapevine” makes matters worse.

Marvin Gaye’s hit song, “I Heard It Through The Grapevine” is about gossip, but for our purposes, it is about two investors, one is producing positive returns in his portfolio, the other is producing negative results in his.  This is almost always the case, no matter how bad things may get for our investor, somewhere somebody is making money.  Those people will certainly tell all within earshot, to make matters worst.  Most investors have a very selective memory.  We all seek approval, and we all would like to be considered astute, sophisticated, and successful.

During social gatherings or casual conversations it’s not unusual to stress the positive and repress the negative.  So the investment winners in our portfolios tend to get talked about more than the losers.  Investors with disappointing recent performance will say nothing.  After all, who wants to broadcast failure?  So, the winners brag, and the losers keep silent.  Soon, it may seem to our poor investor like everybody with an IQ over room temperature is making money except him.

So the temptation to second-guess himself grows and grows.  If only his advisor had been more astute, he would be making money too.  Perhaps it’s time to try something else like all those other smart investors are doing.

Once this kind of cycle starts it can deteriorate into a tail-chasing fiasco.  At least dogs that chase their tails remain on level ground.  Investors can dig themselves into a hole as they ratchet themselves ever downward chasing yesterday’s hot stock, hero fund manager, or top performing mutual fund. 

It’s easier said than done, but we have to ignore the grapevine.  And the braggarts of today, will become tomorrow’s silent listener.

The Market Can Beat Up Rambo

America is a can-do country.  Our heroes are action-oriented and full of the right stuff.  Most successful people got that way by using their skills to make something happen.  Rambo claimed authority by showing up with the biggest gun!

Business responds well to can-do, positive, and active management.  If business turns down, there are lots of things a smart business person can do:  Make more phone calls, hire more sales-people, buy advertising, change the product, have a sale, fire the sales manager, buy the competition, increase commissions, or move to a better market.  Success in business depends on active management.

Investing on your own (particularly in stocks, bonds or mutual funds) is a different kind of animal.  It is a very passive activity.  Markets don’t respond to our can-do attitude.  We can’t just whip them into shape. It doesn’t care if you brought a knife to a gun fight.  They have their own flow.  So, we must attach ourselves to the market’s movements and allow it to carry us to our goals.

More often than not, if you have a good strategy in place, the best single thing an investor can do during a disappointing season is nothing.  Of course, this type of thinking can make a successful, can-do, action-oriented, gung-ho investor just a little crazy.  During times of stress, negative performance, or no performance, he wants to do something.  All kinds of self-defeating behaviors come to mind:  Fire the advisor, liquidate the account, move to another brokerage, sell the funds, anything other than sitting still!  The fund that looked so good during last year’s big recovery now looks like a turkey. An advisor who remains focused on the long term, staying put, and maintaining the course of the plan, obviously must be some kind of wimp right?  Any idiot can see things are falling apart and the Rambo in all of us demands action now!

Investor impatience is compounded by a relative pain, relative time problem.  Portfolio downturns hurt a lot more than good times feel good.  it is much more painful to see your portfolio lose one percent than pleasant to see it gain one percent.  And it feels longer.  Two years of back-to-back declines, underperformance, or even just no performance can feel like a lifetime.  And, as we have seen, even a superior portfolio will go through occasional extended periods of disappointment. 

Look Forward NOT Backward!

Smart investors use volatile markets to upgrade their portfolios.  A common mistake investors make during market downturns is that they look backward, not forward.  Investors fixate on lost profits, on what they should have done.  This takes their eyes off what they should be doing to make money going forward. 

You cannot undo the past.  Smart investors don’t miss the future by looking at the past.  They take their lumps, learn their lessons, and do what they can to position their portfolios for the market’s inevitable reversal.  That means smart investors use volatile markets to trim their exposure and adjust accordingly. 

That’s the beauty of the market: at every ups and downs, there’s the probability to profit. 

Bottom line:  Nobody can tell you with certainty the perfect time to invest.  Nobody knows with certainty when a market has bottomed.  What I do believe can be said with a high degree of certainty is that markets move through peaks and troughs.  I can’t guarantee prices will be higher five or ten years from now, but history shows that a consistent investment program produces success over the long term.

First-Hand Experience In Fundamental Economics

Yesterday as my family and I were going into Target (TGT) to browse the toy section for holiday gift ideas, we witnessed a middle-aged man with a cart full of baby products (diapers, wipes, baby lotion, baby shampoo, and a small baby toy) walk out of the store without paying.  There were many people around, some noticed as we did, some didn’t and it was a busy time of day, almost perfect to pull off such a heist.

The man had a determined look on his face, almost a desperate, “I don’t know what else to do” look.  He simply focused straight ahead to the exit and never looked back. 

This is a prime example of how inflation affects America today.  Forget the recent Quantitative Easing solution that is “supposed” to help the economy, in truth all that money that pumped into the system only went to the top-tier citizens of the United States anyway.  The same citizens that caused this demise in the first place!

But, I can relate with the shoplifter, after all I have two young kids of my own, and a baby on the way.  Diapers costs $45 per box of 216 pieces.  Babies go through 8 per day on average.  So, in a little under a month, you’re spending $45 dollars on diapers alone, wipes come to about $20 per box on top of all the other expenses required for a baby.  Crib and crib mattress, sheets for the crib, a changing pad, strollers, car seats, appropriate-sized clothing, formula (if not breastfed), bottles for the milk, bottle warmers, disinfecting bags for pacifiers, bibs, and the list goes on and on!

Desperate times calls for desperate measure, and with the economy the way it is, where jobs are gone, incomes are down or at a plateau, consumer prices are up, the dollar value at an all time low, and lending institutions tightening their standards.  It’s no wonder some can be driven to bunk the system and steal. 

Brace yourselves, my feeling is, more and more people will be driven to do extreme things.

Simplicity Leads to Calmness

A big part of succeeding during volatile markets is staying calm.

When you’re calm, you make much better decisions.  When you’re calm, you don’t overreact to circumstances.  When you’re calm, you think more clearly. 

Being calm prevents you from making mistakes, in trading and in life. 

Of course, knowing you should be calm during crazy markets is one thing; actually being calm is quite another.

One way to ensure that you maintain a measured, calculated approach to volatile markets is by having a clear handle on your financial position and a clear plan of attack.  You do this through simplifying your investment approach.  Instead of choosing four or five stocks out of 7,500 or four or 5 mutual funds out of 19,000 to put in your portfolio, reduce the burden by Indexing.  This way, your costs are low and the probability of success increases in your favor.

The best piece of advice I’ve read about when it comes to trading strategy is the “KISS” concept.  Keep It Simple, Stupid!

I can’t think of any time when simple doesn’t beat complex.  That’s especially the case during volatile markets.

Be A Partaker, Not An Outsmarter

There are two kinds of investors:  Outsmarters and Partakers. 

Outsmarters believe they’re so clever they can beat the system, through inside advice and superior brainpower.  Partakers understand that the best way to make money is to share in the profits of successful businesses, by buying stock in Apple, Cisco, Walmart or McDonalds, for example.

Many investors, especially baby boomers, who are convinced they were born more brilliant than everyone else, begin their investing careers as Outsmarters.  They invariably get outsmarted themselves.

According to Bill Clinton’s autobiography, that’s exactly what happened to them in 1978.  They went into a typical Outsmarter deal-borrowing money to buy land in the Ozarks through Whitewater Development, a company they set up with an insider named James McDougal, along with his wife Susan.  Real Estate is especially tempting to Outsmarters since it’s a game in which the other players often appear to be rubes.  In this case, however, the Clintons and McDougals bought land for $880 an acre from a group that had purchased the property just 19 days earlier for $440 an acre.

The intention of the Whitewater investors was to find people to buy the lots at more than $880 an acre and make a big profit.  But in the end, they found that such buyers did not exist ($440 an acre turned out to be the right number).  The Clintons lost $68,300, according to an accountant’s report they commissioned.

The Clintons are just an example of Outsmarters out there as there are a lot of them.  There are, for example day traders, who think they can profit from tiny ups and downs of stocks over minutes or hours.  I do not doubt that some people can make a profit this way-after all, some people are born with the ability to throw a baseball 100 miles per hour.  But, beyond a tiny fraction of super talented and super-dedicated, day traders eaten up by the transaction costs-the commissions, the spreads between bid and asked prices and the interest incurred in buying stocks on margin.

Other Outsmarters are bottom fishers.  They figure they can identify stocks that have plunged but will soon emerge from the depths.  Occasionally, a smart investor will win by betting on these kinds of stocks, but most of the time…no.  When a stock is exceptionally cheap, there is almost always a reason. 

Remember that a stock that’s fallen can keep falling.  Did Internet Capital Group look like a good buy after it had declined from $196 to $45 in the first four months of 2000?  I sure did, and got burned in the process.  Over the next year it dropped to 34 cents.

Partaking, on the other hand, is the ticket to success in the stock market.  Investing in an index fund with an option to go Inverse (to profit when prices fall) is a way to share in the long-term growth and trend of the U.S. economy. 

My own preference is partaking in the growth of great companies.  Occasionally, it strikes me how incredibly generous the stock market is.  At little cost, I can become a partner in a business like GE, Microsoft or Apple, tagging along on a very profitable ride.