The F-Word

One of the least discussed but most important factors to consider when hiring a financial advisor is whether or not they are a fiduciary. This means the advisor has a legal obligation to put their clients’ interests ahead of their own. Most consumers assume that their advisor is acting in this capacity, when many times he is not.

The law regards the job of advisor as a position of trust and requires those with a fiduciary obligation to disclose any conflicts of interest and to act with a heightened sense of duty toward clients. Registered Investment Advisors with the Securities and Exchange Commission are held to this standard. As of July 1, 2008, Certified Financial Planners had the ethical standards by which they are held revised, making it explicit they too must put clients’ interests first, act as fiduciary and disclose the scope of their engagement and their compensation when engaging in planning activities.

Because a broker’s job is considered to be transactional as they are often placing trades on a client’s behalf, they are held to a different regulatory standard. Their duty is to make a recommendation that is “suitable” to their client’s circumstances. If a brokerage house manages a large cap growth mutual fund that has an internal expense ratio of 1.50% and an additional 12b-1 marketing fee of 1% that is paid to the broker, this would be considered suitable instead of recommending another large cap growth fund with much lower internal costs.

In the financial services industry, there has been a lot of talk about how consumers are confused about the difference between brokers who call themselves "financial advisors" or "investment advisors" and Registered Investment Advisors who are held to a fiduciary standard. In the past each were paid very differently – advisors charged management fees and brokers received commissions. Over the past several years many brokers have begun charging fees, giving consumers the impression that they are acting as fiduciaries.

The recently proposed financial regulatory reform legislation gives members of Congress the opportunity to improve the world of consumer finance. Fortunately Mary Shapiro, head of the Securities and Exchange Commission, has stated that the SEC might recommend creating a single standard that applies to advisors and brokers – a fiduciary standard.

In the interim, make sure you question your financial advisor as to which standard they are held.

By Chris Carleton, CFP®

Casualties of Complexity

At the risk of sounding naïve, I believe that many of the problems we experience as investors and the institutions that regulate us are brought on by complexity.

The book, A Demon of our Own Design, got me started thinking this way. Written by Richard Bookstaber in 2007, it gives an insider’s view of the 1987 Crash and the collapse of Long-Term Capital Management, the hedge fund that took down UBS when it collapsed in 1998. Each disaster, and several others described in the book, was caused by an attempt to use complex financial strategies to circumvent the normal movement of financial markets – and each failed miserably.

None of the designers behind these strategies were intellectual light-weights. The author himself received his PhD from MIT in economics; but in all cases the complexity of the product design (portfolio insurance, currency options, etc.) failed to take into consideration some factor that only seemed obvious in hindsight. There was too much complexity in the plan to take all possibilities into consideration in advance.

Ironically, the last chapter of the book recommended that “rather than adding complexity and then trying to manage its consequences with regulation, we should rein in the sources of complexity at the outset.” This was written before collateralized debt obligations and other complex financial instruments created what some are now calling the Great Recession of 2008.

Not only did we experience a global drop in the equity markets in 2008, but to add insult to injury people had their money stolen from them by people like Bernie Madoff. Now the Obama administration is proposing regulation to prevent what we’ve been through from happening again. While I believe that regulation usually does more harm than good, I understand that something needs to be done.

If complex regulations are proposed to control investment companies then more inventive ways to circumvent the regulations will result. I propose simplicity instead. Make all brokers, financial planners, financial consultants, investment advisors, money managers, etc. follow the same 3 rules:

1. Use an INDEPENDENT company to hold your client’s assets.
2. Hold yourself to a fiduciary standard when you work with your client.
3. No matter what you are doing, or who you work for, follow rules 1 and 2.

There is hope, since the Obama proposal mentions establishing a fiduciary duty requirement for all advisors, but we’ll see if it makes it through a Congress that is heavily lobbied by groups that don’t want to be held to the standard.

People who lost money before these rules were in place might have been saved by them, but they could have saved themselves as well. All of the Bernie Madoff victims interviewed said they did not know how he was investing their money and could not explain how he could give them a steady 10% per month return when markets were falling. Complexity can be very seductive to investors because it appeals to the belief that really, really smart people have secret ways of outperforming the market.

If we don’t understand something because it is too complex, then we risk becoming a casualty of the complexity. My rule – keep it simple enough to know what you have and what you are doing. It works in life as well as investing, but that’s for another day and another blog…

By Jeannette Jones, CFP®

You Need A Budget (.com)

Over the last several months, many of us have re-realized the importance of a good budget. This is normally a four-letter word at worst and, at best, something we periodically place on the to-do list between “clean out the gutters” and “wash the windows”.

When we do get around to it, we spend a rainy weekend knee deep in piles of old bills, credit card statements and receipts trying to figure out where exactly all of our money went. Whether through Excel, Money or Quicken, we eventually produce some kind of budget that represents the recent past in a somewhat coherent pattern. We make a few cuts, have a talk with members of our household and set forth with our new budget. The net result of all of this effort generally proves to have the same staying power as our new year’s resolution to eat less and workout more. Perhaps it’s time to revisit this time honored approach to budgeting and look at some new tools and ideas that can help.

A budget, in short, is what allows you to live within your means. The word “live” is optimal here as your budget needs to be a part of your daily life. That’s not to say that it needs to become an obsessive habit, but with all the technology available to help you stick to your well made plans, why not make keeping this resolution as easy as possible? Mint, Finicity, Wesabe and YNAB (You Need a Budget) are just a few of the online-based products out there today that attempt to take these principles to the next level.

YNAB, a personal favorite, goes as far as to suggest a whole new way to look at your budget, establishing four rules as keys to a successful budget. To borrow from their website, they are paraphrased as follows . . .

1. Stop Living Paycheck to Paycheck – or, simply, live on last month’s income not this month’s. While it may take 4-6 months to save and work to that point, it will greatly increase responsible spending while alleviating many of the stresses that come from timing monthly expenses to pay day, whether that be waiting on the next pay check, social security payment or monthly portfolio withdrawal.

2. Give Every Dollar a Job – sit down each month and allocate where the income you’ve built up from the prior month is to be allocated. Continue this process until you have no more dollars to allocate. Once you’re comfortable with this process, it should take no more than 15-20 minutes each month and will greatly improve financial communications and comfort levels throughout the household. Whether a car payment, entertainment, savings, or a vacation, every dollar will be assigned a task. As the website suggests, “dollars are like teenagers, unless given some guidance, they’ll own you.”

3. Prepare for Rain – This is fairly self explanatory. Make sure you are saving in advance for those bigger ticket items like property taxes or auto insurance and that you’re setting some additional funds aside for the unexpected.

4. Roll with the Punches – You and your budget will fail from time to time. The key is to recover quickly and make adjustments to the current allocation that will allow for a softer correction rather than a harsh, unexpected cash flow stoppage down the road.

Regardless of what you decide to do, do something different next time the budget makes your to-do list. As we will undoubtedly see dramatic changes over the next several years in how we approach finance in this country, it only makes sense to make this a time of personal review as well.

By Chip Workman

Start Reading Your Statements

President Obama recently signed credit card reforms into law, but credit card companies don't have to start playing by the rules until July, 2010. That means that these credit card companies have only the next year to get it while they can, and unfortunately, many of them are already looking for ways to make more money before the deadline. It might come as a shock to some, but these new fees and higher rates do NOT just apply to those with low credit scores. Anyone who carries a balance could see changes.

The new law is meant to combat some practices that are not exactly fair to the consumer. Things like:
Hiding fees
Raising rates for any or no reason
Balooning rates when you've missed a payment on another of your bills
Applying payments to the lowest rate balances first

While these new rules are meant to be more fair to the consumer, they are being slammed with fees and higher rates in the interim. The average rate on a credit card has ticked up more than 1.5% recently, and analysts expect that to rise an additional 1-2 points by the year end. The new law will restrict the practices of late and over-the-limit fees, so we will likely see many cards add an annual fee.

Credit limits have already been slashed, as many consumers now have access to less than half the credit they had just months ago. If you're a person who never uses their credit card, it wouldn't be a bad idea to use it once a month for gas, then pay it off. Doing this will make you somewhat less of a target for a limit decrease.

While no one should be surprised that subprime cards and those with instant approval are disappearing, it is disheartening to see your rewards program get watered down. Some cards will simply not be able to offer the rewards that they used to. Some banks are even talking about charging interest from the day you make the purchase, so even those who pay in full each month will have to fork over interest!

If you've never gotten in the practice of going over your credit card statement, now is the time to start. Those last 3 pages of small print? Read them! And if you start to see any of the changes discussed previously happening to you, don't be afraid to call and speak up!
-If you are fortunate enought to have good credit, you have some leverage.

By Amanda Bashore, CFP®

The New Rich

A financial crisis causes us to reevaluate every aspect of our lives. Many people have discovered that they have been so busy accumulating “stuff” to keep up with the Jones’ (not Jeannette and Greg), that when this is no longer possible, the emptiness in their lives becomes apparent.

For the past 19 years I have gotten a first-hand look at how people deal with the financial matters. The most important lesson I have learned is that money and happiness do not go hand- in-hand. Many times it’s the people who spend the most that never seem to achieve the degree of satisfaction they seek, and those who focus on what they have, and not what they lack, are truly rich.

No one likes to lose money or experience an economic downturn, but if this causes us to look inward for our wealth, many of us will find we are already rich. For those who do not, look for other ways in which you can prosper such as reconnecting with family or friends and volunteering to help others less fortunate than yourself. The rewards will last through all cycles of the economy.

By Chris Carleton, CFP®