A common misconception about the investment world is that the person giving you financial advice is either commission-based or fee-based. At The Asset Advisory Group we are neither. We are fee-only. This means that we do not receive any compensation from the investment companies whose products we use to implement our client’s financial plans.
A commission-based salesperson will always have a temptation to make a recommendation based on what would be best for themselves or the company they represent, not their client. I’m not saying this is intentional, but I have seen it happen time and again.
If a client comes to me with $500,000 to invest, I will charge them a 1% annual management fee and allocate their funds to low cost institutional no load mutual funds. I receive no compensation from the mutual fund company. If the same client were to walk into a broker’s office, they may end up with a $500,000 annuity which pays the broker a $24,000 commission. When looking at an immediate payout of $4,000 or $24,000*, which would most salespeople choose? And do you think they will continue to give on-going advice to this client or look for their next prospect?
There are many advisors that are fee-based which accept both an ongoing management fee from their clients as well as a commission from the company whose products they are selling. Sounds like a great plan – for the advisor!
While I feel very strongly that fee-only advisors have the best opportunity to serve the interests of their clients, the bottom line is to know how your advisor is compensated. Anyone who gives you financial advice should not have a problem revealing exactly how much money he will make based on his recommendations for your portfolio.
*assumes a 6% commission and an 80% payout on the annuity and an 80% payout on the management fee
Chris Carleton, CFP®
clcarleton@taaginc.com
http://www.taaginc.com
Monday, August 30, 2010
Friday, August 20, 2010
How Mutual Fund Managers are Like Cigarette Makers
(from Jennifer Saranow Schultz's article on the New York Times' Bucks Blog, 8/18/2010 - click here to link to the original post)
Last week, my colleague Tara Siegel Bernard wrote about a recent Morningstar study that found that expenses were the most dependable predictor of fund performance and actually helped investors make better decisions than Morningstar’s star-rating system. Then, on Tuesday, Carl Richards wrote about how the study’s results stacked up with his own findings that the fund with the lowest expenses tended to win.
So, we apologize for coming back to this study one more time, but we couldn’t resist noting the nastiness of the rhetoric in a recent e-mail in which the founders of MarketRiders, an online service that helps investors build E.T.F. portfolios, compared actively managed mutual fund managers to tobacco companies.
They also compare Russel Kinnel, director of mutual fund research at Morningstar and the person who explained the study’s results on Morningstar’s Web site, to whistle-blowing tobacco industry insiders. We’ve excerpted some of the choicer parts of the e-mail, which went out to a MarketRiders e-mail list, below.
“For nearly 40 years, unbiased research from every corner of academia and industry has demonstrated that buying a portfolio of actively managed mutual funds is a “loser’s game” and that the Morningstar 5-Star rating system has little predictive value. Sadly, investors using it have lost billions in retirement savings to unnecessary fees, taxes and under-performance.
A portfolio of actively managed mutual funds is absolutely, without question, as bad for your wealth as smoking is for your health. In 1953, Dr. Ernst Wynder published a groundbreaking study that established the health risks of cigarette smoking. In response, the leading tobacco manufacturers organized a massive counterattack by forming the “Tobacco Institute Research Committee.” What sounded like an unbiased research organization was really a well-funded public relations ploy to calm down the public. For over 40 years, these manufacturers engaged in brutal litigation and campaigns to manipulate public opinion. Finally, industry insiders, Dr. Ian L. Uydess, Dr. William A. Farone and Jerome K. Rivers stepped up and testified against their employer Philip Morris, which forever changed the industry.
For years, the mutual fund industry has waged a similar war against the passive index investment methods that we support. Like big tobacco, the mutual fund industry is large, profitable and immensely powerful. With large advertising budgets to influence “unbiased” mainstream media, they guide investors into bad investments. Morningstar has lined its pockets as a willing accomplice. Mr. Kinnel directs Morningstar’s research and has just announced that their rating system is a little bit better than bogus. In 50 years, will he be heralded as the first industry insider to finally tell the truth?”
Them sound like fighting words to us. What do you think?
Last week, my colleague Tara Siegel Bernard wrote about a recent Morningstar study that found that expenses were the most dependable predictor of fund performance and actually helped investors make better decisions than Morningstar’s star-rating system. Then, on Tuesday, Carl Richards wrote about how the study’s results stacked up with his own findings that the fund with the lowest expenses tended to win.
So, we apologize for coming back to this study one more time, but we couldn’t resist noting the nastiness of the rhetoric in a recent e-mail in which the founders of MarketRiders, an online service that helps investors build E.T.F. portfolios, compared actively managed mutual fund managers to tobacco companies.
They also compare Russel Kinnel, director of mutual fund research at Morningstar and the person who explained the study’s results on Morningstar’s Web site, to whistle-blowing tobacco industry insiders. We’ve excerpted some of the choicer parts of the e-mail, which went out to a MarketRiders e-mail list, below.
“For nearly 40 years, unbiased research from every corner of academia and industry has demonstrated that buying a portfolio of actively managed mutual funds is a “loser’s game” and that the Morningstar 5-Star rating system has little predictive value. Sadly, investors using it have lost billions in retirement savings to unnecessary fees, taxes and under-performance.
A portfolio of actively managed mutual funds is absolutely, without question, as bad for your wealth as smoking is for your health. In 1953, Dr. Ernst Wynder published a groundbreaking study that established the health risks of cigarette smoking. In response, the leading tobacco manufacturers organized a massive counterattack by forming the “Tobacco Institute Research Committee.” What sounded like an unbiased research organization was really a well-funded public relations ploy to calm down the public. For over 40 years, these manufacturers engaged in brutal litigation and campaigns to manipulate public opinion. Finally, industry insiders, Dr. Ian L. Uydess, Dr. William A. Farone and Jerome K. Rivers stepped up and testified against their employer Philip Morris, which forever changed the industry.
For years, the mutual fund industry has waged a similar war against the passive index investment methods that we support. Like big tobacco, the mutual fund industry is large, profitable and immensely powerful. With large advertising budgets to influence “unbiased” mainstream media, they guide investors into bad investments. Morningstar has lined its pockets as a willing accomplice. Mr. Kinnel directs Morningstar’s research and has just announced that their rating system is a little bit better than bogus. In 50 years, will he be heralded as the first industry insider to finally tell the truth?”
Them sound like fighting words to us. What do you think?
Monday, August 16, 2010
Morningstar Says Fees Foretell the Future Better Than the Stars
Morningstar Inc., one of the most well known mutual fund evaluation companies, published a study on August 9th that concluded low fees were the best predictor of a mutual fund’s future success – even better than Morningstar’s own star-rating system.
This is a big deal; because Morningstar’s business consists of looking at past returns of mutual funds using a complicated evaluation system, assigning a star-rating to each one, and selling this information to individual investors, libraries and the financial industry. Mutual fund companies take out full page ads touting their 5 star rating because they know it will attract new deposits. For years, financial magazines have instructed people to invest only in Morningstar 5-star ranked mutual funds if they wanted to own the “best performing” funds.
“If there’s anything in the whole world of mutual funds that you can take to the bank, it’s that expense ratios help you make a better decision. In every single time period and data point tested, low-cost funds beat high-cost funds,” wrote Russel Kinnel, Morningstar director of fund research and the study’s author. This conclusion is very important, because many creators of hedge funds and active mutual funds acknowledge that they are much more expensive than other alternatives, but insist that their outperformance will overcome costs. Based on the study, in every single time period and data point tested, this was not the case. It is too difficult to overcome the burden of high costs.
The investment industry is required to remind people that past performance is no guarantee of future returns. I believe people are deaf to this warning because research shows mutual funds experience a flood of new deposits after they publish high returns, and they are usually severely disappointed with the results. A better tactic is to focus on what you CAN control – what you are paying to invest in the fund. Mr. Kinnel at Morningstar came to the same conclusion: “Perhaps the most compelling argument for expenses is that they worked every time--because costs always are deducted from returns regardless of the market environment. The star rating, as a reflection of past risk-adjusted performance, is more time-period dependent. Investors should make expense ratios a primary test in fund selection. They are still the most dependable predictor of performance.”
I couldn’t have said it any better myself.
Jeannette A. Jones, CPA, CFP®
jjones@taaginc.com
http://www.taaginc.com
This is a big deal; because Morningstar’s business consists of looking at past returns of mutual funds using a complicated evaluation system, assigning a star-rating to each one, and selling this information to individual investors, libraries and the financial industry. Mutual fund companies take out full page ads touting their 5 star rating because they know it will attract new deposits. For years, financial magazines have instructed people to invest only in Morningstar 5-star ranked mutual funds if they wanted to own the “best performing” funds.
“If there’s anything in the whole world of mutual funds that you can take to the bank, it’s that expense ratios help you make a better decision. In every single time period and data point tested, low-cost funds beat high-cost funds,” wrote Russel Kinnel, Morningstar director of fund research and the study’s author. This conclusion is very important, because many creators of hedge funds and active mutual funds acknowledge that they are much more expensive than other alternatives, but insist that their outperformance will overcome costs. Based on the study, in every single time period and data point tested, this was not the case. It is too difficult to overcome the burden of high costs.
The investment industry is required to remind people that past performance is no guarantee of future returns. I believe people are deaf to this warning because research shows mutual funds experience a flood of new deposits after they publish high returns, and they are usually severely disappointed with the results. A better tactic is to focus on what you CAN control – what you are paying to invest in the fund. Mr. Kinnel at Morningstar came to the same conclusion: “Perhaps the most compelling argument for expenses is that they worked every time--because costs always are deducted from returns regardless of the market environment. The star rating, as a reflection of past risk-adjusted performance, is more time-period dependent. Investors should make expense ratios a primary test in fund selection. They are still the most dependable predictor of performance.”
I couldn’t have said it any better myself.
Jeannette A. Jones, CPA, CFP®
jjones@taaginc.com
http://www.taaginc.com
Monday, August 9, 2010
5-Star Weekend
This weekend, I had the honor of joining my father for the Pro Football Hall of Fame induction weekend as a guest of one of the enshrinees, Emmitt Smith, the NFL’s all-time leading rusher. It was an amazing weekend with lots of legends of the game, family, friends and fans all celebrating the accomplishments of the new class and the sacrifices they made to achieve greatness.All weekend, I felt very much like an ad for a must-buy mutual fund in any number of financial publications. All sizzle and no steak, if you will. On multiple occasions, my father and I, along with a thousand or two other friends and family of the inductees, were bused from venue to venue, cutting ahead of throngs of fans as we were ushered to various events. We met some great people and had a wonderful time, but these buses were full of, for lack of a better word, nobodies. That didn’t stop a lot of fans dying to be steps away from fame to surround us as we arrived at each location to study each and every one of us, guessing who we might be. People waited for hours, pushing and prodding their way to the fronts of roped off areas with the promise of something great. What they got was a sunburn and lots of disappointment. Apparently, my autograph isn’t all that in demand.
Why did this make me feel like a hot mutual fund? Much like the tinted windows of the buses held the promise of famous faces, the glossy ads touting 5-star ratings and recent outstanding performance are nothing but window dressing.
Human perception and the need for status is a curious thing. It’s intriguing how we can perceive great value or the promise of a big payoff just based on the way something is presented or packaged without doing any thinking or homework to see if it really makes sense. If any of the people who waited hours to see some famous athletes would’ve taken a few seconds to think through what they were investing their time in, they probably would have realized that the NFL isn’t likely to bring Jerry Rice, Emmitt Smith or any of the other players in attendance right through crowds of people on their way to the ceremonies.
In that same vein, the next time you see an ad, talk to a friend, or see something on TV about a new can’t miss investment product or other idea, ask yourself if you truly understand the investment philosophy of the product being offered and believe it can help you meet your financial goals. More often than not, you’ll realize that it’s just another fund and that the only thing on the other side of the velvet rope it presents itself behind is another experience of chasing returns with disappointing results.
Chip Workman, CFP®
cworkman@taaginc.com
http://www.taaginc.com/
Monday, August 2, 2010
Hiring the "Best" Stock Pickers
This week, we thought we'd have a laugh via famed Dilbert cartoonist Scott Adams, a financial manager prior to starting the cartoon Dilbert that went on to earn him considerable fame and fortune. Adams, a noted fan of passive management, uses his character "Dogbert" to explain the logic, or lack thereof, of the brokerage industry. Enjoy your week!
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