Financial Planning Etiquette: Clients First!
“The interests of the client continue to be sidelined in the way the firm operates and thinks about money.” This is a direct quotation from Greg Smith’s recent op-ed that he penned after stepping down as a senior executive of Goldman Sachs. Holding himself up as a man of integrity, Mr. Smith couldn’t stand working there any longer because “the environment now is as toxic and destructive as I have ever seen it,” and he no longer had personal beliefs that aligned with the firm he had once so passionately supported.
However, this news should not come as a big shock to everyone. Goldman Sachs, Bear Sterns, Merrill Lynch, Wells Fargo and the many other large financial institutions alike have a priority to their shareholders, and that is to make a profit. Greg Smith stated “if you make enough money for the firm you will be promoted to a position of influence” and later went on to add that the most common question he received from junior analysts was, “how much money did we make off the client?” Mr. Smith claims that clients are referred to as “muppets” by senior staff, suggesting that those clients are oblivious to their sole purpose of providing profit for the firm!
According to a study by Harvard and MIT economists, many financial advisors are often more likely to give advice that will lead to higher fees for them than higher returns for their customers. These economists sent hundreds of actors to financial advisory firms and found that in many cases those advisors steered their clients away from a logical investment and instead into one that produced more fees.
Former Bear Stearns CEO Alan Greenberg once said that he would not hold an M.B.A. against prospective hires, but that he much preferred job candidates with a P.S.D. – his term, which is short for Poor, Smart, with a Desire to be rich. After graduating from Cornell University with a degree in Economics, I was eager to put my newfound love for finance to the test in my first job with a well-known national investment firm. However, much to my surprise, the three-week training that came with the position was spent solely on sales techniques. A few weeks later, after bringing in several clients, I then realized that I had no clue what to do next in regards to investing their money!
So what can individual investors do to avoid being a “muppet” for the firm they decide to work with?
Here are a few qualities to seek:
Fiduciary. They act only in your best interest; a fiduciary relationship means we’re legally obligated to do so. Registered Investment Advisory firms are held to a fiduciary standard. This is not the case with others such as insurance companies or broker/dealers.
Fee-only. Their compensation is fully disclosed, fairly priced, and paid strictly by you, their client. Fee-only advisors accept no commissions or other types of incentives from outside sources to distract them from serving as your fiduciary.
Having worked at a brokerage firm prior to my time here at Rockbridge, I personally understand Mr. Smith’s frustration. This is one of the reasons that I am so passionate about our firm’s investment philosophy and the fiduciary standard that we hold ourselves to as fee only investment advisors. At Rockbridge, we have a strong desire to do right by our clients and carry forward the belief that the “Golden Rule” applies to all that we do, including financial planning!
A Decade Lost?
The holiday season is a great time to see friends of old who are back in town and catch up with family you don’t get to see as often as you would like. While getting caught up on each other’s lives, and amidst the small talk, most people these days bring up their dissatisfaction with the stock market. I even hear, from time to time, that some people feel that they would have been better off if they had just stored their savings underneath their mattress rather than dealing with the ups and downs of the recent market.
Over the last decade investors have been faced with a tremendous amount of volatility in the financial markets. The “technology bubble” was the first obstacle investors ran into and unfortunately had to bear with for over two years before the markets began to recover in late 2002. That recovery lasted for around five years and culminated in late 2007 when the Dow Jones hit its all time high. Unfortunately, this high was short lived and in 2008 investors saw one of the worst market corrections of their lifetimes! So has this decade been a waste for investors? Are their depictions of the market over the last ten years correct? Hardly, as long as you were properly diversified.
The graph below shows the performance of various benchmark portfolios and how they have fared over the past ten years. The green line tracks a well-diversified all stock portfolio. What this graph shows is that if you wanted $100,000 today, you would have needed to invest $64,500 ten years ago to achieve that. The blue line shows the returns of a moderate portfolio (50% stocks, 50% bonds), which is a more realistic holding for most investors. With a moderate risk portfolio, an investor could meet his $100,000 demand today with an investment of only $59,200 ten years ago! I know these are double digit annualized returns we are looking at, but to see this kind of growth in supposedly a “lost decade” seems pretty good to me.
Now, let’s take a look at how your investments would have done over a longer period of time. The graph below shows the path of those same benchmark portfolios over a time period of 32 years; a time horizon more indicative of what many investors face during their years of saving. In this case, a mere $4,500 was needed back in 1979 to reach our goal of $100,000 today. That equates to over a 10% annualized return!
The “investment rollercoaster” of the past decade has played with many investors’ emotions and has been hard to handle. However, for those who have stayed the course and were properly diversified, you are better off for it.
It is times like these that we need to step back and look at the bigger picture and realize that the recent volatility is nothing more than a few potholes on the road to your financial success!
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Don’t Sweat the Small Stuff . . . Well Maybe Sometimes
In the world we live in today, we are constantly reminded not to sweat the small stuff. We are told to not let the little things get in the way of living our lives and pursuing our dreams! That is so true and why we shouldn’t worry about the gossip being spread around at work, what our neighbor might think if we can’t get to mowing our lawn today, those stubborn few pounds we just can’t seem to lose, and what outfit we should wear to the company’s holiday party this year. All of these things clutter our mind on a daily basis and keep us from focusing on what’s truly important. What about the costs associated with your investment portfolio? Your advisor may try to categorize these as “small stuff” as well, but should they?
Rockbridge Investment Management is a firm that prides itself on controlling the controllable when it comes to investing, thus addressing the issue of investment costs is something we don’t take lightly. The average cost to invest in mutual funds with the typical brokerage firm is 1.5%, while here at Rockbridge the typical client pays around 0.25%. Are we just sweating the small stuff? Let’s find out!
Let’s take a look at an American family with a combined income of $75,000 who is saving 10% a year for forty years and is getting a fixed rate of return. Can an extra 1.25% in expenses make that much difference in their standard of living during retirement? The graph below shows the impact that fees can have on a portfolio – the results are staggering! The family with the low cost portfolio retired with over $2,000,000, which should allow them to comfortably draw around $100,000 from their portfolio each year during retirement! On the other hand, the couple who had higher portfolio expenses only accumulated $1,500,000 at retirement, giving them only a $55,000 draw from their account on an annual basis, after taking into account the lower balance and the higher continuing expenses.
(Assumptions: A couple saving $7,500 annually for 40 years with an 8% fixed rate of return. To make withdrawal rates equal in retirement, I used a 5% withdrawal rate for the low cost portfolio and reduced the other portfolio’s rate by the difference in fees.)
The notion of not sweating the small stuff is very important; it helps cancel out the everyday noise in our lives, allowing us to focus on living and pursuing our dreams. However, most of our dreams include a comfortable and fulfilling retirement, and a nearly fifty percent reduction in retirement spending may be a factor in that dream being reached. But I will let you be the judge of that!
What Everybody Ought to Know About Dividend Paying Stocks
All too often lately, I have heard people talking about their individual stock holdings and the income they are providing them in retirement. They love mentioning how they are receiving quarterly income from these companies regardless if the stock market is trending up or down. The stockbrokers refer to this as the “get paid while you wait” way to invest in the market. What they are referring to are dividend paying stocks, and with interest rates where they are today, they seem to have quite the appeal with many investors in retirement. The theory is that dividend paying stocks are providing both a systematic payout method and stability in their portfolio. Are they being misguided?
Thoughts to consider:
1. Dividends are not a “free lunch”: Stocks that pay dividends tend to be large companies who focus less on growth and instead pay out a portion of current income in the form of a dividend to its stockholders. Non-dividend paying stocks reinvest back into the company in an effort to provide more opportunity for growth. All else being equal, dividends are a trade-off, taking current income for slower growth in the company’s sales, earnings, and stock price.
2. Remember to diversify: Most dividend paying stocks are large capitalization companies. These are great to have in a portfolio, but only if they are accompanied by other equity investments to provide some diversification. We all remember what the market did in 2008, but what many forget is that it was the smaller US companies and international stocks which really helped drive the market back upwards in the following two years.
3. How much risk are you taking in your portfolio?: If you own a portfolio of dividend paying stocks then the answer is probably too much. Just because a stock is providing you income does not make it any less volatile. There is an inherent risk in owning stocks, which must be offset with a fixed income investment (bonds) for both the stability and further diversification it brings to your portfolio.
4. Dividend paying stocks are not an alternative to bonds: The “Dogs of the Dow” are a well-known index of dividend paying stocks. How well did the strategy do in the recent market downturn? Not so great. As the S&P 500 Index plunged 37% in 2008, the Dogs of the Dow recorded a negative 38.8% return. Bonds held up quite well during the same period. As measured by the Vanguard Total Bond Market Index Fund, bonds were up 5% over the same period.
Coming up with a systematic way to provide yourself with income in retirement is very important, but you want to make sure you do so in a way that makes sense from a risk standpoint as well. Dividends from a stock portfolio will fulfill the income need you may desire at retirement, but it may come at a cost! We, as investors, can’t control the direction of the stock market, yet we can control our exposure. This becomes even more important when you are nearing retirement and why proper diversification is crucial. Investing is a long road and when you reach retirement you are only halfway there, so make sure to work together with your advisor to come up with a strategy that makes sense for you!
The Folly of Active Management and TV Gurus
Last year I wrote an article about where to invest in 2010 and took that opportunity to remind investors not to fall into the excitement of active management and stock trading. Instead I cautioned them to focus on what you can control, like investment cost, risk, and asset allocation and to ignore the rest. So did I steer readers in the right direction? I was most confident that I had, but figured I would do some research on how one of the loudest stock trading icons had fared over the past year.
As the host of his show Mad Money, Jim Cramer is constantly on CNBC giving investment advice to listeners. In December of 2009, he stated that 2010 was the year of active investing and in particular certain sectors had a clear advantage. After the turmoil in 2008, he saw the financial industry as a definite opportunity in 2010 and named off several companies to buy. Not to my surprise, half of the stocks rose in value over the year while the other half showed negative year-end returns.
Furthermore, Cramer saw an opportunity in the energy sector, specifically in the recovery of natural gas versus oil. Here he listed over a dozen companies to invest in, with one of his favorites being a company that makes engines that run on natural gas and other alternative energies. The total return of these stocks for the year was 11.72%, and that is before you take into consideration trading costs. An investor in the small-cap index, Russell 2000, saw a 26.9% rate of return while taking on considerably less individual company risk.
Yet maybe 2010 was just a bad year for Cramer. I mean he does have a show on national television so he must know what he is doing, right? Since 2000, an objective research team from Massachusetts has tracked Cramer’s stock predictions to see how he has done. What they found was that over those ten years only 47% of the time had Cramer beaten the benchmark return through his stock picking! After watching his show, that seems like a lot of wasted energy to only beat benchmark returns at a rate less than that of a simple coin toss.
There is one takeaway from Cramer’s show that I do think all investors should listen to. On more than one occasion, Cramer reminds listeners that “no one will ever care more for your money than you do” and there is so much truth in that statement. Television ratings are the main goal of Cramer’s Mad Money series, and most investors have very different goals when it comes to their retirement accounts. A trusted advisor will put your interests first, and by doing so, you will have a much higher likelihood of achieving a successful retirement!
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