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The BAD Guys (non-fiduciary "advisers" who can't be trusted) VERSUS
The GOOD Guys (fiduciary advisers who legally work for you)
Doing it yourself
If you choose to work with an adviser to help you invest your money then perhaps the most important term you need to learn about is "fiduciary". Do you even know if you are working with a fiduciary adviser? We constantly see commercials for large brokerage firms who imply that they are on your side. But are they really? Perhaps the single biggest mistake made by investors (who don't do it themselves) is to just assume that the financial professional that they get advice from is working in their own best client interests. Shockingly about 85% of investment professionals in the US are not fiduciaries, and most investors don't even know what a fiduciary is.
A fiduciary adviser has a legal duty to select investments for you that are in your best interests, whereas a non-fiduciary is legally allowed to select inferior and more expensive investments for you based on how much commission money he stands to earn from the transaction. In other words, with non-fiduciary "advisers", conflict of interest is perfectly legal! They really don’t care much about your best interests because they don't have to. They want to fatten their own wallets. They are merely "SALESMEN" in search of excuses to convince you to make another transaction so that they can get paid again. Legally these "advisers" work for the best interests of themselves or their company whether the investments they push on you are good choices for you or not. By default you can expect to be sold actively managed mutual funds or other inferior, illiquid, "alternative", riskier and vastly more expensive investments by these non-fiduciary salesmen who also act in the capacity of "financial advice givers". This conflict of interest is perfectly evident when you compare "passively managed" mutual funds with "actively managed" mutual funds or when you compare annuities to better alternatives. You think that you're getting a bargain because your adviser doesn't directly charge you any fees, when in reality they are indirectly taking you to the cleaners. Most investors are completely unaware that they are being fleeced. You may even become a victim of churning.
WARNING: While most fiduciary advisers are honest, some fiduciary advisers may break the law. This firm boasted of having fiduciary registered investment advisers but is alleged to have been running a Ponzi scheme. This underscores the importance of having a written contractual agreement, compensation disclosure documentation, etc AND the importance of learning which investment products to avoid, what basic rules to follow, and other lines of defense.
FEE-BASED VS FEE-ONLY: The best line of defense in weeding out conflict of interest is to seek out a "fee-ONLY" fiduciary adviser (rather than a "fee-BASED" fiduciary adviser) because "fee-only" means that legally they cannot earn compensation from any source other than you. Fee-only advisers legally may not earn compensation from transactions, which means at least legally these is no opportunity for conflict of interest resulting in you being sold inferior products like annuities, actively managed mutual funds and other oddball investment products. There may well be good intentioned fee-BASED advisers out there, but you can never be sure if they are allowed to earn commissions. I have encountered "fee-based" advisers who still manage to find reasons to push those inferior annuity products, and when they do so they get to "double-dip" by earning back-door commissions. Then it becomes impossible to prove whether they sold you that commision based product because it was in your best interests or theirs. The only way to be sure to to hire a fee-ONLY fiduciary adviser.
“Brokers" are non-fiduciaries and they are legally allowed to choose any title for themselves such as "adviser", "financial planner", "vice president", "investment consultant", "wealth manager" or any other title of their own choosing that gives the impression that they are trustworthy in selecting investments that are in your best interests. Never make the mistake of using a broker to help you buy, sell or hold securities. Brokers = Salesmen.
A CFP (Certified Financial Planner) credential says nothing about whether they are a fiduciary or not. Lots of CFP's are not fiduciaries. I encounter many CFP's who aggressively push annuities. That should tell you everything about that adviser's priorities because annuities (other than Vanguard) are commission-based products. CFP sometimes get disciplined. When it comes to selecting investments, by default NO certification should be relied upon as a seal of trust unless they are representing you in the capacity of a fee-only fiduciary.
Also never seek personalized investment advice from other non-fiduciary "advisers" such as insurance agents or bank employees. If you choose to seek help with investing or financial planning then the first line of defense is always to be certain that you are at all times working under written contract with a fee-ONLY fiduciary on a ONE-time consultation or ONE-task basis. This legally eliminates the potential for the most common conflicts of interest.
The non-fiduciary "Suitability Standard" that supposedly protects you by law is nothing short of a joke!
Never lose sight of the fact that non-fiduciaries are nothing more than salesmen. Brokers and other non-fiduciaries love to falsely put you at ease by telling you that the law requires them to only sell investments that are "suitable" for the client. Sounds like you're safe and secure right? Wrong!!! Unfortunately this "suitability standard" is a joke and will hardly protect you! The suitability standard is the problem! Licensed brokers are legally allowed to select investments for clients based on how much commission money they stand to earn or earn for their company. Accordingly expect your broker to sell you the very investments that you should be AVOIDING -- namely long term, illiquid investments with high fees, front end loads or back end loads, higher taxes, higher risk, etc. For example an actively managed mutual fund with no front-end load may seem like a sound investment until you compare the high fees with equivalent ETF's. If you insist on seeking financial advice from someone, then never let them broker the deal, process the paperwork, etc. That means only work with a fiduciary. After you pay for their advice, then you should process your investment transactions on your own via a deep discount brokerage firm. Discuss this with them up front.
Registered Investment Advisers VS Certified Financial Planners
Remember that certifications only tell you half of the story. Don't lose sight of the fact that the most important question is whether your adviiser is a fee-ONLY fiduciary or not. They must accept fiduciary duty to you in writing (via a signed contract), and provide you with copies of both parts of a "Form ADV", and a written disclosure of exactly how he will / may be compensated for his services and list any potential conflicts of interest.
The securities and exchange commission has this to say about the two certifications:
Q: What is the difference between an investment adviser and a financial planner?
A: Most financial planners are investment advisers, but not all investment advisers are financial planners. Some financial planners assess every aspect of your financial life—including saving, investments, insurance, taxes, retirement, and estate planning—and help you develop a detailed strategy or financial plan for meeting all your financial goals. Others call themselves financial planners, but they may only be able to recommend that you invest in a narrow range of products, and sometimes products that aren't securities.
STORY: There is a reason why in England it is now illegal for advisers to earn commissions off of the investment products they sell. Commissions = conflict of interest. Hopefully one day the United States will wake up and protect the fleecing of American investors that happens every day. Don't expect this to happen without a fight from insurance company lobbyists, full service brokerage firms and other special interests because they know full well that their entire business model (of fleecing investors) will suffer greatly if their advisers are not allowed to recommend inferior investment products that pay large commissions.
Beware of oddball investment products
When non-fiduciary "advisers" try to get their clients to buy annuities, limited partnerships, life settlement investments, pooled funds, house funds, non-traded REITs, or other oddball investment "products" that have "guarantees", "front end loads", "entry fees", "early withdrawal penalties", "early exit fees", "redemption fees" or "surrender fees", they are foaming at the mouth over the giant commission that they will earn. Instead of pitching a mix of stock and bond based ETF's, they push investments that benefit THEMSELVES or their firm!
It's usually when investors say "I have given up on the stock market" that they get themselves into trouble through riskier, expensive, under performing alternative investments sold by commission hungry brokers, insurance agents, bank employees and other self-serving salesmen, none of whom legally work for you. You should know that over long time periods of 10 to 15 years it is stocks that have historically been the best performing asset class. The best, most successful and most promising companies and investments are liquid and publicly traded (as stocks or as stock or bond ETF's) all sold for less than $10 per trade through any deep discount brokerage. In this day and age there is NO NEED to invest your money in illiquid oddball investments that you can't touch for a number of years. With over 6,500 listings traded on the stock exchanges there is absolutely no reason why an investor would need to look elsewhere.
Regardless of whether you do it yourself or work with an adviser, the only investment checks you write should always be paid to the order of your deep discount brokerage firm (such as E Trade, Scottrade, TD Ameritrade)!
Critical line of defense: If an investment is not sold through your deep discount brokerage firm then don't touch it! Never ever ever hand your investment money over to anyone else! This way no adviser can access, control or steal your money. It follows that you should never hand investment money to any investment planning firm or individual, financial consultant, money manager, retirement planner, estate planner, investment strategist, registered representative, adviser, proprietary offering, trust, insurance company, etc.
If you can't invest in it by placing an order through your deep discount brokerage then by default you ought to consider it inferior, riskier than disclosed, a scam or a high commission based investment product that a broker, insurance agent or bank employee is trying to sell you. Buying securities online is incredibly simple and easy, and by default you can only buy publicly traded investments. Deep discount brokerage firms only provide trading services while you do all of your decision making and investing yourself. I happen to use E Trade, but others include AmeriTrade and Scottrade. Deep discount brokerages do allow you to purchase mutual funds of all flavors, but after doing your own due dilligence, you will want to avoid "actively managed" mutual fund products in favor of "passively managed" funds which merely track indexes (also known as ETF's or index funds). "Passively managed" funds consistently outperform "actively managed" funds and have MUCH lower fees. Also beware that deep discount brokerages also allow you to purchase penny stocks, but after doing your own due dilligence and reading this article on Pump & Dump hopefully you will know to avoid those as well. Instead stick with broad market index funds (ETF's).
Placing an order to buy an index fund is very easy through deep discount brokerages like E Trade, AmeriTrade, or ScottTrade. And whether you buy a thousand dollars worth of shares or a hundred thousand, it's still just a $10 trade! Compare that with whatever Mr. Broker is trying to sell you! (WARNING: Be sure not to confuse "deep discount brokerage firms" with "full service brokerage firms" which have non-fiduciary "advisers" who by default should be regarded as nothing more than salesmen).
Don't trust ANYONE not just with, but involved with large amounts of your money!
PONZI SCHEMES and other FRAUDULENT SCEMES
All too often investors let their guard down for various reasons, such as when they do business with a company or person who is a friend or referred by a friend or family, someone with high profile clientele, someone nice, charming, charismatic, professional, religious, a philanthropist, well credentialed, well certified, long established, well dressed, young or old, famous, articulate, an eloquent speaker, high profile with fancy brochures and a nice website, someone well connected, or even low key and meek. These attributes mean nothing! Con artists usually fit some or most of these profiles. They're the people you would least expect to rip you off, give bad advice or dis serve you in any way. Ponzi schemes are not rare. Only the highest profile ones get news coverage. In realty Ponzi schemes are constantly being uncovered, and the typical victim of fraud is often affluent and college educated. Also it is not uncommon for advisers to unwittingly solicit Ponzi schemes to their clients. Even the very best intentioned investment advisors and firms sometimes know nothing about the investments they pitch beyond what they’re told by promoters! What good does that do you? Money does not grow on trees and it shouldn't be treated so loosely, yet we constantly hear new stories about everyday people losing big chunks or all of their life savings to some sort of investment fraud, con-artist, Ponzi scheme, bad investment, etc because they broke the most simple, basic rules of investing, that all began when they started working with a non-fiduciary (violating rule #1). Had these people simply followed either rule #2 (the 5% rule) or rule #4 (avoid investments that are not publicly traded) then these investors wouldn't be in such financial ruin!
CONFLICT OF INTEREST
EXPENSIVE, RISKIER, UNDERPERFORMING INVESTMENT PRODUCTS THAT PAY MR. BROKER BIG COMMISSIONS: There's more than just Ponzi schemes that you need to look out for. Investors are usually completely unaware that they have been victimized by conflict of interest. Investors are dis served every day and usually it isn't even illegal. Understand that non-fiduciary advisers earn large back door commissions even when they don't directly charge you any fees at all. Simply having their name listed on certain investment statements as your "agent", "rep" or "broker" can entitle them to commissions and "trailer fee" commissions without you ever knowing it. How can you trust ANY adviser to give advice in YOUR best interest when they earn a hefty 5 to 14% commission when they convince you to buy that annuity, limited partnership, or other inferior, expensive investment that has an early withdrawal penalty, but earn nothing extra when touting ETF's? "Actively managed" (professionally managed) mutual funds typically pay Mr Broker a 2 - 3% commission, even though unmanaged index fund ETF's consistently outperform the average professionally managed fund. Whenever you hear the words "front end load, "entry fee", "surrender fee", "exit fee", "redemption fee" or "early withdrawal penalty" attached to an investment, that's code for "your broker will earn a big sales commission if he can convince you to invest in it". Yet no investment adviser will ever explain to their client the many negative reasons why the securities they are pushing, such as actively managed mutual funds, annuities, are inferior investments because the commissions that they stand to earn are too irresistible. Typically these investment advisers push long term, non liquid investments on clients even though you should avoid putting your money in "prison". In fact SEC (Securities and Exchange Commission) laws actually allow brokers to select investments for their clients based on how much commission they get to earn for themselves as long as the investment is "suitable" for the investor. The problem is that the requirements for what is "suitable" is very low and hardly protects the public enough.
FROM BAD TO WORSE: CHURNING
Non-fiduciary advisers are always looking for justifications to call you to get you to buy new securities as often as possible because their income is dependent on making transactions. But at some point too much trading becomes illegal, even under the low "suitability standard". Churning occurs when a broker engages in excessive buying and selling of securities in a customer’s account chiefly to generate commissions that benefit the broker. Churning is against the law. What constitutes churning is a complex subject that an attorney should tackle, but one thing that can be said is that long-term investments like annuities and mutual funds are almost always not meant to be surrendered short-term.
TRUE OR FALSE: In order to earn higher returns you should invest your money in professionally managed or "actively managed" funds.
False. The statistical evidence is clear that unmanaged index funds (AKA ETF's or "passively managed" mutual funds) outperform "actively managed" funds. Ditto for those paid newsletters. These authors do no better than the broad market indexes.
Doing it yourself by investing in bond and stock ETF's
BUY EXCHANGE TRADED FUNDS (ETF's): Overshadowing all of the many pitfalls of investing is a little known fact that no non-fiduciary will ever tell you, and that is that the statistical evidence is clear that unmanaged index funds (example: the Total Stock Market index) outperform actively managed mutual funds. While hiring a fee-only fiduciary adviser for a one-time consultation is a good idea, you don't need to pay 1% to 2% per year to some "asset manager" to hold your hand year after year, nor do you need to lock your money up in "prison" in long-term investments that have front-end or back-end "loads", high management fees and high turnover ratio costs. There are super low cost ETF's for almost every investment strategy, aggressive or conservative. With low cost ETF's you can easily invest in bonds, various indexes (such as small cap, mid cap and large), industries, sectors, commodities, metals, countries, and currencies. Investing in index ETF's is as easy as opening an account with a deep discount brokerage firm and then placing a "buy" order for only about $10 per trade. And you can can sell an ETF at any time for about ten bucks, and without the early withdrawal penalties or just plain high fees that are often associated with annuities, limited partnerships, "actively managed" mutual funds, non-traded REIT's, etc. And ETF are generally taxed at the lower, more reasonable "capital gains" rate -- unlike some other investments such as annuities which are taxed as "ordinary income". For someone who doesn't have the time to manage their own money, ETF's are the smart choice. Hiring a fee-only fiduciary adviser for a one time consultation to select a portfolio based on your appetite for risk is advisable for most investors. Then you'll have the peace of mind in knowing that nobody can take advantage of you. Even Jim Cramer (MSNBC's Mad Money), who devotes about 99% of his show to discussions about individual stocks, has recommended ETF's to those who don't have the time to study stocks. Evidence suggests that we can take it a step further by saying that most investors who do study stocks and market trends would fare better by investing in ETF's than if they were to try to pick and trade stocks. According to John Bogle (of the Vanguard fund group) it is a mathematical certainty that over a lifetime you cannot beat the indexes with active management (example- actively managed mutual funds). Source: PBS
In this 5-year study (ending in June 2012) randomly selected 3-fund portfolios consisting of actively managed funds were compared versus a comparable index fund portfolio. The three funds were Intermediate-term municipal bond funds, large cap blend US stocks and large cap blend foreign stocks. A whopping 82% of the actively managed 3-fund portfolios were beaten by the comparable benchmark index fund portfolio. The average "actively managed" portfolio did 1.1% worse than the index fund portfolio. 1.1% might not seem like a lot but at that rate an investment of $100,000 would be worth $259,374 versus $234,573, or $24,800 less than the index fund portfolio after just 10 years! That's a difference of not 1.1% but about ten percent of your wealth! In other words fees matter! Avoid actively managed! See chart below.
"All the time and effort that people devote to picking the right fund, the hot hand, the great manager, have in most cases led to NO advantage.” -- Peter Lynch, legendary manager of the highly successful Fidelity Magellan mutual fund
"By periodically investing in an index fund the know-nothing investor can actually outperform most investment professionals." -- Warren Buffett
"The statistical evidence proving that stock index funds outperform between 80% and 90% of actively managed equity funds is so overwhelming that it takes enormously expensive advertising campaigns to obscure the truth from investors.” -- Peter Lynch
Another must read article: Avoid individual stocks. Buy ETF's.
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