All that glitters is gold. With gold back above $1,000 an ounce, everyone thinks that it is the investment you cannot miss. With the Government printing money faster than they can run the machine, inflation is almost a surety. However, there is another side of the story on gold. Humphrey O’Neil, a writer from the 30’s, had a famous quote, “When everyone thinks the same way, everyone is usually wrong.”

Put another way, when something is this obvious, it usually isn’t the right strategy. I think that there is a another side of the story to gold. I wanted to share something that Vitaliy N. Katsenelson wrote on Gold. It is an excellent article.

Five Reasons to Avoid the Gold Rush (updated)

1. For investors (not speculators) it is very hard to own gold, because you cannot attach a logical value to it. Unlike stocks or bonds, gold has no cash flow and has a negative cost of carry – it costs you money to hold it. It is only worth what people perceive it to be worth right now. The argument I commonly hear is, “What about all those Enron’s, Lehman’s, Citigroup’s, etc. that either went bankrupt or came close? What was the value of those?” If the lesson learned is not to own stocks but to own gold, it is the wrong lesson. The lesson should be: own companies you can analyze (the aforementioned companies were unable to be analyzed) and diversify – don’t put your all net worth into one stock.

2. The gold ETF SPDR Gold Shares (GLD) is the seventh largest holder of physical gold in the world. If its holders decide to sell (or are forced to sell; think of hedge-fund liquidations), who will they sell it to? This is extremely important, as the presence of GLD changes the dynamics of the gold price, both to the upside and downside. If gold keeps climbing, the ease of buying will drive gold prices higher than in GLD’s absence. In the event of a significant sell-off, there are not enough natural buyers of physical gold. It is a bit like a roach motel – easy to get in, hard to get out.

3. In the past, gold had a monopoly on the inflation and fear trade. Not anymore. Now you have competition from Treasury Inflation-Protected Securities (TIPS), currency ETFs, short US Treasury ETFs, government guaranteed/insured FDIC checking accounts, etc. TIPS suffer from the flaw of the CPI being measured and reported by the US government, which has an inherent bias to understate inflation; returns of commodity ETFs are skewed by price differentials between financial derivatives and spot prices of underlying commodities; returns of leveraged ETFs diverge significantly over the intermediate and long run from the underlying index; FDIC reserves are being depleted with the every-Friday-night bank bailout (but believe you me, the US government will not let FDIC go bankrupt, even if it means it has to raise taxes and impose draconian fees on the banking sector).

The bottom line is this: none of these investment vehicles are perfect. In fact many have significant flaws but despite their flaws they attract money away from gold, thus undermining gold’s monopoly on the fear/inflation/currency debasement trade. (I’ve discussed this in greater detail in my book).

4. If, because of points 2 or 3 above, gold fails to perform as expected, the perception of what gold is worth may change dramatically.

5. Over the last 200 years, gold was really not a good investment. It may have a day in the sun, but it may not. And the cost of being wrong is fairly high.

Though gold bugs make it sound as such, gold is not the only or the best alternative if the worst fears come to pass. The best way to deal with the risks of dollar devaluation and high inflation – with a much lower cost to being wrong – is, instead, to own stocks of companies that have pricing power of their product. When inflation hits, they will be able to raise prices and thus maintain their profitability. Also, companies that generate a large portion of their sales from outside the US will benefit from the declining dollar.

Gold bugs look at gold as a currency, but it is not one and unlikely to be one in our lifetime. Here is why: there is not enough of it around, so even if world government were to adopt a fractional system (currency in circulation as a multiple of gold reserves), they will never go for it, because central banks and governments will never give up their monetary tools – inflation is a very addictive tool to fight growing monetary obligations.

There is a wild card in the price of gold, though: China (John Burbank made that argument at the Value Investor Congress in Pasadena). If it decides to switch partially from owning US treasuries to owning gold, the price of gold will skyrocket.

Tags: bankrupt, Bob Brooks, Deceptive Money, FDIC, gold, Gold Rush, Government, inflation, Investment, Prudent Money, Treasury Inflation-Protected Securities

Financial writers love to vilify the mutual fund industry for the fees that are charged in mutual funds. Fees are an easy target. Who doesn’t like to get upset with the big company that is getting rich by charging excessive fees without delivering much in return?

The notion is that you should not invest in the managed mutual funds that have larger expense ratios. Instead, you should invest in mutual funds with as low expense ratios as possible. They argue that these fees add up over time which in turn lowers your over-all return.

By looking at expenses only you miss the forest for the trees.

You have to look at the expenses versus what you are getting for those expenses. In other words, is the money manager who is charging higher expenses providing you value for those higher expenses?

I will be mentioning two funds in this piece. However, please know that I am not in any way making a recommendation. These are for illustrative purposes only. The Yacktman Fund has an expense ratio of .99%. The Vanguard Wellington has an expense ratio of .27%. If you go by the notion that you always avoid higher expense funds then you would not invest in the Yacktman Fund.

However, between 12/1999 and 12/2008, the Yacktman fund has grown by 70% and the Vanguard Wellington Fund grew by 34.63%. Did the higher expense ratio hurt the Yacktman investor in any way?

The bottom line – It is prudent to pay attention to fees. However, the bottom line after fees is what makes the most difference and not the fee itself.

Tags: Bob Brooks, expense ratios, expenses, Fees, mutual fund industry, Prudent Money, Vanguard Wellington Fund, Yacktman Fund

A listener asks his follow up question: I thought this was something that was useful to share but it is a little long. I hope it is worth the read because you might be wondering the same thing. Here is part I.

Question: Okay, hypothetically speaking, I took my money, did my homework, invested in what appeared to be a sound investment, and lost it. I pay tithes cheerfully; I gave and continue to give alms, why would God allow me to lose or any Christian for that matter? We lose, we gain, we lose, we gain, some lose all, some gain much.

That’s the risk we take with investing and no matter your intent. At the end of the day our intent is to gain money by hoping that the company you’ve invested in is productive. Sounds like luck to me, just on a long term scale. But what if that company is involved in some illegal activity that we can’t see on the surface and they eventually get caught and the stock tanks?

I see the scriptures pointed out above (in original reply) but I can’t see them being clear as to whether investing money in a hope that is risky is wise. I think our investments should go toward sound Christian organizations/companies etc. I think Christians should involve ourselves with a barter system so we won’t have to invest in the potential “ponzi” scams of the world. Although God has His hand on our lives, I think He may draw the line at investing in stock. I’m not absolute in that idea, I’m just thinking of how the chance to lose money is always present and if the chance is always present (no matter how much homework we do about the investment), then would God really consider that wise?

I’m really looking for solid answers. What keeps me at odds is this past economical crisis we’ve entered. I lost a lot, but when the market leveled off, I gained it back and a little more. How can I be confident that investing in the market is wise, especially if the risks do not decline?

What would I have been able to do? I was close to retirement and took a loss like that. Would I have been able to say, “that was a wise investment”? Forgive my rambling. I tend to type what I think without organization. But I think I’ve expressed the gist of my dilemma.

Answer: Very well thought out. Let me unpack this and keep it on a broader scale. First of all, it is important to keep God involved in all of our investments. We don’t make an investment without God’s peace.

Second, investing is going to be the best way that you ultimately take care of the future of your family. Third, and here is the missing piece I think that affects all investors, you have to learn how to invest in a bear market. We know how to invest in bull markets. What about bear markets? There is something no one is teaching the masses.

There are principles to learn so that you can indentify risk and know when to get out of an investment just like you knew why you invested in an investment. In other words, you need to learn how to protect God’s money just like you studied to invest God’s money. Believe it or not, you can make money in a bear market. You just need to learn the principles behind doing so. Unfortunately, the financial services industry doesn’t want you to attempt to manage your money. They would rather you just buy and hold.

There is a lot to learn about investing to do it the right way. I have been investing and managing since 1992 and still learn everyday. You never figure everything out. You just keep learning. It takes hard work and discipline. However, anything that God asks of us takes hard work and discipline. It is funny. I was just telling someone that I really wanted to write a book on this very subject. I hope that it is my next book project.

When we get frustrated with anything in our lives, it just means there is more that God wants us to learn. Why would God allow you to lose or any Christian for that matter? That is just life. God allows life to happen, wants us to live having total dependence on Him, and doesn’t allow anything to happen that He thinks we cannot handle. God blesses you for being faithful and tithing. The only caveat is that it is His choice how He will bless us.

Tags: Bob Brooks, Deceptive Money, discipline, gambling, God, hard work, Investing, money, Prudent Money, risk

Q:
I’m sure this has been asked of you before, but I wanted to know what Biblical rationale can I use to invest in the stock market? I was just thinking this morning about my 403(b) plan and how it is very aggressive with stock. Stocks are risky and that means taking a gamble. How is investing in the stock market any different from going to Vegas and gambling?

A:
I think that stock market investing done the wrong way could be the same as gambling. As managers of what God has given us, He has charged us with the responsibility to be prudent when it comes to what He has given us and what He still owns.

Let’s start off by looking at the definitions of gambling and risk and then see how they are two different things.

Gambling, according to Wikipedia, is the wagering of money or something of material value on an event with an uncertain outcome with the primary intent of winning additional money and/or material goods. Typically, the outcome of the wager is evident within a short period.

Risk can be defined as the probability that an action or event will negatively or positively affect a person’s financial goal. When you take risk, there is either a high or a low probability that you will make or lose money.

When you gamble with God’s money, you are taking high risk because in most cases you put yourself in a situation where the probability is high that you will lose it all. More importantly, we have to look at why we gamble in the first place. We gamble because of greed. We want to get as much as possible for doing as little or nothing in a short amount of time. The Bible doesn’t specifically address gambling. However, Christ warns us about the chief reason we gamble which is greed. “Beware and be on your guard against every form of greed” Luke 12:15.

So, you have to look at why you are investing. If your motivation is to make as much money as quickly as possible and you are willing to use God’s money to do so, you have to stop and check your motivation. Is this about greed (earning something for nothing in a short-time period with the potential to lose it all) or is this about taking care of future financial goals for you and your family (1 Timothy 5:8).

It is all about how you approach risk when it comes to investing. Remember, we take risk because we want to make our money work harder for us. At the same time, we have to be prudent about taking risk. If we had all of the money in the world, you would not need to take risk. You could have the luxury of putting your money in riskless investments. If you are going to take risk, you can gamble or approach it like a prudent steward and understand, learn to invest and manage for risk.

Tags: Bob Brooks, Deceptive Money, gambling, God, Investing, Prudent Money, risk, stock, Stock Market

Three Misconceptions about Working with an Advisor

Misconception #1: “My Advisor has the answer and it always works.”

If there is a magic solution that works 100% of the time, I would love to know it. By knowing this magic solution, I can reduce my workload tremendously and assure that all my clients reach their goals 100% of the time.

Run for the hills when you come across someone that states they have the answer or have it figured out. If that person has the answer, demand to see how that strategy worked 100% of the time in all circumstances. Financial services marketing is notorious for this type of message.

Use the “too good to be true” test. It usually works.

Misconception #2:”My Advisor is managing my money.”

There are two main components to the investment process. First, you invest money. Second, you manage the investments for changes in the stock market, economy and mainly for risk.

Unfortunately, most advisors stop after the first step. In my book, that is where the advisor should start. The traditional commission based financial services industry is not a business that encourages investment advisors to manage money. Truth be told, the industry doesn’t want advisors trying anything other than a buy and hold strategy.

Think about it for a second. Commission sales are always about closing deals. Money management takes time. If an advisor was managing money, when would they have time to close deals? After all, advisors need to make a living and sales managers have quotas.

The client assumes that the money is being looked after and managed. Unfortunately, in most cases that is not the case.

I can attest to the fact that the traditional buy and hold investing, does not allow an advisor to effectively manage money. This was one of the primary reasons I went independent and away from the industry.

Misconception #3: “My Advisor is qualified to Handle My Needs.”

There is a big difference between a good sales person and a competent financial advisor. Anyone can be trained to say the right things and appear competent. In fact, I have argued that some of the biggest money managers on Wall Street probably don’t truly understand how markets work.

It takes a lot of time and dedication to be effective. Unfortunately, the sales people greatly outweigh those who are qualified to be advisors.

Degrees and certifications don’t always mean that someone is qualified. It really depends on the area of expertise. I have had many clients come to me with big financial messes that were created by very educated and certified individuals.

Take your time when choosing an advisor. Make sure they are qualified by checking references and checking performance and track records. If an advisor sounds like they are reading script when answering questions, head for the door. Someone who is qualified to be a sales person and setting sales records might not be the one you want making recommendations for one of the more important areas in your life.

Tags: Advisor, Bob Brooks, Buy and Hold, commission, Deceptive Money, financial services marketing, managing money, Misconceptions, Prudent Money, Wall Street

A key to being a successful investor is the ability to tell the difference between the marketing and reality. Investors make the biggest mistakes when they make a decision based on the marketing pitch.

You have probably heard the pitch made by insurance companies on equity indexed annuities. They claim that you will get to participate in market gains while the market goes up and never lose any money when the market goes down. You can get a great return without taking risk. Basically, it is an insurance product that is marketed like an investment program. Due to this irresponsible marketing, the federal regulators are cracking down on this industry. The insurance industry says that equity indexed annuities are not investments. However, the federal regulators say that it is an investment contract and should be regulated like one.

Many of the marketing pitches for these guaranteed investments have several elements that make them irresponsible.

First, the marketing is full of big claims with little details that intentionally attempt to create an impression that is not altogether true but isn’t necessarily a lie. It is just a marketing message that intentionally and conveniently leaves out the details.

Second, the marketing pitch creates the illusion that there is no risk and no downside in the investment. Remember, there is always risk of some kind when investing money.

Third, these marketing pitches use a play on numbers. You can take a set of numbers and make them say anything.

On paper, these equity indexed annuities will perform as advertized. In other words, you will see your account value go up with the market and stay steady when the market falls. So the illusion plays out for a long time. Unfortunately, reality will surface down the road. When you are ready to take the money out, you will realize that you are taking the money out on the terms of the insurance company and not on your terms. Thus, that great marketing pitch doesn’t seem so great anymore.

Tags: Bob Brooks, Deceptive Money, equity indexed annuities, insurance companies, investments, investor, irresponsible marketing, marketing, Prudent Money

I cannot tell you how many times I come across this question. There is a lot to be dissatisfied with today when it comes to the investment process. You would think that it comes down to investment loss. However, in meeting with a great deal of dissatisfied people (which is why they end up in my office), I have found that the number one reason investors are not happy is because of a lack of communication.

When I say communication, I am referring to many different aspects. First, there is the ability to communicate with the advisor and be treated with respect. I often hear stories of how the client is talked down to or their concerns are quickly dismissed rather than addressed. Second, there is no written or verbal communication. Basically, the client has no idea what is happening with the investments.

Is the financial advisor really doing their job? You are not going to like the answer to this question one bit. Yes, in most cases, they are doing their job.

A month ago, I wrote a piece on the how the different types of advisors work. I received a great deal of feedback about that piece. So, I thought I would revisit the topic. It is important for investors to understand what truly to expect.

Registered Representative

Most financial advisors are registered representatives of a broker dealer. The majority work on a commission basis. It is important to understand what is required of registered representatives. The Financial Industry Regulatory Authority (FINRA) states that registered representatives are required to recommend that which is “suitable” for clients. However, FINRA doesn’t require that a registered representative do that which is in the best interest of the client. If it is not in the client’s best interest, whose best interest is it in?

They are not required to call you. They are not required to manage money. In fact, truth be told, broker dealers don’t want their registered reps trying to manage money.

Registered Investment Advisor

A Registered Investment Advisor (RIA) takes the roll of a fiduciary which is held to a higher standard. An RIA must act in the best interest of the client. The RIA must keep the client informed. RIA’s are fee based. If an RIA is doing their job, their clients should get a hands-on approach and a step up from being sold a set of investments.

For me, suitability is only one part of the initial investment process. As long as the investment portfolio is suitable, the Registered Representative has done their job. The role of a fiduciary never stops.

The Problem with Assumptions.
When a client meets with an advisor about investing, there are many assumptions made.

• The advisor is going to watch my investments and recommend changes along the way
• The advisor is going to stay in touch
• The advisor is taking care of everything so that I don’t have to

The Bottom Line of Working with an Advisor

The best advice I can give anyone who is in search of an advisor is to not assume and ask the tough questions. Know for a fact exactly what an advisor is going to do for you. Ask many different ways. If there is any hesitation, then continue looking. There are good and bad in both categories of advisors.

A good advisor can tell you how they manage money, about their systems, and how they handle all situations. Most importantly, they can set your expectations on communications. If an advisor’s example of an investment strategy is buying and holding, make sure that you are very comfortable with the advisor doing nothing.

Tags: Bob Brooks, broker dealer, Deceptive Money, financial advisor, FINRA, Investing, investment portfolio, investors, Prudent Money, Registered Investment Advisor, registered representatives

New Stock Market Alert : Summer Time Blues

New Debt Tip : Prudent Mortgage Refinancing Isn’t About Getting a Lower Payment

I had the opportunity to go on vacation last week. My family and I went to Red River, New Mexico. I guess this was good for me. There was no internet where we were staying. The satellite went in and out not giving me much access to news. My iPhone would work only when we were in town. So, for the first time in as long as I can remember, I was literally out of touch with the crazy world of markets.

It gave me some time to think through what was happening in the economy and stock markets without the constant interruption of market news. There are so many various risks that you could consider right now. In thinking through it, there is one risk that should be followed by an explanation point. In fact, it is one risk that I think will ultimately be a real problem for the stock market.

Allow me to take you through my thought process. We invest money in order to make it grow so that we can use it for specific financial goals down the road. Unfortunately, things aren’t always rosy when it comes to the wonderful world of investing. There are periods of time when you can lose a lot of money. So, you have two choices. First, you can just buy and hold and HOPE that everything works out well in the end. I adamantly disagree with the financial services industry that you just hold tight and take the losses during those times. Second, you can be more proactive and reduce risk (reducing how much money is invested in any type of stocks or stock funds – for further explanation see below) and reduce the potential for losing money.

Today, it is tough to consider reducing risk in the investments. If you listen to politicians and Wall Street, the worst is behind us. Thus, it would be crazy to reduce your risk now. Then you start thinking of all of the craziness that is occurring. I think you would agree that it is risky out there but to what extent?

This is what every 401(k) participant and anyone invested in stock needs to know about risk. For me, there are many known and unknown situations today that create risk for investors. However, there is one that is easy to explain and one that I feel will ultimately spell a great deal of trouble for those who are not proactive. It comes down to what I would now refer to as the unemployment crisis.

Think through this cycle with me. For the stock market to be positive, we need a positive economic outlook. For a positive economy, we need consumers to spend money. For consumers to spend money, there needs to be plenty of jobs. Unfortunately, the unemployment situation gets bleaker as the months go by.

Before I write about it, let me make sure that I debunk a few counter-arguments. First, Wall Street will tell you that you are looking at the past when looking at the unemployment report and that things could already be getting better. Unfortunately, we look at unemployment numbers on a weekly basis and those are real time. Those look just as bad. Second, Wall Street will tell you that things always look bad before they get better. When there are no real solutions, unemployment can get much worse.

The latest unemployment report showed 467,000 jobs were lost. That was after the Government “estimated” 185,000 jobs were created (for an explanation of how these estimates work, read this report). If you didn’t count that “estimate”, we would look at a loss of 652,000 jobs for just last month. Since the beginning of the year, the Government has “estimated” over 500,000 jobs that were created out of thin air. Out of those 523,000 “estimated” jobs that were created, 56% of those jobs were “estimated” to be created in the…Leisure and Hospitality Sector. Of course, you could see where the Government would assume that sector is hot. After all, think of all of the money that Americans are spending in the Leisure and Hospitality Sector during the greatest recession since the Great Depression (please note the sarcasm).

The “stated” unemployment rate of 9.5% is the highest in 26 years. The Department of Labor has another employment rate that they follow, which adds back into the total, the workers who fall out of the system. That rate is 16.5%. Shadow Stats, which is a company that takes economic data and calculates the real numbers, shows an unemployment rate of close to 21%.

President Obama reassures everyone that this problem is getting fixed. He claims that many of these “infrastructure” projects are about to be started. In other words, he is about to create a handful of jobs to work on infrastructure projects. This is far from a fix for unemployment.

So this remains a major risk for the stock market and why I will continue to suggest that investors consider the risk that they are taking. Yes, the market could start to look better and could start making money for a period of time. However, any gains are going to be tough to sustain with this unemployment crisis hanging over our heads.

Note: You manage for risk two ways. First, you reduce your exposure to stocks and stock based funds. This is a very general strategy for reducing risk. Second, you can also have someone manage your money for risk.

Tags: 401(k), Bob Brooks, Deceptive Money, Department of Labor, economic data, economy, financial goals, financial services industry, Givernment, internew, Investing, jobs, news, politicians, President Obama, Prudent Money, risks, Shadow stats, stock funds, stock markets, stocks, unemployment crisis, unemployment report, vacation, Wall Street

New Debt Tip!

I had a client send me an analysis of her 401(k) plan from a system called Financial Engines.  This is a software program that Fidelity uses with their 401(k) plans to help participants determine if they are taking the right amount of risk.

My client is one year away from retiring.  She plugged the information into the system. The analysis was as follows:

How are you doing?  – Your Investment Risk

Your risk level is appropriate for an investor with one year until retirement. 

How we can help?

Not sure how to maintain a degree of investment risk that makes sense for you?  We can help.  See details on the following pages.

Then on the following page they give her a brand new portfolio that they recommend she use.  They compare the current allocation to a suggested allocation.  Now keep in mind, I allocated this for her a while back and she only has 15% of the entire portfolio in stocks. 

The suggested allocation increases her stock exposure from 15% to 76%!! YIKES!!!!  No one that is one year from retirement should have that high of an exposure to risk.  It is quite unbelievable.  The reality is that these software programs are out of touch with what is occurring today.  They are programmed as if we are always in a bull market.

The unfortunate thing is that people are using this service and taking the recommendations.  You never want to get any advice from a software system.  Risk should be assessed for you by someone that knows what they are doing.  Incidentally, that would not include salespeople.

Tags: 401(k), Bob Brooks, bull market, Deceptive Money, Fidelity, Financial Engines, investment risk, investor, portfolio, Prudent Money

John Bogle, founder of Vanguard Mutual Fund Company, says that market timing never works.  Of course, any executive of a mutual fund company does not want investors moving money around.  Besides his obvious bias, I don’t think that he is entirely correct stating an absolute.

Market timing is a misunderstood concept when it comes to investing.  The mutual fund industry defines market timing as a process of attempting to perfectly time the tops of markets (before a market declines) and perfectly time the bottom of stock market declines (before the stock market goes up).

In other words, an investor is trying to sell at the perfect time and buy at the perfect time.  The mutual fund industry doesn’t want you to time the market.  Thus, they came up with a perfect example of why market timing is a disastrous strategy.  

The basis of their argument is that if you try to time the market you might miss the best days of the month or year.  If you miss those days when the market has big gains, then your overall investment return will really suffer.  So they publish these studies.

Barron’s Magazine published an article that showed what an investor would have made if invested in the S&P 500 index from February 1966 through October 2001.  During that 36-year period, an initial investment of $1,000 would be worth $11,710.  

A study done by Birinyi Associates performed a complement study to the one in Barron’s.  They stated that if an investor missed the five best days every calendar year, the $1,000 would have shrunk to $150.

That is pretty convincing.  An average investor would look at that statistic and conclude that market timing is a horrible strategy.  Why would you want to try and pick when to be in the stock market and when to be out of the stock market?  If you just missed a few good days, you might miss the entire opportunity.  

I ran my own study.  I wanted to know what would happen if you missed the worst months to be in the stock market.  I took a look at the S&P 500 between January 1950 and December 2007.

If you invested $10,000 January 1950, it would have grown to $869,120 by December 2007.  

If you missed the 30 best months, that $11,000 would have turned into $284,167.  If you would have just stayed invested and not tried market timing, your $10,000 would have turned into $3,069,325. Instead, you tried to market time and ended up with only $35,404.

What if you would have missed the 30 worst months between January 1950 and December 2007?  

If you missed the 30 worst months, your $1,000 would have turned into $9,509,094.  

Which do you think is more important?  Being in there for the gains or protecting yourself in the bad markets?

This isn’t about market timing and trying to pick tops and bottoms of the market.  This is about protecting your investments when stock market risk gets high.  Remember you reduce risk as you reduce the amount of money invested in stocks.  

When you experience excessive losses, it just takes so much time to gain back the loss.

If you were to lose -40%, it would require a return of 67% just to get back to even again.  It would take a long time to achieve that return.  This is why risk matters and having a risk strategy is extremely important.

Now obviously neither you or I are going to be able to look into the future and pick good and bad days in the market.  This is just to illustrate the impact of loss on a portfolio.  This is primarily directed towards investors who stay heavily invested in stocks.  At some point you have to start taking profits and get your portfolio balanced and properly diversified.  The problem is that most people are not properly diversified.

If you’re concerned about your investments, you can email me through AskBob.

When a client sits down with an investment advisor, there is a lot of assuming that occurs.  Investment clients assume that they are getting advice.  They assume that their money is being watched.  They assume that the advisor is taking their best interests at heart.  It is important to understand how the investment business is set-up and to make sure you are making the right assumptions.

So here are the two questions you need to explore.

(1)       Is your financial professional just selling you investment products, giving you appropriate advice, and/or watching your investments? 

(2)      Behind the title financial consultant, financial advisor, or financial planner, what is your financial professional LICENSED and REQUIRED to do as your advisor?

It comes down to whether the financial professional is a Registered Representative or a Registered Investment Advisor.  Forget about the title that the financial professional uses in the introduction.  How are they licensed?

A buddy of mine sent me an e-mail that I thought really cleared up the big difference.  Let’s take a look at the difference between the two.

Registered Investment Advisers, who are regulated by states or the SEC depending on the amount of investments they manage, are legally required to act in their clients’ best interest.  They work on a fee basis when working as a Registered Investment Advisor

Registered Representatives, who are regulated by the Financial Industry Regulatory Authority, can give “incidental advice” in the course of their business and recommend what is suitable, but not necessarily best, for clients.  They work on a commission basis.

Out of the two types of licenses, only Registered Investment Advisors are LEGALLY required to act in their clients’ best interest.  Here lies the problem with the business of investing.  A Registered Representative determines if a product is suitable or is appropriate for the client.  Beyond that, the investment that is being recommended does not have to be the best fit for the client.

Wouldn’t you want to know that your financial advisor was giving the very best investment recommendation available? 

Unfortunately, it is tough when commissions are involved.  Registered Representatives only recommend what they can sell or the products that their company is licensed to sell.  In that type of environment, those products might be suitable for the client.  However, those products don’t represent the best strategy for the client.  The advisor did their job and the client only received what was suitable. 

Buy and hold investing is at the center of the Registered Representative world.  Investment management is at the center of the Registered Investment Advisor world.    

Would you rather have an investment plan that is sold to you because it was suitable or an investment strategy that is constantly managed with the objective of being the very best strategy at all times? 

The Registered Investment Advisor is either earning the fee or not.  With a commission based Registered Representative, they aren’t earning a fee to work for you.  That commission was already paid at the beginning.  In most cases, there is no ongoing management involved.        

Tags: Bob Brooks, Deceptive Money, financial advisor, investment advisor, licensed, Prudent Money, Registered Investment Advisor, Registered Representative

There was an interesting article in the Dallas Morning News entitled, Rotten to the Core – Our reliance on a bad 401(k) system may be ruining our retirements from the inside out.  I found this article very interesting from the standpoint that I don’t disagree with the thesis. However, I do disagree with what is making 401(k) plans the problem today.  The article starts with a quote from the King of the Mutual Fund world John Bogle.  Mr. Bogle started Vanguard Mutual Fund Company and is one of the biggest advocates of buy and hold investing.

“Our nation’s system of retirement security is imperiled, headed for a serious train wreck.  That wreck is not merely waiting to happen; we are running on a dangerous track that is leading directly to a serious crash that will disable major parts of our retirement system.”    –John Bogle, Feb. 24, 2009

I don’t disagree.  Leaving retirement up to Americans to handle for themselves has been disastrous.  Most people are ill-prepared for retirement today.  During the good ol’ days, the pension plan was there to bail (for lack of a better word) people out at retirement. John Bogle is calling for people to put their money in annuity type investments to make sure that they don’t out live their retirement.  Of course, he wants America to go back to the old pension system.  The problem is that what is left of today’s pension system is in just as much trouble.

I think that we are a nation of investors that are not ready for retirement and a good majority will outlive their savings.  However, I don’t think that the answer is going into annuities or relying on pensions to take care of retirement because we as individuals are incapable of making our own decisions.  I truly think that it comes down to the paradox of what Mr. Bogle thinks works in these retirement accounts.  He preaches buy and hold is the only way to invest for the long-term.  Buy and hold and all of the philosophies that are taught by the financial services industry are the problem. They are taught as if they are absolutes.  An absolute is something that always works.  That couldn’t be further from the truth.  As the last 10 years has proven, buy and hold doesn’t always work.

People need to be taught how to manage their own 401(k) plans for risk.  They need to be taught some simple portfolio management techniques that keep them out of harms way.  They need to be taught that market timing is not evil and can work.  Does it work all of the time?  No, nor does buy and hold.   The mutual fund industry will tell you that if you try to market time and miss the best 5 days, you will drastically reduce your return.  However, they don’t show the dramatic difference in return when you miss the worst days.  The big bear markets are the problem.

It isn’t the system that is broken, Mr. Bogle.  It is the beliefs that we are using to implement the system that are taught as absolutes by the mutual fund industry.

Tags: 401(k), annuity, Bob Brooks, buy and hold investing, Dallas Morning NEws, Deceptive Money, investments, John Bogle, Mutual Fund, mutual fund industry, pension system, Prudent Money, retirement, risk, Vanguard Mutual Fund

John Bogle is on the war path defending what he has hailed as the only philosophy to follow when it comes to investing.  He unequivocally states that buy and hold investing is the only way to go.    

John Bogle, who just turned 80 years old, is considered an authority on investing.  He founded Vanguard Mutual Funds and has preached from the pulpit of Buy and Hold for decades.  Of course, this is also the guy who told an audience on CNBC last fall to just ignore all of the “noise.”  As any founder of any mutual fund company will tell you, it makes no sense to try to do anything other than buy and hold.  

I think that absolutes such as buy and hold always work are extremely dangerous when thinking about investments.  If there was an investment strategy that always worked, then all of this would be easy.  That is just not the case.  Buy and hold doesn’t always work.  

However, this is what the mutual fund industry preaches.  So, the investor stays invested no matter what, when the reality is that buy and hold hasn’t worked and the probabilities remain high that will be the case for time to come.  

Let’s take a very conservative buy and hold approach to investing over the past 10 years.  If you took 80% and invested it into the Vanguard Total Bond Market index and then 20% into the Vanguard S&P 500 Index Fund, you would have had an average return of 4.4%.  (12/31/1998 to 12/31/2008)  This takes into account annually rebalancing back to the 20/80 mix.  This would be an appropriate mix for an investor who is retired.  The problem is that with inflation and a withdrawal rate of 5% this would be bad news for an investor only making 4.4% a year.  

Ask anyone who is retired if they could really make it on 4.4%?  Once again, this is a very conservative approach to buy and hold investing.  

Here is the problem with the philosophies of buy and hold or invest for the long-term.  

Yes, buy and hold works in some situations and some it does not.  If you retired at the beginning of 1982, you would have been in the greatest situation ever. You would have retired during the start of the greatest bull market we have been through in this country.  If you would have retired December 1999, you would be in a world of trouble.  It is all about the timing and when you need the money.  If you are much younger and grow up on buy and hold, you will also face that moment where you need the money and buy and hold might not work.  If buy and hold is all you know, then chances are you will not try anything different.

This is why it pays to have a system that manages these investments which is counter to buy and hold.  That system involves market timing.  John Bogle would tell you that market timing is a losing game.  Yes, market timing doesn’t work all of the time.  However, it does work and if you can miss the worst of times in the market you have a much higher probability of being successful.  Remember nothing works all of the time.  However, a system that will protect you when risk is high is invaluable.

At Prudent Money Financial Services, I have used an active management model that I call the Prudent Money Management Model.  Through the use of modeling and risk management, we were able to secure a 2008 return of 12.22%.  I only put that in print to let you know that there are systems that work and you don’t have to be the victim of buy and hold investing when the strategy just doesn’t work anymore.  

Investing in the Prudent Money Management Model involves certain risks, including in all or some cases leverage, liquidity concentration, non-diversification, market, and investment technique.  Moreover, there is no guarantee that the Prudent Money Management Model will achieve a positive outcome.  These risks can increase volatility and decrease performance.

The Prudent Money Management Model is not a mutual fund nor is it a fund of funds strategy as defined by the SEC.  It is an investment strategy.

It is important to note that the Prudent Money Management Model may or may not be suitable for all investors. 

Past performance does not guarantee future results.  The performance data quoted represents past performance and current returns may be lower or higher.  The investment return and net asset value will fluctuate so that an investor’s account, when redeemed may be worth more or less than the original cost.

Tags: active management model, Bob Brooks, bull market, buy and hold investing, Deceptive Money, inflation, investment strategy, John Bogle, market, mutual fund company, Prudent Money, Prudent Money Financial Services, Prudent Money Management Model, rate, retires, risk, risk management, Strategy, Vanguard Mutual funds

Over the weekend, I received an e-mail from a listener in Japan.  He listens to Prudent Money via the daily podcasts.  He was asking me about an investment trading strategy that he had some success using.  He asked me if it were a zero sum game if he was making money while everyone else lost. 

My answer to him was that whenever someone loses money, there is someone who makes money.  When the market was going down last year, there was someone making money.  With any investment trade, you have a winner and a loser.  You just need to have a strategy.  What most investors think of as a strategy might really end up being a disaster.  This listener has gone out and learned an investment strategy.  Buying and holding and doing nothing is a strategy.  However, it is not a good one considering this particular environment.

When I speak of this particular environment, I am talking about the new environment which is a permanent change.  I truly believe that we will never go back to the old days (pre-2008) when it comes to investing.  If I am correct in my thinking, those who do not adapt to this new environment could be in for some real heartache.

Well, consider the environment and tell me how this enormous amount of debt is going to go away and things get back to normal.  Also consider that the Federal Government seems to be set on continuing to add to the debt on a daily basis with more and more government spending.  The following excerpt is from Michael Panzner’s blog Financial Armageddon.

Even under the best of economic circumstances, tax season is a tense time for American households. The number of hours we collectively spend working on our returns is probably a lot more than government agencies claim.

The burden in financial terms is even greater: A recent independent survey found that the average American’s total federal, state and local tax bill roughly equals his or her entire earnings from January 1 up until right before tax day.

Now imagine that tax bill doubling over time.

In recent years, the federal government has spent more money than it takes in at an increasing rate. Total federal debt almost doubled during President George W. Bush’s administration and, as much as we needed some stimulus spending to boost the economy, the nonpartisan Congressional Budget Office now estimates total debt levels could almost double again over the next eight years based on the budget recently outlined by President Obama.

Regardless of what politicians tell you, any additional accumulations of debt are, absent dramatic reductions in the size and role of government, basically deferred tax increases. Remember the old saw? “You can pay me now or you can pay me later, with interest.”

To help put things in perspective, the Peterson Foundation calculated the federal government accumulated $56.4 trillion in total liabilities and unfunded promises for Medicare and Social Security as of September 30, 2008. The numbers used to calculate this figure come directly from the audited financial statements of the U.S. government.

If $56.4 trillion in financial commitments is too big a number to digest, think of it as $483,000 per American household, or $184,000 for every man, woman and child in the country.

So, this is the environment that we are dealt and it is full of risk.  Investors need to learn a strategy or have someone manage money that understands the concept of strategy and investing versus buying and holding.

I read a very disturbing article today.  The Wall Street Journal reports that some 401(k) plans are not allowing participants to withdraw their own money.  Think about it for a second.  If you have been laid off and you find yourself in need of money, obviously the 401(k) plan is not the best place to go.  However, in time of financial crisis, you take whatever steps you have to.  So, you go to your plan to take out money and they will not let you have your own money.

If you think that you might get laid off or are concerned that this trend is occurring, you might consider the following precautions.

·        Many investors have gone to these stable value funds inside their 401(k) plans as a safe haven against loss.  They are conservative investments.  However, they have been one of the funds that have been restrictive.  So, you might want to consider a money market inside of the 401(k) plan instead. 

·        Real Estate Funds were highlighted in the article.  Since REITS can be investing in commercial buildings, they might run into a problem since the debt and credit crisis has spread to the commercial properties.  Thus, you might want to consider limiting your exposure to REITS right now.

·        If you think that there is a chance you might need to get into that money, leaving a percentage in cash is not a bad idea.  It is better to be safe than sorry.

·        Finally, the number one rule of thumb is to always move your money away from a 401(k) plan as soon as you leave your job.  Regardless of the situation, it is prudent to set up an IRA and transfer an old 401(k) plan the minute you have the ability to do so.

Obviously, any changes with a 401(k) plan need to be congruent with your goals and objectives.

Tags: 401(k), Bob Brooks, credit crisis, Deceptive Money, financial crisis, goals, investors, money, money market, objectives, Prudent Money, Real Estate Funds, REITS, trend, Wall Street Journal