How About A Warning Label For Investors?

How About A Warning Label For Investors?

By: Brendan Magee

Everywhere you look there are warning labels that make consumers aware of threats. They are designed to help people avoid activities that through research have proven to be detrimental to their well being. The Surgeon General’s warning is on all tobacco ads and packaging. Drug companies are required to detail the possible side effects in taking their medications. Toy companies have to let you know if a toy is appropriate for the age of your child. I am curious why investors aren't given the same consideration?

I had this thought when I was sent an offer to receive a brokerage company’s free brochure. This company touts their 20 year track record of dealing with high net worth individuals (portfolios of $500,000 and up). They’re also very proud of their transparent fee structure and how that puts them on the same side of the table as their clients. They offered me their free Stock Market Outlook report which would include their views on:

-How the elections would impact the market

-What third quarter results could mean for fourth quarter returns

-How investor sentiment may impact the market

-Which economic issues I should most be concerned about

That and much, much more would be contained in this free report.

Within these proposed  benefits,  and in the thousands of pitches investors receive every day is where I say  investors should receive the same consideration as smokers and people who take prescription medications. The average person works hard to earn a living, pay their taxes, educate their children, build a little savings, and then provide for their retirement.  Certainly the public’s welfare is put to risk when investors are goaded into investing their money for retirement and their children’s educations via wasteful strategies.

  In the Prudent Investor Rule  there is as strong a warning label as can be written. Bargain shopping in an effort to identify winners and exclude losers through forecasting of performance is simply deemed wasteful. The Prudent Investor Rule was written back in 1990 and is based on the Nobel Prize winning research of the University of Chicago’s Harry Markowitz. His research became known as Modern Portfolio Theory and is believed to be as groundbreaking as Sir Isaac Newton’s theories on gravity. The Prudent Investor Rule is the basis for the laws that prevail over money that is invested in trusts and retirement plans.

The benefits of the report are entirely rooted in forecasting and speculation. The words that are used, would, may, should, and could are all in use and pertain to how the market will perform in the future. Could you imagine if this brokerage house had to put below their claims, the Chairman of the Security and Exchange’s warning, Bargain shopping in an effort to identify winners and exclude losers through forecasting of performance is deemed wasteful.  Certainly they would lose a lot of their credibility, and many investors in seeing the warning would avoid investing that involved forecasting and speculation.

This forecasting of returns extends to what people would consider conservative investments as well and has had a tremendous negative impact. In 2009 the Dalbar Corporation published a report documenting the annualized rates of return for the average mutual fund investor  from the year 1991 through 2008. Mutual fund investors achieved a dismal 1.77% annualized rate of return in that time. They didn’t even keep pace with inflation for that time period. How many funds don’t lure investors to their funds without the use of track records?  Aren’t investors led to believe that the ones with the best five, ten, and twenty year track records are going to be the winners in the future?

So here’s the crux of the situation. If you choose to smoke cigarettes in spite of the warning labels and your health suffers as a result, there’s no one to hold accountable but yourself. If you choose to buy a toy for your child that warns that toy is for children age 10 and your two year old is injured playing with that toy the responsibility is the parents. People can’t be responsible for things until they’re made aware of them. I think if investors were given the benefit of a warning label it would go a long way towards helping investors become more responsible for themselves and avoid destructive strategies.

Brendan Magee is the founder and president of Inevitable Wealth Coaching. Should you have a question, comment, or suggestion for a future article call 610-446-4322 or send an e-mail to Brendan@coachgee.com.

Investing Facts You Should Know-

But Chances Are You Don’t

                                By: Brendan Magee, Dec. 2010

More times than I can count, I often read or hear statements made about the stock market and investing, and as time eventually proves those statements telling us the way things are,  prove to be not the way things are. I read an article written in the New York Times by securities fraud attorney and author Dan Solin. The article is entitled, Ten Things You Should Know About investing-But Probably Don’t, and it is a good example of statements or widely held views about investing that are proven to be untrue.

The first, is a statement I have heard countless times over the past decade, “This has been the lost decade for stocks.” The basis of such a statement is the S&P 500, and yes if we focused on the impact of the bear markets of 2000 to 2002 and 2008 looking solely at U.S. Large Co. stocks that statement appears to be true. It’s not true if we look at a portfolio made up of 60% stocks and 40% bonds which is the allocation of most defined benefit pension funds. That portfolio mix over the last decade did an annualized six percent. A portfolio of 100% stocks globally diversified over the past decade had an annualized rate of return of eight percent. Both of these portfolios produced returns high enough to outpace the rising cost of living and were a lot more satisfying than C.D.’s or money market funds.

Now these portfolios might not be the right mix for everyone, but why someone would make a statement using only the S&P 500 as the basis to make a statement about all stock s is hard to fathom. My question is what about all those investors who believed in such statements, saw their investment balances go down, then  pulled their money out of equities all together, and made the impact of their losses permanent? Where do they go for restitution? The person who made that statement is long gone.

Another absolute statement is: “Great Companies Make Great Investments.” Bear Stearns, General Motors, Lehman Brothers, IGA. The list could go on forever of companies believed to be great, but if you had a significant amount of money in them recently you unfortunately know that great doesn’t mean infallible.

What also doesn’t get conveyed to investors is that owning these great companies on an individual basis means the investor has assumed two to three times more risk than if they owned them in an index. For some the additional risk wouldn’t be so bad if it meant a higher expected rate of return, but one stock has no more higher expected return than all of those that would make up its index.

Here’s another, “Mutual Fund Performance Is Based On Fund Managers Skill, Not Luck.” 2,100 funds were recently researched. They did have superior five year track records, but there was no evidence that superior returns could be attributed to anything more than luck.

This is not what the mutual fund companies  want investors to believe when they publish their funds’ stellar track records. They want investors to believe they got a skill and insights that no one else has. The real skill here isn’t knowing which funds did the best over the last 20, 10, or five years, it’s knowing which are a going to produce superior rates of return over the next 20, 10, or five years. If track records were based on skill, the same funds would consistently appear on the top performers list. Studies show that every year about a third of the funds will outperform its index. Unfortunately, that top third keeps changing every year, and studies show that none of the funds outperform its index over a ten year period of time.

You probably can deduce that you’d be better off going for the return of the index which is available at a third to half of its actively managed funds, but the mutual fund companies don’t want to let you know that.

The lesson here is, if anyone is making absolute statements about the stock market in terms of how it is or will be performing run do not walk in the opposite direction.

This is just a portion of the article published in the New YorK Times. If you’d like to read the rest of the article send me an email and I’ll e-mail it to you along with access to all the studies used.

Brendan Magee is an Investor Coach. He is the founder and president of Inevitable Wealth Coaching in Drexel Hill, Pa. If you have questions, comments, or suggestions call 610-446-4322 or send an e-mail to Brendan@coachgee.com. You can also listen his radio show, The Investor Coach’s Show on am1340 WHAT. You can also listen over the web at www.am1340what.com.