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May-30-17

An Open Letter To Brokers

I come in peace.

I have been hard on you in the past. At times, I was insensitive to the fact that you are husbands, wives, Moms and Dads. You have mortgages to pay and children to educate. You’re under pressure to generate revenue for your employer, and they’re not exactly a charitable group.

All too frequently, you met your revenue goals by selling products you knew weren’t suitable for your clients. Typically, these were high commission investments, like non-traded REITS, annuities, hedge funds, structured notes and derivatives. The core of your investment strategy was (and likely still is) the sale of high expense ratio, actively managed mutual funds. These funds often tacked on sales charges (called “front-end loads”), which could range from 3% to 8.5%. When investors protested, the mutual fund industry created a “back-end load,” which penalized investors who sold prior to holding for six years. In addition, these funds charged a 12b-1 marketing fee of about 1% a year.

You’re an intelligent group. You’ve known for a long time that this was a giant rip-off. Your clients would likely have been far better off in a low management fee index fund from a fund family like Vanguard. But you had bills to pay. Your branch manager was ruthless about meeting quotas, and relatively few investors knew about the benefits of index funds.

Now, everything has changed. Over the past three years, investors have pulled $525 billion from U.S. actively managed stock funds (like the ones you’ve been selling). Index and passive funds had inflows of $458 billion during the same period.

The writing is on the wall. We both know it. Investors are more savvy. They’re not falling for the shopworn pitch about your ability to time the market, pick outperforming stocks or select the next “hot” fund manager. Your business is in jeopardy.

The news isn’t all bleak. While a door has closed, a large window has opened. Instead of fighting against index- based investing, join it. It’s a much more appealing position to take with investors. You’ll be doing the right thing and impacting your clients positively.

Instead of relying on your wit and guile, and ultimately deceiving your clients, you can embrace the overwhelming academic evidence supporting index-based investing. It’s a piece of cake compared to what you have been doing.

I know what you’re thinking. How will you demonstrate your value when anyone can buy index funds directly from fund families? How will you justify your fee?

Don’t worry. I’ve got you covered. In The Smartest Portfolio You’ll Ever Own, I provide the academic underpinnings for a “SuperSmart Portfolio”, consisting of nine ETFs and index funds. The stock portion of this portfolio tilts towards small size and value stocks. It optimizes the trade-off between risk and return. It minimizes risk by including seven asset classes for stocks and two asset classes for bonds, providing broad, global diversification.

While some investors can implement this portfolio without assistance, it’s too complicated for many. Other investors, like trustees of a trust or sponsors of a retirement plan, will be strongly inclined to retain an advisor. You’ll be perfectly positioned to assist them.

Here’s another reason why this shift to a sound, academically based investment strategy is in your best interest. There’s been a strong trend towards managed accounts, where the primary revenue generator is the management fee. That fee is not affected by which investments are in the portfolio. You can do right by your clients and not sacrifice income! it’s a win-win.

Do you have an option? Are you just going to watch your clients flee to index funds? I’m offering you a far better choice. You can be pro-active. You can differentiate yourself from your colleagues who are simply hoping investors won’t figure out there’s a better way. You’ll be offering them that way!

There are hundreds of thousands of stockbrokers in the U.S. What if only 10% of you adopted my suggestion? Think about the number of investors whose lives you can change.

Finally, reach out to me. I’ll help you make the transition. I mean it.

I told you I came in peace.

An Open Letter To Brokers blog was originally posted on The Huffington Post website.

 

2014-04-01-Hiresfrontbookcover.jpgDan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You’ll Ever Read, The Smartest Retirement Book You’ll Ever Read, The Smartest 401(k) Book You’ll Ever Read and his latest, The Smartest Sales Book You’ll Ever Read. He is a wealth advisor with Buckingham and Director of Investor Advocacy for The BAM ALLIANCE.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

 

 

By: Dan Solin | 0 comments
May-23-17

A Hidden Bias Is Killing Your Returns

Until recently, it was frustrating trying to convince you to become an evidence-based investor. Part of the problem was persuading you that brokers and self-appointed stock market gurus are emperors with no clothes. There’s no credible evidence anyone has the expertise to reliably and consistently pick outperforming stocks, tell you when to get in and out of the market or pick the next “hot” mutual fund manager.

Yet an entire industry is built on this false premise, supported by much of the financial media which derives massive revenues from perpetuating these myths.

How times have changed.

The tide has shifted

According to Morningstar, in April, 2017, investors put $17.1 billion in U.S. stock passive funds and pulled $16.8 billion from actively managed funds. This pattern of outflows from actively managed funds started over a decade ago. For the ten years ending March, 2016, actively managed U.S. stock funds have experienced net outflows of almost $890 billion.

Investors have figured out that the low odds of an actively managed fund outperforming a comparable index fund are low, primarily due to high costs. The odds of a portfolio of actively managed funds outperforming a comparable portfolio of passive funds is infinitesimal.

Most investors ignore the evidence

There’s overwhelming data that “...few funds sustain outperformance over time and that some funds with excess returns over their benchmark can become underperformers over time.” Few who study the peer-reviewed evidence would disagree with the conclusion of William D. Nordhause, a Yale economics professor, that “most investors will be better off using index funds as the cornerstones of their portfolios.

Why then, do a majority of individual investors ignore the data and continue to invest in actively managed mutual funds? According to Dr. Mark Perry, a professor of economics at the University of Michigan, as of 2014, only 30% of investors owned at least one index fund and only a minority made passive funds the core part of their portfolios.

Are these investors engaged in cognitive dissonance? Are they irrational? Why do they cling to what some journalists describe as “the triumph of hype and hope and marketing over wisdom and experience”?

The answer may lie in understanding a hidden bias.

The endowment effect

According to Investopedia, the “endowment effect” describes the tendency of people to place a higher value on things they own compared to a similar item they don’t own.

How does the endowment effect apply to investors? You’ll frequently hear investors talk about “my broker”, “my stocks” and “my mutual funds.” These investors believe they have an ownership interest in their broker and their investments. This perception may cause them to over value what they own and fail to do an objective analysis of alternatives (like index funds). An article in Morningstar correctly notes “the cognitive tendency to ‘love what you own’ applies to the shares, bonds and funds in your portfolio.”

You can overcome the endowment effect, but first you need to recognize it as a sub-conscious bias.

A Hidden Bias Is Killing Your Returns blog was originally posted on The Huffington Post website.

 

2014-04-01-Hiresfrontbookcover.jpgDan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You’ll Ever Read, The Smartest Retirement Book You’ll Ever Read, The Smartest 401(k) Book You’ll Ever Read and his latest, The Smartest Sales Book You’ll Ever Read. He is a wealth advisor with Buckingham and Director of Investor Advocacy for The BAM ALLIANCE.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

 

 

By: Dan Solin | 0 comments
May-16-17

Hot Tips For A Cool Retirement

It’s all about fees. There are many fees that eat into your retirement nest egg. The most significant ones are the management fees charged by mutual funds (called “expense ratios”), advisory fees and commissions. Here are some hot tips for dealing with these fees.

Hot tip # 1: Require all fees to be expressed in dollars

Did you ever wonder why mutual funds and advisors express their fees as a percentage of assets? For example, an actively managed mutual fund might have an expense ratio of 1%. This is the cost for running the fund and typically includes administrative costs 12b-1 fees and other expenses.

By expressing the expense ratio as a percentage of assets, the actual cost is both minimized and trivialized. Who cares about 1%? But what if this expense was expressed in dollars? On an investment of $200,000, 1% is $2000. The dollar figure gets your attention. The percentage number doesn’t.

It gets worse.

Hot tip # 2: Use a compound calculator

A mutual fund (and an investment advisor) charges an annual fee. In the example above, you’ll be paying $2000 a year (and perhaps more or less depending on the value of your holdings). What impact does this fee have on your retirement savings? To find out, use a compound calculator.

Let’s assume that, instead of investing in an actively managed fund that charged an expense ratio of 1% annually, you invested in an index fund or exchange traded fund with an expense ratio of only 0.15%. Your annual fee would only be $300 instead of $2000. Now let’s assume you invested the difference ($1700) and earned a modest return of 4% annually for 20 years. Here’s where the compound calculator comes in handy.

At the end of 20 years, your annual investment of $1700 would be worth $56,372.55.

That’s the kind of money that can make a big difference in achieving your retirement goals.

Hot tip # 3: Minimize mutual fund fees

Financial journalist and author Jonathan Clements wrote this wonderful blog post about the price war among major index fund providers. He shows you how to build a broadly diversified portfolio using just three index funds. Remarkably, you can do so using the lowest cost funds he identifies for a weighted average expense ratio of a puny 0.05% of your assets. In dollar terms, on a portfolio of $100,000, that’s just $50 bucks a year.

Hot tip # 4: Minimize advisor’s and broker’s fees

Most advisors express their fees as a percentage of assets under management. You now know to ask them to express their fees in dollars and to use a compound calculator to determine the impact of those fees.

The first question to ask yourself is whether you need any advisor or broker. Some investors are perfectly capable of investing on their own, following the recommendations in Clement’s blog or in my blog on this subject.

For some investors, only one index fund may be sufficient for your needs. I discuss low management funds that might be suitable in this blog.

If you need help, consider using a financial planner who doesn’t manage money or sell products and who charges a flat fee for preparing a financial plan. Many planners will help you implement a do-it-yourself investment strategy. Because they charge a flat, one time fee (with optional fees for yearly reviews), these planners cost significantly less than most asset-based advisors. You can find a reliable list of qualified planners on the website of the Garrett Planning Network.

If you need assistance, you can get it from the new breed of robo-advisors. Some are fully automated. Large mutual fund families like Fidelity, Charles Schwab and Vanguard offer “hybrid” services that provide personal advice and automated investing. You can find helpful information about some of these providers here and on the websites of the fund families. All of these alternatives charge significantly less than a traditional full service advisor.

A full service advisor can offer significant value (over and above investing expertise) to higher net-worth investors and those with more complex financial issues. Even these advisors are feeling the pinch of new competitors. You may be able to negotiate their fees. It’s worth a try.

Hot tip #5: Shift your focus

Most investors focus on stock picking, market timing and selecting a “hot” mutual fund manager. Instead, shift your focus to building a low management fee, globally diversified portfolio of index funds, in an asset allocation suitable for you. Your new focus is on fees charged by advisors, brokers and mutual funds.

That’s my hot tip for a cool retirement.

Hot Tips For A Cool Retirement blog was originally posted on The Huffington Post website.

 

2014-04-01-Hiresfrontbookcover.jpgDan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You’ll Ever Read, The Smartest Retirement Book You’ll Ever Read, The Smartest 401(k) Book You’ll Ever Read and his latest, The Smartest Sales Book You’ll Ever Read. He is a wealth advisor with Buckingham and Director of Investor Advocacy for The BAM ALLIANCE.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

 

 

By: Dan Solin | 0 comments
May-03-17

A $17 Billion Annual Wealth Transfer

Pigs feeding at the trough have nothing on 401(k) plan administrators who permit high cost funds to populate 401(k) plans, when comparable lower cost funds, with the same or higher expected returns, are readily available.

The study

A recent study by RiXtrema analyzed 52,529 retirement plans. The purpose of the study was to determine whether participants in retirement plans with aggregate assets, as of March, 2015, of $6.8 trillion, were overpaying by purchasing expensive, actively managed funds.

The study determined whether a fund in a plan could be replaced with at least one alternative fund that was less expensive. In order to qualify as an alternative, the less expensive fund couldn’t significantly change the risk/return profile of the plan menu.

The study then calculated the annual savings from switching to these comparable, readily available, less expensive funds that had both “high similarity” to the fund already in the plan, and a track record of outperforming it over a ten-year period.

The findings

By including lower cost funds, plans of all sizes significantly reduced their expenses. For example, the smallest plans, with assets under $1 million, reduced expenses from 0.82% to 0.42%. At the other end of the spectrum, the largest plans, with assets over $100 million, reduced expenses from 0.49% to 0.26%.

The ramifications of this cost reduction are staggering. Here’s the stunning conclusion: “...the overall savings available to defined contribution plans are $17.07 billion per year only on the investment expense of the funds.”

This number — as huge as it is — is actually understated. If you include the aggregate outperformance of the lower fee funds, the “actual benefit could be twice as large.”

Another filter

Perhaps the most fascinating (and disturbing) finding of the study was a further analysis that excluded all index funds and exchange traded funds as possible alternatives. This filter was applied in anticipation of the argument that such a large flow of capital into these funds might create market instability.

Excluding these funds had almost no (or very minimal) effect on the savings available to plan participants. There were still many lower cost funds that could be substituted for more expensive ones.

How difficult, in this computer age, would it be for plan sponsors to insure the fund options in the plan were the lowest cost, comparable funds available, with a significant track record of outperformance?

High priced consultants to retirement plans, who currently spend their time hiring and firing mutual fund managers, could be replaced by the same technology that generated this study. The cost savings from not paying their fees — standing alone — would be considerable.

The conclusion

Here’s the key finding in this important study: “...most defined contribution plans in the US are very inefficient and retirees would be much better served by adoption of fiduciary best practices in the design of the plan menu. The savings available from applying quantitative approaches to fiduciary best practices could be $17 billion annually as a conservative estimate.”

That’s $17 billion (or more) in your pocket instead of transferring this massive wealth every year to the securities industry.

A $17 Billion Annual Wealth Transfer blog was originally posted on The Huffington Post website.

 

2014-04-01-Hiresfrontbookcover.jpgDan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You’ll Ever Read, The Smartest Retirement Book You’ll Ever Read, The Smartest 401(k) Book You’ll Ever Read and his latest, The Smartest Sales Book You’ll Ever Read. He is a wealth advisor with Buckingham and Director of Investor Advocacy for The BAM ALLIANCE.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

 

 

By: Dan Solin | 0 comments