Tuesday, December 01, 2009

Whom Can You Trust?

“How do you turn an investment portfolio into $1 million? Start with $2 million.” That is an old stock market joke that is more formally illustrated by the following: “ Speculation is an effort, probably unsuccessful, to turn a little money into a lot. Investment is an effort, which should be successful, to prevent a lot of money from becoming a little.” That observation is from a book published in 1940 exemplifying the fact that the investment game hasn’t changed very much.

Actually, the title of that 60-year old book is perhaps even more perfectly evocative of today’s investment climate despite the fact that it too derives from a joke, a classic that you probably have heard before: "Once, during a stock market boom, an out-of-town visitor was being shown the wonders of the New York financial district. When the party arrived at the Battery, one of his guides pointed to some handsome ships riding at anchor saying ‘Look, those are the bankers' and brokers' yachts.’ ‘Very impressive’ said the naïve visitor, ‘But where are the customers' yachts?’"

Fred Schwed, the author of that book, took what was essentially the punch line of that story and used it as the title for the book: Where Are the Customers’ Yachts?: or A Good Hard Look at Wall Street. Mr. Schwed had been a stockbroker during the 1920’s, and lost a good deal of money when the crash of 1929 occurred. The book gained popularity because it was a poke in the eye of Wall Street and the shenanigans that had become an integral part of the system, not too different from today’s environment. Mr. Schwed’s basic philosophy was that the way to get rich was to “Buy when the market is in the midst of a recession, and sell when times are booming.” Here is a more recent update on that philosophy: “Be fearful when others are greedy, and be greedy when others are fearful.” While you may not pay attention to Mr. Schwed’s advice since it is unlikely that you have ever heard of him, you might be more interested in the latter suggestion emanating from Warren Buffett.

Mr. Schwed’s book is now considered a classic, and despite its age, it has recently been reissued in paperback form. It has been reviewed as “humorous and entertaining,” as well as exposing the folly and hypocrisy of Wall Street while “offering a true look at the world of investing, in which brokers get rich while their customers go broke…opening the eyes of investors to the reality of Wall Street.” Can this rather jaundiced look at the core investing system as it existed some 60 years ago, be applied to today’s investment environment? The answer is a resounding “YES!”

Based on the recent near collapse of our economic system, as well as a systemic reacceptance of the Gordon Gecko manifesto (remember the movie Wall Street?) that “greed is good,” In fact, the immediacy of that movie is so consequential that a sequel, Wall Street 2, is scheduled to appear early in 2010. So, the question posed above: “Whom can you trust?” should be uppermost in every investor’s mind.

Last Month’s Viewpointe Article

That question is especially significant when seeking the services of any type of financial manager and might be typified by an article printed in last month’s issue of Viewpointe. The article’s headline read, “Do You Need a Professional Money Manager?” It was accepted for publication despite significant opposition by the editors, not entirely because of the content, but because of its informational characteristics (as an unpaid advertisement).

The article, presumably written by the marketing department of an affiliate of Wells Fargo Bank Co., was typical boilerplate rhetoric, and was submitted by a Wells Fargo employee. You can guess its response to the headlined question, a reply that asserted that for many investors, the use of a Wells Fargo “money manager” (remember that title) would be beneficial. But here is where that conclusion becomes not only confusing, but also problematic. Choosing someone to manage your money is not something to be taken lightly. Probably, most investors spend more time researching the purchase of a new automobile than they do searching for someone to whom they hand over their life savings. (It took me 25 years to find the right organization.)

Wells Fargo Ranked #1

Before we examine the somewhat questionable, yet at the same time almost comical aspects of the Wells Fargo article, it should be recognized that the company itself has a long and highly respected history. The fact that Warren Buffett’s Berkshire Hathaway is Wells Fargo’s largest shareholder could be considered evidence of its standing in its field. In addition, in May 2009, Forrester Research conducted a survey based on the perception of some 4,500 clients of financial service companies to the question, “Is your financial provider looking out for your best interests, not just their own bottom line?” Wells Fargo ranked #1 out of 11 investment firms rated. However, you can judge whether in an attempt to generate more customers, the article provides misleading and, as inferred above, comically contradicts the benefits of its own organizational structure.

Two Questions Posed

The article poses two questions, suggesting that an investor consider before “taking the plunge into professional management.” One is, “Do I have enough time to take advantage of potential new investment opportunities that may surface on any given day?” What? Are we day trading here? Is this the long-term, low risk philosophy that the average investor should expect? Or is it sheer speculation with odds worse than Las Vegas (or is it Indian tribe) gambling casinos?

The second question is equally problematic. “Am I comfortable making buy-and-sell decisions on my own?” It elaborates on this by stating “Once hired, a money manger can make the buy-and-sell decisions for your portfolio, based on your financial objectives.” The implication here is that a buy-and-sell strategy, involving individual company stocks and bonds will be the focus of portfolio management. Allow me to ask a question. “Why is there not one mention of the well acknowledged fact that the single most influential determinant of a portfolio’s performance is ‘asset allocation,’ not the selection of individual securities by an aggressive, hyper active manager.” Replacing that now outdated icon is the steadily rising popularity of passive investment styles, using mutual index funds and exchange traded index funds, thus enabling greater diversification and reducing risk as well.

The Comedy Show

Okay! That was the serious stuff –– now the comical. The article emphasizes the supposedly critical and beneficial status of the Wells Fargo “Money Manager.” It then proceeds to destroy the image of another breed, the “Financial Advisor.” It relates, “Unlike a Financial Advisor, who typically must consult you before making a trade, a Money Manager can be solely responsible for trade decisions based on guidelines you establish.” It also accentuates that unlike Money Managers who are compensated with a pre-arranged fee based on the value of the portfolio (thus putting the manager on the side of the investor), Financial Advisors “usually receive a commission” (thereby escalating trading activity). Remember that statement as well, since the Financial Advisor part is not always true.

Assuming the descriptions above are accurate, the article actually underestimates the failings of Financial Advisors. Steven G. Blum, a lecturer at The Wharton School of the University of Pennsylvania, an attorney and a registered investment advisor says the following: “To make it more challenging [to find a financial professional], there are Financial Advisors bearing a hundred different titles on almost every street corner, anxious to do business with us, and eager to please.” According to the Bureau of Labor Statistics, there are 176,000 people out there calling themselves “Financial Advisors.” Blum continues, “Unfortunately the typical Financial Advisor does not come close to meeting the standards of practice that most clients really need.” Now hold that thought.

What’s a CFP?

The article then proceeds to denigrate those bearing the title of Certified Financial Planner (CFP). Contrast that position with this definition of a CFP: “Those with the CFP designation have demonstrated competency in all areas of finance related to financial planning. Candidates complete studies on over 100 topics, including stocks, bonds, taxes, insurance, retirement planning, and estate planning. In addition, to passing a very strict [and difficult] CFP certification exam [only 53% pass], candidates must also complete qualifying work experience and agree to the CFP Board’s code of ethics, and professional responsibility and financial planning standards.” According to the Wells Fargo article, why would anyone hire a person with those credentials? (Ironically, a number of Wells Fargo employees are CFP’s.)

So, unlike Wells Fargo, based on the above definition, “CFP’s” –– GOOD.

Remember however, we agree with Wells Fargo –– “Financial Advisors” –– BAD.

Here It Comes

So, here’s the punch line: The person who submitted the Wells Fargo article to Viewpointe listed his name at the end, along with his title as “Senior Vice President Investments, Financial Advisor.” Huh? But there’s more. An official Wells Fargo press release dated, May 8, 2009 was headlined “Wachovia Securities, Now Wells Fargo Advisors.” In the release the president and CEO stated proudly, “We chose advisors because the term illustrates the role we play in guiding investors and helping them meet their financial goals.” Now listen to what he next said: “Wells Fargo brokerage businesses have nearly 16,000 full-service Financial Advisors…” What? Picked up off the street corners, perhaps?

To top it off, three days before this article was sent to the publisher, a half page color ad was run in the November 22 nd edition of the Sunday New York Times. The headline read, “With you when you want an advisor who puts you first,” or maybe second, or even last if last month’s Viewpointe article about Wells Fargo is accurate. Note to the Wells Fargo marketing department: Heads will roll!


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