Misleading Headlines, Financial Journalists getting played; how we report honestly

March 11, 2015: Headline: Wall St. ends down for 2nd session on rate concerns

Well, yes, the Dow Jones and NASDAQ which essentially are a proxy for large US stocks, were down slightly, around 0.15 to 0.2%.

But indexes that follow international stock other than USA and that follow small US Stocks were up from 0.6 to 0.76% - a very good day. The reverse happens as well - large stocks up, other very important major market dimensions down.

Couldn't they take a few more seconds to tell us how small stocks, international and emerging markets performed that day? These are three additional very important dimensions of the market that any prudent investor should own!

Barry Ritholtz wrote the article Financial Journalists Need to Understand Numbers Better If They Want to Avoid Getting Played (click for article). He goes through several examples of the media reporting misleading numbers.

In our numbers that we report to the public, we go back as far as we can (17+ years) based on availability of appropriate indexes that accurately model funds in our portfolios. We would go back further if we didn't lose an important data source. We think like statisticians - the more data, the more statistically sound the comparison. We're admitted math nerds, not financial product salespersons.

In the first few years of that time frame, the S&P500 is in favor and beats our models. (We come back to win in the end including now except for our 3 most conservative portfolios which are not expected to challenge the S&P500 since they have more fixed income.) A few years later, the S&P500 goes into disfavor and we are soundly beating that index. What if we didn't go back as far, and started reporting at the time the S&P500 goes into disfavor? Well, with that new start date, the S&P500 never even comes close - even after it's recent run as it has been in favor. The race starts and the S&P500 is in last place the entire time period. Though that data is accurate - it is based on adjusting the start of the data - and that is dishonest.

We won't go there.   

Fund Choices in a 401(k) Plan, Do's and Don'ts

Myth: Choice is Good inside a 401(k) Plan

Americans love freedom and choice! So isn't it good to have many fund choices in 401(k) plans? To answer that question, we have to address diversification.

Diversification: The Employee Retirement Income Security Act (ERISA), the Uniform Prudent Investor Act (UPIA) and the Restatement 3rd of Trusts (Prudent Investor Rule) all agree that the key to long term investment success is broad diversification of risk.

Therefore as a plan overseer, one of your most important duties is to increase the probability that each participant has maximum diversification in their account. If you want to know more about why diversification is so critical, please contact us.

Too many funds choices is bad because it takes away from diversification. What's "too many"? See common mistakes, next section below.

Common Mistakes

1) Tyranny of Choice: If your plan participants invest in more than one fund in the same asset class - they unknowingly concentrate their assets, causing less diversification, more volatility which hurts their long term returns. This problem occurs most often in the large cap space. Here's a great article on this problem, "The Tyranny of Choice."

2) Bundled Plans: Often a bundled plan of funds - one fund family - will share their "best investment ideas" among the funds. So you will find the same stock in many different funds and participants' assets become concentrated in certain individual stocks. Again, this lowers diversification, increases volatility and hurts long term returns.

3) Retail mutual funds: Often retail mutual funds have the problem of style drift or not investing as their fund name would suggest. This leads to, yes, you guessed it, less diversification, higher volatility, lower returns.

What to Do Next

Easiest Solution: You're probably not trained as an investment advisor. Use an ERISA Section 3(21) independent advisor that insists on bringing an ERISA Section 3(38) independent advisor with them. The 3(38) advisor takes over responsibility for fund selection and monitoring. They do it for you, relieve you of significant fiduciary liability and are cost competitive. They are investment experts - and specifically for 401(k) plans which are uniquely different than an investment advisor investing your personal account..

If you are delaying a move to a 3(38)-based plan, then you just need to avoid the most common mistakes listed above. Break the myth, be a "choice contrarian" and help your participants get better long term returns through greater diversification and lower volatility!

Most plans ought to be able to achieve good diversification and avoid concentration with about 10-15 funds. A few of your participants may rebel a bit at first, but you can confidently move forward knowing that you are doing what's best for everyone in th plan and fulfilling your fiduciary oversight responsibility with flying colors!

We can provide a free benchmark of your plan which you are supposed to be doing anyway, contact us for more information or click on the Schedule a Meeting button below.

Fiducaries vs. Financial Product Salesperson (8/10/2010)

Follow the Money It's important to know how your advisor gets compensated because it impacts their behavior: so follow the money!Two ways for a financial advisor to get paid:1) Commissions from the products they sell you, or from security trades they make for you or2) A percentage fee charged on the assets under management  - called "fee-only advisor".The problem with commissions is they influence advisor loyalty toward their boss or to the products they sell, rather than to you.   It's not an indictment of the person receiving the commissions.  Their intentions are probably good, but all things being equal why deal with the possibility that their judgment could be impacted?  Often hidden fees and penalties are present in this environment as well as we point out in an example below.The only investment professionals held to a fiduciary level of responsibility are Registered Investment Advisors (RIA) often called fee-only advisors.Lynn O'Shaughnessy wrote a wonderful article, "Financial advice better from fiduciary than broker" on this important topic. Common Mistakes 1) Using a commission-based advisor (broker) and not demanding (in a nice way)complete disclosure of all fees.    Be specific and get it in writing.2) Comparing expenses of a fiduciary RIA vs. a broker before getting a complete disclosure of the broker's fees.    You may mistakenly assume the RIA is more expensive since they fully disclose.   Usually RIA's are competitive, and often provide superior service for the same or less cost.(We know of a recent situation where an RIA was charging an initial one-time financial planning fee of $2,000 with ongoing planning at no cost.   The prospective client decided to hire a broker with "no up front fee".  However, when the client asked further disclosure questions at our advice, an up front hidden fee of more than $20,000 was revealed.   At that point $2,000 sounds pretty good and the client received a comprehensive initial strategy for it.)3) Using multiple advisors as a fail-safe or diversification strategy.   Unfortunately this puts you in charge of allocating assets between the advisors which is likely not your area of expertise   It's best to have one trusted advisor with access to excellent diversification vehicles allocate all your investable assets.  You overall level of diversification will be higher. What to Do Next Thinking about trying a new advisor?   We encourage you to work with a fiduciary RIA fee-only advisor since their fee structure is aligned with your interests.    No matter who you work with, demand fee transparency - disclosure in writing.Begin with The End in Mind:  For any successful journey, you need a compelling vision AS THE OVERALL FIRST STEP.We help people put their vision on paper using a tool called Financial Road Map for Living Your life on Purpose.    We facilitate Road Maps for individuals/couple as a community service, even knowing in advance that you may not be a fit to us. Contact us to schedule a Road Map meeting.  We can also provide a 20-30 minute Road Map demo on the phone.You may wish to read articles about how to choose an advisor.   Be sure tounderstand their fees.    Call us.   We have a book we can share with you that includes advice on how to find a good advisor, what to ask, how to interview.Newsletter Archive

Until our next issue... Sincerely, John O'ReillyO'Reilly Wealth Advisors