Keisha No Comments

5 Ways to Avoid a Ponzi Scheme

Katy Marquardt (Article in U.S. News & World Report) December 16, 2008Now that the money’s gone, investors and regulators say there were red flags flying all around Bernard Madoff’s enterprise. Here’s how you can avoid potential scams.

Imagine trusting your hard-earned money — such as your retirement savings — to a financial adviser only to lose it all in a fraudulent scheme.

Obsessing about whether your money manager could be the next Bernard Madoff, the alleged mastermind of a $50 billion Ponzi scheme, isn’t going to do much good, but some healthy skepticism won’t hurt.

Here are five tips that can help you avoid getting taken to the cleaners:

1. Make sure your adviser is legit

If you’re looking for financial advice, ask friends and relatives for recommendations — but don’t stop there. A scary truth is that anyone can call himself or herself a financial planner or adviser, so it pays to check with national organizations that issue credentials.

They include the National Association of Personal Financial Advisors, the Financial Planning Association and the Certified Financial Planner Board of Standards.

Each offers a searchable database with contact information for planners in each state. The American Institute of Certified Public Accountants has a list of CPAs who’ve earned the personal financial specialist designation.

2. Dig deep

Put on your gumshoes and find out how long the adviser has been in the business.

Ask to see his or her ADV Form, Part II, which a planner files with the Securities and Exchange Commission. It contains information about the adviser’s background, services and fees. Check for complaints filed though your state’s securities regulator (contact information is available here).

A site visit might also be helpful, says Tim Kochis, chief executive of Aspiriant, a wealth management company with offices in San Francisco and Los Angeles that caters to high-net-worth clients.

“Reputation and apparent track record are not enough,” Kochis says. “You have to go way beyond that to really investigate the operations of the org and find out if what is claimed is real.”

3. Understand the difference between a manager and a custodian

A custodian, which would include the Fidelitys and Charles Schwabs (SCHW, news, msgs) of the world, is in possession of your investment account and issues periodic statements of transactions.

The manager of assets executes those transactions. “A lot of people fail to understand why it’s important to separate these functions,” says Kochis. “Frauds almost always occur when those two things are put together.”

In other words, watch out for an investment manager who wants complete control of your money and asks that checks be made out to him or her.

You can sleep tight if your funds are in the custody of a broker-dealer firm regulated by the Financial Industry Regulatory Authority and backed by the Securities Investor Protection Corp. But make sure you receive at least quarterly statements, says Mickey Cargile, founder and managing partner WNB Private Client Services, in Midland, Texas. “The key is that you get it directly from the custodian and not from the adviser.”

4. Be skeptical of pitches for exotic or obscure products

Banks, brokerages and planners offer a wide range of financial products, including exotic investments that incorporate leverage and complex derivatives. If you get a pitch for an asset class you’re not familiar with, make sure you understand the process by which it achieves returns.

Jim Wiandt, editor and publisher of the Journal of Indexes and publisher of IndexUniverse.com, puts it like this: “If you don’t understand it, you shouldn’t be in it.”

Cargile takes it a step further: “Only invest in transparent assets. We don’t invest in anything we can’t turn to cash in three days or less, which limits us to stocks, bonds, mutual funds and exchange-traded funds.”

A hedge fund, which isn’t required to disclose its holdings, is an example of a nontransparent investment. Also, be especially wary if your adviser downplays or denies risk.

5. Be especially vigilant if you’re nearing or in retirement

According to a recent study by the North American Securities Administrators Association, nearly half of all investor complaints submitted to state securities agencies came from the senior set.

According to the association, bogus operators sometimes con older investors through free-lunch seminars that are followed by calls from salespeople a few days later (a common recommendation is to liquidate securities and use the proceeds to buy indexed or variable annuities).

Oh, and one bonus tip: If someone promises an investment return that is unnaturally high or steady, the warning alarm should start sounding.

Carole No Comments

Resist the Folly of Market Timing

James K. Glassman (Kiplinger) November 2011In a time of market turbulence, with stocks losing altitude, it’s only natural to feel compelled to buy and sell according to your own forecasts of whether a stock — or the market as a whole — will rise or fall in the short term. My advice: Resist!

Unfortunately, the urge is strong — almost irresistible. It looks so easy in hindsight, and the results are so spectacular. Let’s pick a stock at random: Waters Corp. (symbol WAT), a midsize manufacturer of high-tech equipment, such as liquid chromatography systems. Waters is not an especially volatile stock, yet in nine of the 12 years starting in 2000, its yearly high has been at least 50% higher than its low. In 2000, you could have bought 1,000 shares at $22, sold them in 2001 for $85, bought them back again in 2003 for $20 and sold them in 2011 for $100. Total gain: $143,000. But if you had bought the stock at the start of 2000 and held it continuously through September 9, 2011, when the shares closed at $75, you would have earned just $53,000.

Or consider the U.S. market, as represented by SPDR S&P 500 (SPY), the popular exchange-traded fund that tracks Standard & Poor’s 500-stock index. If you had $10,000 in Spiders at the start of 2001, you would have had $11,519, including reinvested dividends, at the end of 2010. But if you had pulled your money out at the start of 2001, 2002 and 2008 — all down years for stocks — stuck the cash under the mattress, then reinvested the money at the start of the years that produced gains, you would have had $26,316.

The Efficient-Market Hypothesis (EMH)

Market timing — the term for the process of moving in and out of assets according to predictions of what their prices will do next — looks like it can be a hugely successful strategy. So might the strategy of guessing the numbered slot into which a roulette ball will fall after the wheel is spun. The only problem is that most mortals can’t time the markets consistently well enough to make the strategy worthwhile. And because of the vagaries of human emotions, the act of trying to time the stock market often produces far worse results than just buying a diversified bundle of stocks and holding them for the long haul. People tend to sell in a panic at the bottom and buy in a flush of confidence at the top.

John Bogle, founder of the Vanguard Group of mutual funds, wrote of market timing: “After nearly 50 years in this business, I do not know of anybody who has done it successfully and consistently. I don’t even know of anybody who knows anybody who has done it successfully and consistently.”

The reason is that markets are efficient. University of Chicago economist Eugene Fama first formulated the efficient-market hypothesis (EMH) in his PhD thesis: “In an efficient market, competition among the many intelligent participants leads to a situation where, at any point in time, actual prices of individual securities already reflect the effects of information based both on events that have already occurred and on events which, as of now, the market expects to take place in the future. In other words, in an efficient market at any point in time the actual price of a security will be a good estimate of its intrinsic value.”

Put it another way, a stock’s price represents the consensus judgment based on all the knowledge that can be gleaned about the underlying company at that moment. Tomorrow’s price is unknown and unknowable. Because of the EMH, economist Burton Malkiel, of Princeton, wrote that “a blindfolded chimpanzee throwing darts at the Wall Street Journal can select a portfolio that performs as well as those managed by the experts.”

The EMH is actually liberating. It implies that you don’t have to spend your time trying to guess the short-term movement of a stock, because you can’t predict it any better than anyone else.

So is this a good time to buy shares of Waters? It is as good a time as any if you believe the EMH because the price of Waters reflects everything that could possibly be known. The rest is mystery. As a result, the best stock-buying strategy is to find great companies, buy them now and hold them for a long time.

Luck or Genius?

But can’t some geniuses, such as Warren Buffett, beat the market by buying and selling stocks (or whole companies) at the right time? The jury is still out. The laws of chance predict that some investors will time the market correctly for a while at least. They look smart, but they may just be lucky.

Buffett certainly has a great record. But if you had decided a decade ago to capitalize on his brilliance by investing in the holding company he chairs, Berkshire Hathaway (BRK-B), you would have been dis­appointed. Berkshire outperformed the S&P 500 in six years and trailed it in five years (including 2011, through September 9). Bill Miller, manager of Legg Mason Capital Management Value Fund (LMVTX), beat the S&P every year from 1991 through 2005, but since then his record has been less than stellar. He’s trailed the S&P in five of the past six years (again, including 2011), and, for the ten-year period through September 9, his fund ranks in the bottom 1% of its category, according to Morningstar.

Mark Hulbert, whose Hulbert Financial Digest has followed predictions in financial newsletters for 31 years, concludes that “market timing is not impossible but very difficult.” At my request, he went through the 97 newsletters that he tracks and that have been around for at least ten years and produced a list of those whose timing calls exceeded the 3.7% annualized return of the broad Wilshire 5000 index over the past decade. (Hulbert measures a service’s timing calls by assuming that an investor in stocks earns the return of the Wilshire 5000 and that an investor in cash earns the yield of a 90-day Treasury bill.)

Only seven newsletters beat the index, including two edited by Dan Sullivan, one of my longtime favorite newsletter editors. But although Hulbert can point to experts who have beaten the market over some periods, “the question,” he says, “is whether they can do it in subsequent periods.”

In his book Fooled by Randomness, Nassim Nicholas Taleb writes that if you set an infinite number of monkeys in front of an infinite number of typewriters, one of them will produce an exact version of Homer’s Iliad (the key word here is infinite). But then Taleb adds, “Now that we have found that hero among monkeys, would any reader invest his life’s savings on a bet that the monkey would write the Odyssey next?”

Irresistible Investments

If you still can’t fight the urge to try to time the market, do it as little as possible and concentrate on areas in which the EMH has the least effect. Buy stocks in areas where information is harder to come by and fewer analysts are paying attention or where, for some reason, investors are shunning perfectly good com­panies. Three such sectors are developing markets (stocks of companies in places such as China, Brazil and Indonesia), micro caps (too small for most mutual funds to buy) and value stocks (which, by definition, have lower valuations than the market as a whole).

Global X China Consumer (CHIQ), an ETF, provides an excellent way to buy Chinese companies — such as the beautifully named Want Want China Holdings, a maker of rice crackers and dairy products — that benefit from that nation’s booming domestic market. For micro caps, as well as emerging markets, stock picking is difficult, so instead of buying individual stocks you are usually better off with something like Aegis Value (AVALX), an actively managed mutual fund with a good record and a turnover rate of just 10% a year (but, unfortunately, high expenses, at 1.45% annually).

A great hunting ground for value stocks is the portfolio of Vanguard Dividend Growth (VDIGX), which, as its name suggests, invests in companies that regularly boost their payouts. The fund, a member of the Kiplinger 25, has beaten the S&P 500 by an average of three percentage points per year over the past five years and has done so with far lower risk. Among its top holdings are defense contractor Northrop Grumman (NOC), with a price-earnings ratio of just 8 based on expected 2011 profits and a dividend yield of 3.9%, and Medtronic (MDT), a maker of medical devices whose stock yields 2.9% and trades for 10 times estimated earnings for the fiscal year that ends next April.

The best time to buy? What about right now?

James K. Glassman, executive director of the George W. Bush Institute, in Dallas, is the author of Safety Net: The Strategy for De-Risking Your Investments in a Time of Turbulence. He owns none of the stocks or funds mentioned.

Carole No Comments

Strategies to Steer Through a Market Correction

(U.S. News & World Report), Kira Brecht, July 14, 2015

One of the biggest mistakes long-term investors make is getting out of the stock market at the wrong time. We’ve all heard the saying “buy low, sell high,” but mom-and-pop investors have a tendency to panic during market declines and sell when stock prices are down, locking in losses.

U.S. stocks have ridden a rising trend for six years as of March, a long stretch by historical standards. While that doesn’t guarantee the stock market will crash anytime soon, it’s always wise to review strategies to handle a declining market. If you are prepared, you can avoid emotional decision-making, which can be detrimental to your financial health, experts say.

Declining stock markets often bring out strong emotions such as fear, anxiety and depression, says Dr. Gary Dayton, a psychologist and founder of Glastonbury, Connecticut-based TradingPsychologyEdge.com, a trading psychology coaching firm. “Making investment decisions based on emotions is always the worst way to invest,” he says.

While institutional investors look at market downturns as buying opportunities, individual investors often sell their investments. “This striking tendency has been documented for over 100 years. At some point in a falling market, individual investors’ fear will be at its highest. Frightened at the prospect of losing even more money, many investors panic and sell their holdings,” Dayton says.

For individuals investing for retirement, with a time horizon of 10, 20 or 30 years, short-term bear cycles may not matter. The problem for long-term investors who sell in market declines is getting back into the market without missing the upturn.

“Numerous studies have shown that investors tend to panic during declines and at bottoms. It hurts because once markets recover, they tend to go up quite rapidly before investors realize that things are going back to normal,” says David L. Blain, chief executive officer of BlueSky Wealth Advisors LLC, a New Bern, North Carolina-headquartered wealth advisory firm. “By then, they have missed out on a large portion of the upside.”

The herd mentality also can play a part in stock market selling pressures. “Herding is the tendency of a group of market participants to behave like a school of fish or a flock of birds. When market conditions deteriorate, there is an initial rush to the exits,” says Dr. Kenneth Reid, a trading coach and founder of Santa Fe, New Mexico-based DayTradingPsychology.com.

To avoid becoming a casualty of the herd and selling at the wrong time, consider employing these six strategies in a declining stock market.

  1. Turn off the news. Listening to the news and reading about the dire economic predictions can heighten your nervousness. “Don’t look at your portfolio all the time. Turn off the TV and stop listening to your neighbor and the doom-and-gloom prognosticators. Focus on what you can control, which is your spending and saving. Make a new goal to save an extra X dollars a month while things are declining, and then invest it,” Blain says.
  2. Reevaluate your portfolio. Do the stocks you hold continue to meet your investment criteria? Winnow out the weak stocks by selling them. Stocks that no longer meet strong investment criteria are likely to decline the most in a market fall. You will be increasing your cash position, which can be used for the purchase of new stocks at attractive prices once the decline is over,” Dayton says.
  3. Make a list of stocks or funds you want to buy. A declining market can offer the opportunity to add to your long-term investment portfolio at a lower price point. “Long-term investors should welcome the occasional bear market if they have a good investment strategy and the discipline to see it through. The historical stock market trend is upward, and occasional bear markets are an opportunity to buy stocks while they are ‘on sale.’ As Warren Buffett observed, it is profitable to be greedy when others are fearful,” says Derek C. Hamilton, a certified financial planner at Indianapolis-based Elser Financial Planning Inc.
  4. Stay diversified. A portfolio allocation with 60 percent stocks and 40 percent bonds is an old benchmark and starting point for portfolio diversification. Check out stock-and-bond mixes in a target-date fund based on your age to get an idea of appropriate allocations for your time horizon. Rebalancing your allocations is an important task you can do on a quarterly or annual basis so your portfolio will be ready if the market heads south. “If you have different asset classes, something will be going up. In the global financial crisis, it was U.S. Treasuries. The point is to determine ahead of time what sort of decline you can tolerate, and don’t invest in such a large percentage of stock that you will panic in a decline,” Blain says.
  5. Work with a financial advisor. Develop a comprehensive, written plan that sets out your important financial goals and how you will achieve them. This will be your map when the going gets tough. “We are all human beings, and fear can get the better of us. The best inoculation against a fear-driven investment mistake is professional guidance and a good plan,” Hamilton says.

A fee-only financial adviser can help navigate you through a declining market. “He or she can help you avoid hasty, emotionally driven moves and see to it that any course corrections are well-considered and keep you on track to meet your goals,” Hamilton adds.

  1. Get a grip on your emotions. You may not be able to avoid an emotional response, but you can manage it. “Science is showing that the practice of mindfulness helps us reduce stress, changes brain regions associated with fear and therefore improves our internal control over emotions, and helps us be more aware of both opportunities and dangers when we are in challenging situations such as declining stock markets,” Dayton says. “Mindfulness helps investors maintain an even emotional keel and make better investment decisions. It is the one mental skill I suggest all investors learn.”

He adds: “Following an investment process and being prepared for the inevitable market declines helps you act prudently, keep truly great companies in your portfolio for the long term, protect them during market slumps and be in a position to buy other great companies at attractive prices when others are selling them in panic.”