F Who? for Halloween

I was quoted in a Geoff Williams article in US News & World Report this week. The piece discusses common mistakes made after the death of a spouse. It's not the most enjoyable topic to discuss, but Halloween is an appropriate time to review your "what if" plans for death.

 

F Who?

It’s almost time for the annual flight of the Great Pumpkin. Remember him from Peanuts? If so, you may also remember Linus’s quote,

“There are three things I have learned never to discuss with people...religion, politics, and the Great Pumpkin.”

I generally steer clear of all three of those topics in the Accountable Update, but the “debate” over putting customers’ interests first in the Department of Labor’s Fiduciary proposals is why I’m going to tempt fate and violate a couple of Linus’s rules this week.

Since we’ve already broached the Great Pumpkin topic, we might as well delve into politics, too…

"It's a very simple principle: You want to give financial advice, you've got to put your client's interests first." – President Barack Obama, February 23, 2015

If you have to ask, "F Who?", when someone mentions the word fiduciary, you are probably in good company. The Department of Labor has proposed a Fiduciary Rule to protect investors from backdoor payments and hidden fees in retirement investment advice. The retirement investment advice industry, on the other hand, has been keenly focused on defeating these proposals that will cost it an estimated $40 billion over the next 10 years.

$40 billion will buy a lot of pumpkins.

Groups such as the Coalition to Protect Retirement Security & Choice, made up primarily of insurance companies, are countering that the proposal will limit consumer access to their local advisor or make it more expensive.

No, that’s not pumpkin scent you smell.

Believe it or not, the majority of brokers and insurance agents that provide retirement advice are not bound by law to act as a fiduciary. In other words, they aren’t legally required to put your interests ahead of their own. These salespeople have only to prove that any advice they provide is “suitable.”

Think of it like shopping for a car. You tell the salesperson that your wife is expecting your first child and that you are shopping for a car for her. He could show you a nice four door sedan with great safety features, good gas mileage, and ample backseat and trunk space. Or, he could recommend a souped-up high performance four-wheel drive SUV. You may be smart enough to know that the SUV may be impractical, but you may not realize that he shows it to everyone because of the higher commission potential, knowing on occasion that someone will buy on impulse.  

Now imagine that you get home with the SUV and your spouse helps you come to your senses and makes you return it. In the car world, you are at least protected by consumer laws that generally give you a cooling off period to change your mind. In the investment world, the standard of suitability means that the broker only has to show that the product will work for you, even if he knows there were superior solutions available at a better price.

A fiduciary standard would require the salesperson to explain and disclose how he gets paid on one vehicle versus the other, and ultimately to steer you to the one that is most prudent for you.

I have to admit that my opinion on the matter is biased. You see, as a Registered Investment Advisor, I am legally bound by the Investment Advisors Act of 1940 to act as a fiduciary to my clients. I also hold the CFP® designation, which has standards of conduct for those that provide financial planning services (such as myself) that require a fiduciary duty of care.

Finally, I have made a Fiduciary Standard of Care pledge as a cornerstone of ATX Portfolio Advisors business. I have firmly committed to putting my clients’ interest first and feel that the status quo puts me at an advantage over much of my competition that isn’t required by law or ethical standards to put clients ahead of profits. Oh, and did I forget to mention that we do it quite inexpensively?

If your advisor isn’t a fiduciary, how can you be confidant that he or she is looking out for your best interests? Just like Linus had unwavering faith that the Great Pumpkin would take flight on Halloween, you can hope that Uncle Sam will protect you.

Or you can choose to work with someone who puts your needs first. Happy Halloween!

Which Hat Are You Wearing?

Jim Parker, Outside the Flags
Vice President, Dimensional Fund Advisors

Most of us have multiple roles—as business owners, professionals, workers, consumers, citizens, students, parents and investors. So our views of the world can differ according to whatever hat we’re wearing at any one time.

This complexity of people and their range of motivations, depending on their circumstances, highlight the inadequacy of cookie-cutter or automated investment solutions.

For instance, if you work for a taxi booking firm, you’re naturally going to take greater-than-usual interest in technology that allows consumers to book cabs directly. That’s because these new disintermediated services might affect how you make your living.

On the other hand, as a consumer you may welcome any initiative that increases competition, widens your choice and lowers prices.

As a taxpayer, you may look kindly on efforts to encourage user-pays systems in universities. But as a parent, you may be concerned about your teenage children taking on excessive debt to fund their education.

As citizens, we might champion a laissez faire approach to economic policy. But as investors, we may feel uncomfortable about certain policies and seek to express our values by placing limits on how our money is invested.

The point is everyone has the right to their own opinions and intelligent people can legitimately and respectfully disagree on many issues, including about what might happen in the world economy and about how policymakers should act.

The trick is in being clear with ourselves about which hat we are wearing when we make investment decisions and the trade-offs involved in reconciling our personal opinions with our desired investment outcomes.

For example, you may have an opinion on what central banks should do in normalizing interest rates. But do you really want to hang your decision about your portfolio allocation to longer-term bonds on your view of the interest rate outlook?

As a worker in an industry undergoing digital disruption, you may have an aversion to the technology putting you out of a job. But as an investor, do you want to forsake earning a share of the wealth from the new forces created by this disruption?

As a resident of a suburb near the airport, you may oppose on noise grounds a government decision to build a new runway, but as an investor and a worker you might benefit from the increased productivity generated by the investment.

The point is we have many roles in life and there often can be conflicts between our personal beliefs and opinions in one area with our desires in another.

Our strong view on the economic outlook may lead us to think the market will come around to pricing assets based on that opinion. But the power of markets is such that they reflect the views of millions of people, many of whom may hold contrary views.

Keep in mind, also, that competitors in those markets include professional investors with multiple sources of information and state-of-the-art technology. And even they have trouble getting these forecasts right with any consistency.

This isn’t to say we can’t invest based on our personal principles. But we first have to start from the assumption that in liquid markets competition drives prices to fair value. Prices reveal information about expected returns. That leaves us to diversify around known risks according to our own preferences and goals.

In short, life is full of trade-offs. It is the same in investment. We may pursue higher expected returns, but we want to do so without sacrificing diversification or cost.

The over-riding principle is to understand what we can and can’t control. We can have an opinion on government policy and we can express it through our vote, but we can’t control the investment outcome. We can have an opinion on what should happen to interest rates, but we can’t control what happens. So we diversify.

The role of a financial advisor is to help you understand these trade-offs and to separate opinion from fact, to balance your risk preferences with your desired wealth outcomes, and to accommodate your personal values within a diversified portfolio.

People with many hats require many different investment solutions. And that’s a good thing.

Dimensional Fund Advisors LP ("Dimensional") is an investment advisor registered with the Securities and Exchange Commission. 

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. This content is provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services. 

Guest Article - Unhealthy Attachments

By Jim Parker, Outside the Flags
VP, Dimensional Fund Advisors

Have you ever made yourself suffer through a bad movie because, having paid for the ticket, you felt you had to get your money’s worth? Some people treat investment the same way.

Behavioral economists have a name for this tendency of people and organizations to stick with a losing strategy purely on the basis that they have put so much time and money into it already. It’s called the “sunk cost fallacy.”

Let’s say a couple buy a property next to a freeway, believing that planting trees and double-glazing will block out the noise. Thousands of dollars later the place is still unlivable, but they won’t sell because “that would be a waste of money”.

This is an example of a sunk cost. Despite the strong likelihood that you’ll never get your money back, regardless of outcomes, you are reluctant to cut your losses and sell because that would involve an admission of defeat.

It works like this in the equity market too. People will often speculate on a particular stock on the basis of newspaper articles about prospects for the company or industry. When those forecasts don’t come to pass, they hold on regardless.

It might be a mining stock that is hyped based on bullish projections for a new tenement. Later, when it becomes clear the prospect is not what its promoters claimed, some investors will still hold on, based on the erroneous view that they can make their money back.

The motivations behind the sunk cost fallacy are understandable. We want our investments to do well and we don’t want to believe our efforts have been in vain. But there are ways of dealing with this challenge. Here are seven simple rules:

1. Accept that not every investment will be a winner. Stocks rise and fall based on news and on the markets’ collective view of their prospects. That there is risk around outcomes is why there is the prospect of a return.

2. While risk and return are related, not every risk is worth taking. Taking big bets on individual stocks or industries leaves you open to idiosyncratic influences like changing technology.

3. Diversification can help wash away these individual influences. Over time, we know there is a capital market rate of return. But it is not divided equally among stocks or uniformly across time. So spread your risk.

4. Understand how markets work. If you hear on the news about the great prospects for a particular company or sector, the chances are the market already knows that and has priced the security accordingly.

5. Look to the future, not to the past. The financial news is interesting, but it is about what has already happened and there is nothing much you can do about that. Investment is about what happens next.

6. Don’t fall in love with your investments. People often go wrong by sinking emotional capital into a losing stock that they just can’t let go. It’s easier to maintain discipline if you maintain a little distance from your portfolio.

7. Rebalance regularly. This is another way of staying disciplined. If the equity part of your portfolio has risen in value, you might sell down the winners and put the money into bonds to maintain your desired allocation.

These are simple rules. But they are all practical ways of taking your ego out of the investment process and avoiding the sunk cost fallacy.

There is no single perfect portfolio, by the way. There are in fact an infinite number of possibilities, but based on the needs and risk profile of each individual, not on “hot tips” or the views of high-profile financial commentators.

This approach may not be as interesting. But by keeping an emotional distance between yourself and your portfolio, you can avoid some unhealthy attachments.

Diversification does not eliminate the risk of market loss. There is no guarantee investing strategies will be successful.
Dimensional Fund Advisors LP ("Dimensional") is an investment advisor registered with the Securities and Exchange Commission. 
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. This content is provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.