Temperament over Intellect

Warren Buffett once said, “The most important quality for an investor is temperament not intellect.”

Investors very often buy at high prices when the market is hot and attractive, and sell at low prices after observing periods of poor performance.

This leads average investors to severely trail both the S&P 500 index and the Barclays Aggregate Bond Index over long time periods.  This is why investors are very often their own worst enemy.

CBS MoneyWatch author Larry Swedroe recommends in a recent article that you ask yourself if you believe that you’re best served by being your own advisor:

  • Do I have the temperament and the emotional discipline needed to adhere to a plan in the face of the many crises I will almost certainly face?
  • Am I confident that I have the fortitude to withstand a severe drop in the value of my portfolio without panicking?
  • Will I be able to re-balance back to my target allocations (keeping my head while most others are losing theirs), buying more stocks when the light at the end of the tunnel seems to be a truck coming the other way?

 

“Shelf-Space” – Another dirty little secret about big brokerage firms

Cereal companies pay grocery stores to place their products at eye level on the shelves.  Higher visibility leads to higher sales.

Mutual funds do the same thing.  They pay big brokerage firms big money to tout their products.  So when you call up a firm like UBS or Morgan Stanley Smith Barney and ask for an investment recommendation, they have a list of preferred mutual funds that they want you to buy so they can make more money.

These “revenue sharing” payments can be very big revenue sources for brokerage firms.  For example, nearly one-third (33%) of Edwards Jones’ $481.8 million profit in 2011 came from “revenue sharing” fees.  Note that Edwards Jones is forced to disclose more information on sensitive matters like this than its competitors thanks to a 2004 regulatory settlement.

Though “revenue sharing” payments are legal, many critics question if they are ethical since it calls into question whether recommendations are based solely on what’s in the best interest of the client.  Brokerages are not fiduciaries and have no requirement to put client’s interests first.

“It’s an unholy alliance between mutual-fund firms and brokerages to exploit their customers,” says John Freeman, emeritus professor of business and professional ethics at the University of South Carolina Law School.

Investors who want to avoid questionable practices like “shelf space” and “revenue sharing” should seek advice from a fiduciary such as a registered investment advisor.

source:
Wall Street Journal: Brokers Raise Fees, but Not For Investors: Why You Should Care

2011 IRA Contribution Reminder

Here’s an important reminder if you have an individual retirement account (IRA) or are considering opening an IRA.

2011 contributions to your IRA accounts can still be made up through April 17th.

Maximum Annual Contributions (IRAs and Roth IRAs only):

• $5,000 for tax year 2011
• Age 50+: Catch up contributions of an additional $1,000

Complex Annuities See Surging Sales ~ Investors Should Beware

An “indexed annuity” is a complex, high-cost, and illiquid financial product. They pay interest based on the performance of stock and bond market indexes.  Insurers guarantee buyers will not lose their principal, but they require investors to lock-up their capital for long periods, often more than a decade.

Indexed annuities are very popular with insurance salespeople because they are a high commission product.  Insurance agents can get an up-front payoff of 12% or more of the invested amount simply by making the sale.  The accompanying chart demonstrates the sales of indexed annuities have surged in the past decade.

Investor protection agencies and authorities are very concerned about abuse and fraudulent activity around annuities sales.  Former California insurance commissioner Steve Pozner warned that agents “who steal from vulnerable seniors will not get away with their shameful tricks.” 

Perils of Private Student Debt

It’s very important to understand the difference between private and federal student loans.

Federal student loans come with

  • lots of consumer protections
  • fixed interest rates
  • many repayment options (including an income-based option that strongly reduces payments)
  • debt forgiveness after 20-25 years

Private student loans, on the other hand, come with

  • very few consumer protections
  • variable interest rates (risky!)
  • very few payment options
  • debt never expires

Using private student loans is like paying for college with credit cards!  But there’s one critical difference — credit card debt can be discharged in bankruptcy but private student loans can not. Private student loan lenders can pursue you to your grave.

Best- practice:
Stick to federal loans because they have a lot of protections and advantages.  Limit yourself to borrowing no more than what you expect to make the first year out of college.

North Carolina Men Charged & Sentenced for Black Diamond Ponzi Scheme

Three North Carolina men have been charged and sentenced in connection with the Black Diamond Ponzi Scheme.

These men were part of a group charged with operating a $40 million Ponzi scheme.  They claimed they were operating a legitimate hedge fund called Black Diamond when in fact they were not.

A Ponzi scheme is a fraudulent investment operation that pays returns to its investors from their own money or the money paid by subsequent investors, rather than from any actual profit earned by the individual or organization running the operation. A hedge fund is an investment fund that can undertake a wider range of investment and trading activities than other funds, but which is only open for investment from particular types of investors specified by regulators.

The group sought money from investors who were often elderly and retired using false and fraudulent claims.

Jeffrey M. Muyres, 36, of Matthews, NC pled guilty on December 7, 2010, to conspiracy to commit securities fraud and money laundering conspiracy.  Muyres was sentenced to 23 months in prison.

Bryan Keith Coats, 51, of Clayton, NC pled guilty on October 24, 2011, to conspiracy to commit securities fraud and money launering conspiracy.  Coat has not been sentenced yet.

Roy E. Scarboro, 47, of Archdale, NC pled guity on December 3, 2010, to securities fraud, money laundering, and making false statements to the FBI.  Scarboro was sentenced to 26 months prison.

Pitfalls of Variable Annuities

The guy that’s about to make a fat commission from selling you a variable annuity probably won’t tell you about the often overlooked pitfalls of this complex financial product.

A variable annuity is effectively a mutual-fund account wrapped inside  an insurance policy.  It consists of three parts: (1) a general account, (2) subaccounts, and (3) a death benefit.

Larry Swedroe elegantly summarizes the disadvantages of variable annuities in his book “Investment Mistakes Even Smart Investors Make and How to Avoid Them.”:

  1. the high cost of the insurance
  2. the high operating costs of the investment accounts
  3. the lack of passive low-cost investment choices
  4. the conversion of preferentially taxes capital gains into highly tax ordinary income

Think carefully before buying a variable annuity.  If you feel you truly need this product, look for one with lower cost structures and better investment choices such as those offered by AEGON, Schwab, TIAA-CREF and Vanguard.

Your 401(k) is NOT Free

It’s nearly impossible for most 401(k) participants to determine how much they pay in fees.  Those fees are not typically disclosed to investors.  But a bright light is about to shine in this dark corner as new Labor Department rules will require 401(k) fee disclosures.

According to the Investment Company Institute, participants of small 401(k) plans (100 participants) pay on average 1.30% per year.  Large plans (1000 participants) typically charge 1.08% per year.

This transparency to the actual costs will put pressure on employers and plan providers to exercise better due diligence.  This includes switching to lower cost funds, combining inexpensive funds with personalized advice, and creating simple disclosure statements.

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