Meet Carol

When I go to cocktail parties and people learn what I do, they ask me if I have any idea where the market is headed. I typically answer “no” and they look at me like I’m some kind of weirdo.

Hey, I can guess as good as the next person but that’s not the point. It’s simply that I think it’s irresponsible to promote this fallacy that that’s what professional investors think about and that being good at that kind of guessing is a skill needed for investing. I don’t believe in guessing where the market’s headed. Nobody knows. It doesn’t matter.

Meet Carol. Carol’s a doctor. The first thing you notice about her is that she’s really tall and, unlike some really tall women, she wears seriously high heels. We’ve met at her office intending to head to the hospital cafeteria for lunch. I struggle to keep up as she strides along the corridors and I don’t know, maybe it’s the lab coat or the stethoscope around her neck, but there’s something about her that tells people she’s in charge and really smart.

Today she’s wants me to know that she’s decided that she needs to pay more attention to her portfolio. Now, if you’ve gotten this far, you know I’m just adamant that you pay attention to your portfolio so I initially applaud her decision. However, it turns out that her version of paying more attention was about to drive both of us crazy.

Here’s why. Carol’s version involves her correctly guessing when the market is going up and when it’s going down. She thinks she can move in and out of stocks virtually guaranteeing that she’ll do better than I will using an approach that ignores market guesses.

You see, I’ve been managing her money for years and she’s done quite well relative to the market. Of course, she lost money last winter and hindsight is calling her. “I could just kick myself for not being more involved. I would’ve done better if I’d been paying more attention’” she says. I’m thinking to myself, okay, I have been paying attention and we’ve done damn well if I do say so myself.

This idea that she can predict the market has been brewing for some time. Last winter in the thick of the downturn and just days before the presidential election she said, “I’m frightened the market will just keep falling and I want to pull out. But I don’t want to do it before the election because I think it will go up when Obama is elected. What do you think?”

“Well Carol, as I’ve said many times before, I have no idea what the market will do and more importantly, I wouldn’t make market predictions the driver of your investment decision making.” Look, I wasn’t taking a position regarding whether Carol should pull her money out, just that doing it or not shouldn’t depend on a naïve belief that she had some special insight into market predicting.

“But, just for the heck of it,” I say, “if I were a betting woman I’d guess that the market will fall when Obama is elected. It’s pretty clear that the outcome of the election will be in Obama’s favor so that fact is already priced into the market. In fact, the market has rallied for the past three weeks and I’m guessing a good part of that is anticipation of his victory.”

“Well,” she says, “I’m going to hang in there because I think it will go up.” And she did.

And then, guess what happened? Obama won the election and the market began a steep decline on Election Day and it continued for several weeks thereafter. Carol, who before the election was evidently feeling as though she couldn’t tolerate the volatility, didn’t listen to what mattered, her risk tolerance, and instead ignored that in favor of the siren call of market prognostication.

What should Carol have done differently? First and foremost, she should get over this idea that it’s all about guessing where the market is headed. I know this is heady stuff driven by media who’ve realized that it’s the sexy part of investing, talking about market swoons and peaks. You know, it’s like human catnip. People get sucked into thinking they’re smarter than everybody and while they acknowledge the statistics that show that no one can fruitfully predict the market, they nonetheless can’t stop themselves from trying it again and again.

Since then, Carol and I have gone many rounds. Rewind and replay: Carol ruminates out loud about where the market is headed, asks what I think about where the market is headed and then what I think we should do about it. I respond each time that I have no idea where the market is headed and think we should keep on keeping on. I explain that the best use of my time is instead paying attention to owning the right investments and constructing the best possible portfolio while letting go of things I can’t control. Yes, her portfolio will go up and down as the markets do the same, but if I can make a portfolio that goes up more than the market and down less then we’ve won.

This spring, Carol opened a new IRA Rollover account and moved several hundred thousand dollars into it. “Don’t invest that money just yet” she says, “I think there’s going to be a major market collapse soon. In fact, I’m going to send you a newsletter that predicts the market will crash in the fall. Have you heard of this guy? What do you think?”

Silently, I think “here we go” and we repeat our well-worn dialogue yet again. This time, Carol keeps her new money out of the market and the market goes up over 50% in the days in the ensuing days and months. Carol’s return for that same period was in the low 30% range as the added cash was a counterweight to the stellar returns posted by her stocks. In normal times, a portfolio rising 30% in several months is not bad at all. This time however the strong move upward was preceded by an equally strong move downward. She needed to earn all 50% to make up for what she’d lost.

In each instance of market timing, she zigged when she should have zagged. And that’s exactly the reason why market timing doesn’t work. I don’t say she failed because her guesses were perfectly ill-timed, I’m saying she never should have fallen into the market timing trap in the first place. She needed to do what I’ll teach you to do and that is to develop your own tolerable range of stock holdings and then to stick with that range as markets go up and down. Had she stayed the course in each instance, her returns this year would have outpaced her losses last year.

Now it’s September and we’re having lunch. The last item on her list is that she has some new money to invest. She thinks she knows what I’m going to say but asks what I think about this guy and his prediction of a major market downturn. She mentions that he’s been right before and wants to know if I think there’s something to his prediction this time. Carol asks, “Do you think I should keep this new money safe until the market falls again, and then I’ll put the money to work after that happens?”

“Carol I don’t know why you think you can make more money or lose less by guessing where the market is headed.” “I know,” she says “they say you can’t predict markets.”

“Carol, what do you mean ‘they say?’ I’m not talking about some abstract statistic here, I’m talking about the fact that you’ve taken several runs at predicting it and each time you’ve been wrong, leaving a substantial percentage of return on the table. What’s with that?”

“Yeah,” she says, “maybe you’re right. But, what do you think I should do?” Uggh.

Carol and I part and I expect we’ll have these discussions for so long as markets remain volatile. A period of slow steady gains will be needed to allay Carol’s desire to play the prediction game. She’s not alone.

Think about it. How many times have you tried and been wrong? Most investors who move in and out focus solely on one side of the investing equation. They pay attention only to pulling out before markets tumble and little to putting it back in before markets take off. I read recently of a study of women’s behavior toward continued use of beauty and weight loss products. When women perceive a product is not working, they continue to use it. The researchers attributed this to the fact that when you think something isn’t working, you simply need to keep at it longer. I’m guessing that whatever it is, the phenomenon applies to market timing because now more than ever investors are trying it, failing and trying it again with increasing fervor at every turn.

And they’ve got plenty of folks feeding their frenzy. Any guru can make a name for himself predicting the market will fall. If he persists in his prediction long enough, he’ll eventually be right. The market will fall. Markets rise and fall; that’s their nature. If the market falls close in time to when he made the prediction, then he’s a genius and will attract many followers who will cite that he predicted this and such market collapse. No one pays attention to the fact that he never says when to put money back into the market.

Professional long-term investors know that investing well has nothing to do with either and plenty to do with much more mundane things. The good news is that the things important to investing well are all things any woman would know. Investing well involves following steps, mixing in the right ingredients, in the right portions and in the right order.

Those of my clients that stayed invested in their unique mix of stocks and bonds fared better than those that jumped in and out. With clients that maintained their overall strategy we were able to use defensive techniques such as buying in equal proportions and rebalancing all of which get little press but which I promise will help you lose less and gain more. And these techniques are all built into my system. You’ll be using them without even knowing it. I’ll teach you.

3 minute game

I have a client who loves to tell me that in the downturn last fall and winter she lost only 20% in her little play account compared to a loss of over 29% in her portfolio I manage. (Let me correct that, what she says is that she lost 20% while I lost her 50%. ) She laments that I can't be as nimble, chalking it off to the fact that I manage so much money. It was easy for her to know exactly what do do at exactly the right time. I want some of that.

Now, what's wrong with this picture? First, she'd be a rare investor indeed if she were actually aware of the percentage return on that little account she has. Few people actually measure the whole and instead just focus on one or two trades. But it's the whole that counts.

Secondly, for arguments sake, let's say that during those agonizing months of September through December of 2008, she actually lost only 20% when everybody else lost much more. Does it really matter when it's only 4 months out of a lifetime of investing?

Another clients wants to know how far up we are from the bottom. As it turns out, the "bottom" hit on March 9th, a day notable in no other respect than it simply (as of this writing) was the day the market bottomed. He wants to know if our portfolios have returned that same percentage since that day. I say no, we've returned just a bit less since March 9th. "Oh" he says.

But what's the magic of beating the market since March 9th? I might have said, we're beating the market since March 3rd, and since the beginning of the year, or over the past 12 months or even for 10 days during February - the measuring periods are infinite and I sure can find plenty for which we're winning.

I shared this random short-term performance measuring phenomenon with a friend and she said it's like being in a football game and focusing on whether you scored more points than your opponent during 3 minutes of the 3rd quarter. So what if you did? Does it matter?

Stuff Happens

It's been a few years since my last post. I saw the movie Julie and Julia over the weekend and decided to go back to see what I'd blogged in those halcyon days before THE CRASH and to reconsider blogging again.

Anyway, long story short - I can't believe how freakin' right on I was in blogging about financial stuff IN 2005 that actually came to fruition IN 2008.

So, I'm going to blog again. Except this time my material will be interesting and engaging. It'll come from my client chronicles. The material is sometimes funny and sometimes serious as I help clients slog through their investing foibles. You'll get a firsthand look into the stupid decisions others have made and in the process learn how to avoid those same pitfalls. Some, like the one entitled "Meet Abigail", I've used in the proposal for my book, Stocks and Blondes, other stuff's just from emails and cocktail party conversations.

Bon Appetit (that's a little Julia humor.)

Management Fee

You pay us an annual management fee of 1.25% as our sole source of compensation for managing your money. We are not a broker dealer, however, so we cannot hold your assets, execute trades or provide you with the account insurance and services of a broker dealer. For that we use the services of a broker dealer - in this case Fidelity - and each client pays commissions directly to Fidelity.

We have negotiated an arrangement with Fidelity on the strength of the multiple millions of our client assets that are held with them. They have agreed to waive all account charges and trade fee minimums and have reduced their commission rate to 4 cents per share. To contrast, you were likely paying on average 50 cents per share at UBS for individual stock trades. So for instance, buying 100 shares at Fidelity will cost you $4, whereas that same trade at UBS would likely run you $50.

Charter doesn't earn anything on the commission so we never trade unless we truly believe that it will add value to your portfolio. Our fee structure is such that our interests are aligned with yours and we stand in your shoes in terms on not wanting you to pay a penny more than absolutely necessary.

Does that answer your concern?
Susan
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What's The Proof

On the critical question, the best way to judge how a financial advisor might do for you is to look at her investment performance. While past performance is no guarantee of future performance, it is the only objective proof of real results.

My point was not that there is no way to tell whether a Money Manager is doing a good job, but rather that most of those falling under the big tent called financial advisor do not in fact have any performance to show you. That is because they are really financial salespeople whose fortunes are driven by the need to create for themselves an income out of the commissions derived from selling investments. As such, neither they nor their wall street firms track or compile performance on their accounts - it's meaningless to either's needs so long as the broker can keep the client happy and productive from the transaction standpoint.

This category of financial salesperson may masquerade by many monikers, all designed to make you think the are advising you or consultanting for you. I don't have any statistics, but I'm guessing that this group represents a huge percentage of the total number of those employed in the financial world and includes stockbrokers, certified financial planners (unless they just provide planning and don't sell any funds to implement the plan, which is really hard to do profitably,) insurance and annuity salespeople.

For their part, investors aren't driving the industry to show performance either. They pick brokers that establish rapport with them and they will keep that broker so long as the warm and fuzzies are there and those employed by big wall street firms get a presumption of competence. (They're competent alright - just the relevant competence is generating commissions.) The industry reinforces messages of trust and security training investors to value the only thing the industry has to offer - a good vibe.

What exactly does it mean when an investor says that Mr. Merrill has "produced a consistent smooth surface on the lake?" I can guarantee you what it doesn't mean. It doesn't mean Mr. Merrill has performed well or adequately because that investor has no clue. For that matter, Mr. Merrill has no clue.

So, who has performance, how is it measured and what does it mean?

Generically speaking, portfolio managers have investment performance. Portfolio managers work at mutual funds where their job is to get the best return for their asset class which in turn helps brokers sell their fund. Portfolio managers also work in trust departments and increasingly at independent Registered Investment Advisory firms, like Charter Financial Group. The commonality among all types is that they make the decision of which individual stock or bond to buy or sell (as opposed to buying mutual funds or other products) or whether to hold money in cash or to put it to work. The are held accountable for the return from the moment they are granted authority to make decisions over the funds.

A mutual fund portfolio manager's portfolio is the whole fund. It's impossible for her to consider as clients those individuals that hold the fund. If her performance is bad then the sales force (brokers) won't be able to sell it any more and she gets fired. If it's really good and she becomes a star, she leaves the fund and starts her own firm and that's why mutual fund families now use teams of portfolio managers to manage the funds. When one leaves, they can still claim the lengthy historic track record. Do you know who is managing your mutual fund. It could be a team of monkeys for all you know.

Charter is in essence a portfolio manager for individuals. Clients hire and grant us discretionary authority to manage their money. For that, we are paid an annual management fee of 1.25% of the asset value and have no other source of revenue. We make our investment decisions using a well conceived methodology and have a track record that proves our talent. We have about 35 client relationships. Our official minimum is $250,000 but I routinely take up and coming clients with less so long as they have enough for me to create a diversified portfolio comprising 25-30 stocks and perhaps some bonds.

We can, and do, measure performance because all accounts with the same investment objective are invested in the same securities, with minor exceptions tailored to individual preferences or tax consequences. We think that the decision to buy say Cisco over Dell should be driven by an analysis of the market and the companies themselves and not by the character of the investor. We do the individual tailoring at the asset allocation level where the mix of stocks, bonds and cash is designed to meet the individual's risk tolerance, liquidity needs, time horizon and tax situation.

This is dramatically different than the book of business your broker maintains which is likely characterized by several hundred clients invested in a hodgepodge of stocks and bonds and mutual funds and other products reflecting whatever of those was being pushed or brought to market at the time the investor had funds to invest. As an aside, when I worked at Merrill Lynch we were offered an extra payout to sell different stocks each day and kept a greater percentage of our commissions selling certain mutual funds over others.

Bottom line, I'm going to attach our net of fee performance of our Multi-Cap Equity Composite. Note that the record is for stock only. It's the record of the every account we've ever managed for individual clients who would be invested in your kind of portfolio. There is no cherry-picking, it includes all discretionary, fee-paying accounts that have a market value of at least $250,000. We have a system that tracks performance and it captures daily values of every account we manage that meet the minimum criteria I just mentioned.

A number of our clients hold bonds and we separately track their record for that portion of their accounts and show their total (both stock and bond) portfolio return as well. We don't publish our bond return as a composite because there is not enough commonality among our clients' bond portfolios to group them for purposes of preparing a composite. Some have Michigan Munis, some have taxable corporate, etc. Bonds really are driven a lot by tax situs so they're all over the map.

Our track record is considered very strong by those that know investment performance. Any time a manager can consistently outperform the market, it is very notable. I mention this, because in an investing world driven by warm fuzzies as opposed to objective criteria, there is little to compare the strength of a track record. Ironically, those without any track record often disparage even stellar ones and there is not context to refute the charge.

How has your WHOLE ACCOUNT performed FROM THE MOMENT YOU HANDED OVER THE REINS? How does the return of the stock portion, including cash earmarked for stock investments performed relative to the S&P 500 performed for the same period? How has the bond portion, including cash earmarked for bonds compared against the relevant bond benchmark for the same period? Don't let Mr. Merrill tell you about the really big gain you got in one stock trade or the great mutual fund he invested you in once. SHOW ME THE MONEY. Everything counts - all the time.

Whew! You'd think I get paid by the word. Sorry.

Susan

Investment Advisor or Salesperson?

Ask your investment advisor to show you evidence of investment expertise in the form of performance history. While past performance is not a guarantee of future results, it’s virtually the only thing that exists as tangible proof of a manager’s ability. If the advisor does not have performance to show you, then you’re probably talking to a financial salesperson not an investment manager and you need to move on.

Susan