If you’re frustrated from having one financial consultant after another financial consultant provide you with inadequate returns on your stock portfolio, then I hope you read my first article “Three Tips for Finding a Superior Financial Consultant.” In this article, I’ll drill down some more to really hammer home those points.
Finding a superior financial consultant, isn’t always about the financial consultant. Sometimes it is also about you. Are you willing to also make the commitments to find a superior financial consultant? In this article, I’ll discuss one more crucial behavior about financial consultants and two regarding the behavior of you, the investor.
Three more tips:
(1) Don’t hold mutual funds;
(2) Don’t be stingy if you find a superior advisor; and
(3) Be patient and ask lots of questions in your search for a superior financial consultant.
Don’t Hold Mutual Funds
Let me tell you why I’m not a fan of mutual funds. Mutual funds have so many hidden fees that it’s often difficult to know exactly what your costs are. Besides upfront costs that can be upward of 5% for some funds, there are 12b-1 advertising , marketing and distribution fees that range from 0.25% to 1.0%, administrative fees that range from 0.20% to 0.40% and of course management fees paid to the mutual fund manager of 0.50% to more than 1.0% annually. This doesn’t even include undisclosed “soft” costs of trade commissions that can add another 2.0% to 4.0% in costs. And yes you didn’t incorrectly read the first part of that last sentence. Many mutual funds charge you 12b-1 expenses they incur from advertisements and commercials that urge you to buy their funds, and if you’re buying no load funds, chances are that your 12b-1 fees are higher than average.
Add to this, intangible costs such as the performance that is sacrificed to maintain the necessary level of liquidity to satisfy share redemption, and your costs become even greater. For a fund that turns over 100% of its assets annually, Roger Edelson of the University of Pennsylvania Wharton School estimated this sacrificed performance to be 1.5% of returns annually. Lastly to add insult to injury, sometimes fund managers sell out of their biggest winners to meet liquidity needs, generating a capital gains income tax for you, the investor, even if the mutual fund lost money that year.
But this isn’t even where the negative traits of mutual funds end. If you have one of the many financial consultants that merely try to jump on the hot emerging market bandwagon by buying mutual funds in China, India, or any other country, I advise you to exercise extreme caution. When pullbacks happen in these country’s economies as will inevitably happen, you are at high risk of losing money quickly. Why? In a mutual fund, you are at the mercy of a herd mentality that more often than not, will induce panic upon the release of bad news, and cause millions of investors to redeem their shares over a short period of time. If this happens, fund prices will plummet before you even knew what hit you.
But if you choose to own just the best stocks in the best industries in these countries, most likely your stock prices will be much more insulated and less volatile in such a scenario. While these stocks may still decline, they will most likely decline a lot less than the fund will. Strong companies’ stock prices tend to weather country-wide economic downturns much better than fund prices, and if they are in the right niche, they may even continue to flourish.
Be Willing to Pay Fees for Superior Advice
Superior advice is superior because a lot of hard work and time go into producing that advice. I remember talking to a potential client one time that had a million dollars in the stock market and was adamant about not paying fees. He just wanted to pay commissions on stock trades. When he showed me his statements (by the way he was with a major Wall Street firm that I won’t name), there seemed to be no structure or investment strategy in his portfolio. He owned a mix of mutual funds and individual stocks, and many times those stocks were traded as soon as there was a nominal 5% gain in any of them. Furthermore, the statements by his financial consultants were misleading. The consultant handwrote on his statements that he was doing great because he was up 6% that quarter (which I believe just about matched the S&P 500’s performance that quarter). He told me that annualized, that the 6% translated into 24% returns.
But when I explained that his net returns would be much lower because his portfolios quarterly 100% turnover rate produced excessively high capital gains taxes that would undercut his net returns, he didn’t seem to understand. I guess his financial consultant didn’t bother explaining this small detail to him. Still, he insisted on paying no fees no matter what. I could tell that he was the type of person that was blindly loyal to his financial consultant, so I moved on without attempting to schedule a second meeting.
Superior advice costs money. And if your financial consultant is superior, he or she will be transparent about his fees and your costs, so that you won’t be confused about what your true gains really are. Don’t be stingy. After what you just learned about mutual funds, why would you not be willing to pay even upwards of 2% annually for superior individual advice and management when you’re almost certain to be paying more than that a year just to own a mutual fund?
Be Patient and Ask Lots of Questions
If you persistently ask the three questions I mentioned in part one of this article, you may get frustrated after talking to ten financial consultants, none of whom can answer those questions. My advice is to just be patient. Don’t give up and don’t settle for a salesperson that is trained to answer those questions to lead you to believe that he or she has answered your questions when that is not the case at all. What do I mean?
For example, when you start drilling down about specific stock picks, a common sales technique to avoid your question is an answer similar to the following: “I’m not a stock picker. But don’t worry. I know how to find the best money managers in the country to manage your money for you, so you’re in great hands.” Don’t be misled by smokescreens like this. Remember that if your financial consultant truly understands how to find you the best money managers, then he or she must necessarily have discussions about geographical preferences, industry preferences, and specific stocks with those money managers. How can a financial consultant claim to select the best money managers for you but have no understanding of what stocks you own and what makes those stocks special?
To summarize, buy individual stocks over mutual funds, be willing to pay fees for an exceptional advisory if you are so lucky as to find one, and remember, the luckiness of finding an exceptional advisor is not really luckiness at all. It comes from your hard work, tough questions, and your unwillingness to be led astray by the professional smoke screens of financial consultants