Researching Investments

We briefly touched on how to research investments in our previous discussion, but will do so more thoroughly here.

Independence

As we said before, the first consideration regarding research is independence. Why? Let's think for a moment about the way investment banks (now chartered as commerical banks, by enlarge, but still fulfilling the primary roll of raising capital for publicly owned businesses) are structured.

The part of brokerage firms with which women are most familiar is that of the investment advisers. This consists of brokers who invest money on behalf of clients, and either:

• Earn commissions for buying and selling securities; or
• Earn a commission based on a percentage of assets under management.

In a related part of the firm, the brokerage earns fees from companies for raising money for them by

• Selling ownership in the company (stock) to their brokers' clients
• Borrowing money for the company (bonds) from their brokers' clients
• Providing strategic management advice to the company about their capitalization (stock and bonds outstanding)

In a separate part of the firm, the brokerage owns stocks and bonds in its own account, and buys and sells those securities to make a profit.

In an additionally separate part of the firm, the brokerage provides investment advice (buy and sell recommendations) to its brokers and to the general public.

While legally, there is a "Chinese wall" separating these various functions in a brokerage firm, it is apparent that there exists the possibility that, if a brokerage wanted to sell a stock from its own account, its analysts could be encouraged to provide a "buy" recommendation on that stock in order to provide both a market and favorable price to sell that stock to its brokers' clients and the general public who follows its research. I am not saying that this does happen; rather, I am saying that it could happen, and therefore there is the a possibilty of impropriety.

Remember, too, that Standard & Poor's and Moodys both provided their highest ratings to so-called Auction Rate Securities, securities that were backed by mortgages, some of which were sub-prime. When reviewing the procedures used to qualify for that rating, it became clear that the fact the issuers of those securities were paying fees to these rating agencies for the rating, resulted at least in part to receiving that highest available rating- the same as is provided to US Treasury debt. Here, the conflict of interest was obvious.

So, researcher independence is critical. Who, then, independent?

Some companies are paid for their research by their clients who are subscibers - not by the companies they analyze. The largest, and most experienced of these companies are

• Value Line (specializing in stock research)
• Morningstar (specializing in mutual fund research)

MORAL: Your research is best when in comes from a company that does not benefit from your decision of whether to buy or sell a security, and has a lengthy track record.

MORAL: Even if you use a full service broker, ask what research she uses. If it's not independent, neither is your broker.

Methodogy

Broadly, there are three types of investing: growth, value and passive.

• Growth investors choose securities that are growing faster than the stock market as a whole, and try to take profits before any negative news causes the stock to drop
• Value investors buy high quality but out-of-favor companies that are inexpensive because of a negative short-term situation
• Passive investors buy an "index" that replicates the market averages, thinking that no one, after trading costs and taxes on sales, beats long term market performance

Growth investors will find Value Line stocks rated as 1 for timeliness as meeting their general criteria. It is noteworthy that, over the last 25 years, a portfolio of such stocks beat the S&P 500 average significantly.

Perhaps the most famous value investor in our time is Warren Buffett. Those securities in his Berkshire Hathaway portfolio are examples of long term value investing. For individual stock research, Mary Buffett's "Buffettology" series is a good way to learn to select and evaluate such stocks. I have worked and taught with Mary, and find her books the most accurate and easy to understand approach to learning value investing research and principles.

Passive investors, and those who prefer to buy mutual funds can use Morningstar reports to find funds that meet their investment goals.

Value Line, Morningstar and the Buffettology series should all be available to you through your public libraries.

There are many other sources of independent research. If you choose to use one, check the author's experience and portfolio performance carefully, and ensure that both have been evaluated independently over at least ten years.

MORAL: Pick an investment strategy and stick to it. Moving back and forth (e.g., growth and value) does not work. Once you know your preferred strategy, use the best source of information available for that method of investing.

Part I - How to Find a Financial Adviser - Investing (cont'd)

From the previous article, you have a general idea of whether you need a lot, a little, or almost no guidance in choosing investment from your adviser.

If you are a woman who is best suited with an adviser who will walk you through the entire investing process, this discussion is for you.

Broadly, there are two type of advisers who fit your needs:

• Full service brokers (like those employed by Goldman Sachs, JP Morgan, etc.)
• Fee-only financial planners

Full Service Brokers

Education and Experience

Series 7 License

A full service broker will have a Series 7 (General Securities Registered Representative)licence, that shows at least 70% accuracy in answering 250 questions about

• Stocks
• Bonds
• Mutual Funds
• Options (derivative instruments)
• Commissions

as well as a Series 63 (State specific) license.

This individual will have passed a background check by the employing firm and be fingerprinted.

Most investment bankers (Goldman Sachs, JP Morgan, Morgan Stanley, etc.) have changed their charter to commercial bankers because it allows them to raise money more cost effectively. If, for example, you bank at Chase, you will find that it is owned by JP Morgan, formerly an investment bank. In your bank branch, you may find a person who sells securities. This person is not a bank employee, but works under a separate "umbrella" company - which is different and separate from JP Morgan brokerage.

Series 6 License

These advisers may have only a Series 6 (mutual fund representative) license, and are not authorized to sell individual stocks and bonds.

These advisers will be familiar with general guidelines as to whether a particular fund or group of funds is appropriate for your level of risk.

CFP - Certified Financial Planner

This is a national designation that the adviser has passed a rigorous course of study that includes budgeting and cash flow, investments, taxation, risk management, education financing and estate planning. There are additional requirements for continued education.

CFA - Chartered Financial Analyst

This person will be skilled in analyzing both portfolios and individual securities.

Other Professional Designations

Advisers may also have licenses to sell insurance products (such as annuities), regional professional designations issued by the American Banker's Association, various universities and other financial education providers. Contacting the issuer will give you the scope of training represented by the license or designation.

ASK THE ADVISER

• What licences she has
• What professional designations she has
• The length of experience she has

and verify that information through:

http://www.finra.org/Investors/ToolsCalculators/BrokerCheck/index.htm

or http://www.cfp.net/search/ for a fee only planner.

You want a person that has significant experience and training.

2. Type of Client

The type of adviser that will likely serve you best is one who serves people like you. If your adviser's clients are primarily 70 year old retired executives from Boeing and you are a 30 year old middle management woman, your adviser may not have the background to best address your particular financial needs.

ASK THE ADVISER TO DESCRIBE HER TYPICAL CLIENT.

• Age
• Average account size
• Occupation
• Risk tolerance

If the description is significantly different from your situation, you may be best advised to keep looking.

3. Historic performance

Over very long periods of time

• The stock market yields about 8 - 10% per year
• The bond market yields about 4.5% - 6.5% per year
• A portfolio of 60% stock and 40% bonds yields about 6.6% to 8.6% per year
• With significant differences from year to year.

One of the red flags that should have been seen by Madoff and Standford's clients was consistently beating market averages year after year after year, with no apparent increase in risk. Not Peter Lynch, not Warren Buffett, not ANYONE has achieved this performance, and no credible investment managers would intimate that such returns are either probably or possible.

Ask your adviser what her average annual performance for clients has been with similar risk tolerance as yours over the past 5 years, and verify that information with her employer.

4. A word about risk tolerance

As it applies to you as an investor, risk tolerance is the answer to "How far can your portfolio go down before you freak out and

• Sell
• Wake up in the middle of the night with cold sweats
• Call you broker and ask what the heck happened to all your money

Markets predictably and regularly correct by 20% +, and as you can see from the recent correction, sometimes 50% +. In the mid-1970's when I was but a babe in the financial industry, such a correction occurred. Another one is in process now. Answer the question about risk tolerance in terms of what percentage of your portfolio are you capable of losing before you panic.

State your risk tolerance in terms of a percentage, and obtain a commitment that your portfolio volatility will remain within an amount acceptable to you.

5. Charges

Keeping in mind the general market returns provided in 3 above, ask what percentage of your portfolio you will pay for management on an annual basis. Fees will vary (some mutual funds charge 5% to buy as a one-time charge), so ask for estimated fees over a 5 year term. Ask the adviser to subtract her fees from your expected portfolio annual return, provide this estimate in writing, and tell that adviser that you're comparing fees with other investment professionals.

6. Discretion

Never ever ever ever grant discretionary trading authority to an adviser, unless you open a "wrap" account, i.e., one where your broker assigns your money to a private money manager. Under any other circumstances, this is a highly inadvisable practice.