The Best Investor 2010 - First Quarter Results

Last January, I posed the question that buying shares in the S and P 500 may be just as effective as following professionals' stock market picks.  Some women who are participating in the Self-Invested Women Pilot Program are considering whether they are passive (people who buy an index, like the S and P 500) or active (people who buy individual stocks or types of stocks, like energy and health care) investors.  This may help you make that decision.
The S and P 500 Index
This index allows investors to buy 75% of the publicly traded companies in the US, many of which derive a significant part of their income outside the country.  While there are many indexes (Dow Jones Industrial, the Russell 2000, the Wilshire 5000), the S and P 500 is the index against which the vast majority of money managers measure their performance.
The Challenge
Last September, ten investment strategists gave their recommendations for which sectors of the market would outperform the total market in 2010 in Barron's magazine.  We chose six of these strategists, representing US Trust, Citigroup, JP Morgan, BlackRock, Deutsche Bank and Goldman Sachs.  We'll compare the S and P 500 index performance against the sectors recommended by each investment professional, assuming you were to invest equally in all sectors.
Fees
It requires no management fee to invest in an index like the S and P 500.  Investment advisers' fees range from 2% to 5%.  We'll use the lower figure, 2%, for this comparison, and deduct 1/2% every quarter from the recommendations by the advisers. 
Since there are trading costs for both individuals and money managers, we'll consider this a "wash."
Long Term Investing
We'll assume that we're in the stock market for long term investing, not short term "trading."  Therefore, one quarter's data is insufficient to make this decision.  We'll look at this performance all year, and discuss how relevant this little experiment is to your long term strategy.
First Quarter Performance
S and P 500
S and P 500 was up 6.04% in the first quarter this year.
US Trust
Technology + 10.45%
Materials + 6.89%
Energy + 5.04%
Industrials + 4.77%
Weighted Average performance +6.7875%, less 1/2% fee = +6.2875%
US Trust's recommendations beat the S and P 500 by about a quarter of one percent in the first quarter.
Citigroup
Materials + 6.89%
Financials - 3.68%
Software + 10.45%
Energy + 5.04%
Weighted Average performance + 4.675%, less 1/2% fee = +4.175%
Citigroup's recommendations lagged the S and P 500 by about 1.87% the first quarter.
JP Morgan
Energy + 5.04%
Industrials + 4.77%
Financials  - 3.68%
Technology + 10.45%
Materials + 6.89%
Weighted Average performance + 6.166%, less 1/2% fee = +5.666%.
JP Morgan's recommendations lagged the S and P 500 by about 3/8 of one percent in the first quarter.
BlackRock
Energy + 5.04%
Health Care + 8.53%
Weighted Average performance + 6.785%, less 1/2% fee = + 6.285%.
BlackRock beat the S and P 500 by just under 1/4 of one percent in the first quarter.
Deutsche Bank
Technology + 10.45%
Health Care + 8.53%
Energy + 5.04%
Industrials + 4.77%
Weighted Average performance + 7.1975%, less 1/2% fee = +6.6975%.
Deutsche Bank beat the S and P 500 by 3/4 of one percent in the first quarter.
Goldman Sachs
Energy + 5.04%
Materials + 6.89%
Financials - 3.68%
Technology + 10.45%
Weighted Average performance + 4.675%, less 1/2% fee = 4.175%.
Goldman Sachs lagged the S and P 500 by 1.865% in the first quarter.
Summary
So far this year, three underperformed the S and P 500 and three lagged behind its performance, with Deutsche Bank doing best, and Goldman worst.
Last year, only Deutsche Bank and JP Morgan beat the averages, and four lagged behind.
Another update after the second quarter.
We'd love to hear your thoughts.  Are you an active or passive investor - and why?

Economic Highs and Lows

After a third quarter that dazzled like a diamond in the pile of coal our economy had been for the prior year and a half, we seem to be standing at a crossroads.  The stock market seems economically cheery, but most of us are not.  What's the best action to take in times like these?

I.  Define your goal in dollars

This sounds simple, but is not.  As a matter of fact, if it's done properly, it requires soul searching.  What is your economic goal?  Not your neighbors', not your friends', not your colleagues'.  Yours.
To know that answer is to define what makes you happy.  If you're doing the things that make you happy, then all you need to do is write down how much you spend on your happy life, and ensure you have the means to live it.
If you're not doing the things that bring you joy, however, this is a big job.  You need to visualize yourself in your fulfilled state, and calculate its economic cost.  That may take some time.
But, it's an investment well worth your effort.

II.  Identify your financial challenges

• DEBT

Now, we're going to do the things that will get you to, or maintain your happy life.   If you're paying off debt, especially credit cards, your first step is easy.  Keep paying them down.  This is the singularly most treacherous obstacle to financial health.

• INVESTING

But, what if you were on the verge of retirement, and all of a sudden, BOOM!  You heard the sound of your crashing 401(k).  Or, what about any of us that are on the path toward financial security, but not there yet?  What is the best course of action to take now?
First of all, as you have seen from the stock market's 60% rise since March, selling in a panic is a very bad idea.  If you did, you learned a valuable, if expensive lesson.  You sold when you should have been buying.  You learned why billionaire investor Warren Buffett says, "Be greedy when others are fearful, and fearful when others are greedy."
If you didn't sell, you're down 30% from the highs, and wish you'd invested more earlier in the year. I advised moving back into the markets slowly last November in order to "buy low."  The price of stocks is not as cheap as it was then.  So what do you do?
First, you put nothing into the market you need within the next five years.  You NEVER put money into the stock market that you need in the next five years.  The last year is a perfect example of why that is true.
Next, you realize that, at the last market top the price (or P/E) was 19.7, and at the last low, it was 10.3.  We're at 16.9 - not cheap.  So, it's very important that you think very carefully about buying stocks that have gone up in price very quickly, like Apple, Google and AIG.  A safer strategy right now is quality value stocks, like Microsoft, GE and Bank of America, whose prices have risen less quickly.
Finally, be judicious, but keep investing.  You're not buying on sale, so don't buy all at once.  Buy more when the market is down, and less on days when it's risen quickly, and put in a little every month rather than a lot all at once. 
But, keep in mind this is where your investments return more than inflation, and don't be deterred in saving for your goals.


III.  Watch your personal sentiment
The positive outlook for the US investor is very high right now.  Warren Buffett's advice is worth repeating here, "Be fearful when others are greedy."  Yet, the sentiment outside of Wall St. is decidedly more somber.
Here, we are discussing your personal sentiment.
No one is advocating a Pollyanna attitude.  Things are tough.
But, it is under our complete control how to face our tough situation.  One of my favorite stories about Thomas Edison included his reaction to a devastating fire that destroyed much of his expensive equipment and scientific notes.  Surveying the damage, he noted that, with "all the mistakes destroyed," he could begin anew with a fresh perspective.
Like him many women welcome less spending over the holidays, making gifts instead of buying them, focusing on spending time, rather than money on loved ones.  Some intend to keep these new rituals as part of their lives even after our financial challenges are behind us.
There is much to be gained by seeing obstacles as opportunities.

Health Care Legislation

In the current debate about health care, facts are few and opinions are many. Here are some facts that may help you form your own opinion.

What We're Spending Now

The US Department of Health and Human Services' Center for Disease Control, using data from the Organisation for Economic Co-operation and Development , notes spending on health goods and services plus health-care infrastructure as a percentage of Gross Domestic Product as follows:

1. United States - 15.3%
2. Switzerland - 11.3%
3. France - 11%
4. Germany - 10.6%
5. Belgium - 10.3%
6. Portugal - 10.2%
7. Austria - 10.1%
8. Canada - 10%
9. Netherlands & Denmark - 9.5%
10. Sweden - 9.2%

Source: http://www.cdc.gov/mmWR/preview/mmwrhtml/mm5813a5.htm

US health care costs have more than tripled in inflation-adjusted terms over the last 20 years to their current level of 15.3%.

What We'll Be Spending If We Do Nothing

Further, if current policies remain unchanged, that percentage will increase to 25% of GDP in 2025, and 49% in 2082.

http://www.cbo.gov/ftpdocs/89xx/doc8948/01-31-HealthTestimony.pdf

Long Live the Rich, and the Poor Die Young

Yet, according to the NY Times, government research shows “large and growing” differences between the lifespan of Americans, based on their wealth. Admitting researchers in disagreement for reasons for this growing disparity, they do agree that a part of the explanation lies in whether an individual has health insurance.

Source: http://www.nytimes.com/2008/03/23/us/23health.html?_r=1

Expand Access and Curb Costs - One Out of Two

The Administration 's main objectives stated earlier this year were:

1. Expand access to health insurance, and
2. Curb runaway costs for the economy has a whole.

Current House legislation being considered, however, "significantly expands the federal responsibility for health-care costs," says Douglas Elmendorf, director of the Congressional Budget Office. The Senate Finance Committe has not yet released their verion of the bill. As both versions of health care legislation advance, expanding coverage has been embraced while few compromises have been made with pharmaceutical companies where savings were to have been made.

Allegations that the CBO has not "credited" such proposals as "preventative care measures" have been asserted. Those assertions are correct. It is apparent that preventative care will result in lower long term health costs. It is inappropriate, however, to assign a dollar amount to that cost savings, as that amount would be impossible to quantify.

One more quantifiable compromise would be to reduce the federal tax subsidy that encourages employers to offer large health-insurance policies, but that proposal has been opposed by labor unions (that have these tax-advantaged plans).

Where We Are Now

Current legislation has not yet achieved the goal of cutting costs in a way that will prevent unsustainable increases in health spending. Special interests on one side - particularly labor unions - are at odds with

• AMA (that wants increases in Medicare payments to doctors)
• Insurance companies (that want to prevent a government-run competitor in the marketplace)

Whatever your opinion, it is time to contact your Congressional representatives. Achieving both access and cost containment is critically important in solving this problem. The link below is provided for your convenience in doing so.

http://www.visi.com/juan/congress/

President Obama's Financial Regulation Proposal - Part V

A smart businesswoman in the Portland area asked for a synopsis of this proposal, saying, "It seems like everywhere we read doom and gloom doom and gloom. I would like to read some kind of balanced piece for once." Thanks for the suggestion, Kelly. Parts I through IV of the proposal were discussed in the three previous posts. Here's the fourth, and final installment.

Raise International Regulatory Standards and Improve International Cooperation

As we discussed previously, without international cooperation, money will move to countries with the most lax regulation and continue the type of high risk/high reward behavior that caused our current crisis. A good example is Stanford Financial, which is under investigation for defrauding investors, where the Texas founder operated freely in the Caribbean. Last April, the G-20 issued a declaration which included:

1. Strengthening the 1988 "Basel Accord" to include financial institution capital requirements that are consistent throughout the world
2. Define "capital" consistently, i.e., what can and cannot be used to substitute for cash in meeting capital requirements
3. Define how leveraged a financial institution may be
4. Set accounting standards that are similar throughout the world.

To improve oversight, the G-20 is working on contracts, to be available this Fall, to standardize and centralize the clearing of derivatives, e.g., credit default swaps, options, etc., as well as strenthening the oversight of all goals stated in the declaration.

So, where's the "gloom and doom?"

US

The US is pushing for financial reforms to address problems that we caused. This weakens our negotiating position for countries that object to more stringent financial requirements, at a time when they are weakened because of buying our Auction Rate Securities and the like.

Some countries are telling us to clean up our mess before telling them what to do. It's hard not to see their point.

Overall, these proposals are strong, having defined the root causes of the problems we face and providing logical, if sometimes politically based, solutions. The weaknesses in the proposal seem to be outweighed by the strengths. To attack the weaknesses without providing a superior solution IS politically based, and to fail to address these problems will all but guarantee that they are repeated.

The full draft of these proposals can be found at http://documents.nytimes.com/draft-of-president-obama-s-financial-regulation-proposal#p=1 I welcome your comments and discussion about any points in this proposal. And thanks, Kelly, for your suggestion to discuss this important issue.

President Obama's Financial Regulation Proposal - Part IV

A smart businesswoman in the Portland area asked for a synopsis of this proposal, saying, "It seems like everywhere we read doom and gloom doom and gloom. I would like to read some kind of balanced piece for once." Thanks for the suggestion, Kelly. Parts I, II and III of the proposal were discussed in the two previous posts. Here's the third installment.

Creation of the Consumer Financial Protection Agency

The seven government agencies named in the prior post did not prevent or address financial problems adequately during the recent crisis. The administration has proposed the creation of the Consumer Financial Protection Agency as one solution. The creation of this agency was discussed in the prior post. In addition to this agency, the administration also seeks to create "resolution regime" for failing Bank Holding Companies and so-called "Tier 1" (too big to fail) Financial Holding Companies.

Resolution Regime

This "regime" will be led by the Treasury Department, and can act only after

• consulting with the President, and
• having obtained the approval of 2/3 of the Fed board, and 2/3 of the FDIC board (if the failing institution is a bank) or 2/3 of the SEC commissioners (if the failing institution is a brokerage firm)

This, with the previously discussed increased capital requirements for "too big to fail" financial institutions, is the solution proposed to avoid situations like those seen recently with AIG and Bear Stearns. Again, the Treasury is the "big boss" when institutions that are large enough to cause widespread financial harm are seen to have significant developing problems.

As the "big boss," the Treasury now must approve loans made by the Fed to such institutions.

Where's the doom and gloom?

MORE Power for the Treasury?

Many people, as discussed before, are uncomfortable with the Treasury Department in the position as the "regulator's regulator." Now, the Fed has to consult with Treasury prior to authorize lending practices related to "too big to fail" institutions.

In reality, the Treasury Secretary was consulted in every instance when action was recently taken by the Fed. This provision makes that practice mandatory.

More Power for the President?

The Treasury must consult with the President before initiating the resolution regime for failing institutions. Some worry that the President may take the initiative and pressure Treasury to take such action. Those who make such accusations fail, in my opinion, to consider that 2/3 of the Fed board and 2/3 of either the FDIC board or SEC commissioners must also approve taking such action. The checks and balances, in this case, seem to be in place to assure that the Executive Branch not have undue influence in making these decisions.

I look forward to your comments, and will address the final part of these proposals in the next post.

Obama Administration Financial Regulation Proposal - Part III

A smart businesswoman in the Portland area asked for a synopsis of this proposal, saying, "It seems like everywhere we read doom and gloom doom and gloom. I would like to read some kind of balanced piece for once." Thanks for the suggestion, Kelly. Parts I and II of the proposal were discussed in the previous post. Here's the second installment.

Protect Consumers and Investors

The Administration seeks to protect consumers against fraud and promote understanding of financial products, like credit cards, savings vehicles, mortgages, and the like. This goal is addressed through the creation of the CFPA (Consumer Financial Protection Agency), which is charged with the responsibility to ensure that consumer protection regulations are "written fairly and enforced vigorously." This new agency will have no jurisdiction over financial products governed by the Securities and Exchange Commission or the Federal Trade Commission, but both existing agencies will have new authorities and resources.

When non-traditional mortgage lenders entered the mortgage market after new mortgage securitization produces were developed by Wall St., the regulatory framework that protected consumers of banks and thrifts did not cover those new lenders. Countrywide Mortgage, for example, incented its sales staff to sell mortgage instruments that were not necessarily risk appropriate for borrowers. While other more traditional mortgage products were available, loan agents were encouraged by amount of incentive paid by product to sell Adjustable Rate Mortgages through "no-doc" (no, or low documentation required) programs that had high up-front fee structures.

And, with respect to credit card lending, certain "fine print" issues have arisen that clearly show that, if given the power to raise interest rates for situations unrelated to current repayment history (like applying for additional credit elsewhere), financial institutions can, and will, categorically raise expenses. In the past, this situation could have been rectified by the market, i.e., customers could merely close accounts with more onerous conditions and transfer them to institutions with more consumer friendly agreements. But, as credit lines froze, such alternative credit providers were unavailable.

The mission of this new Consumer Financial Protection Agency is to ensure that

1. Consumers have the information they need to make responsible financial decisions
   
   
2. Consumers are protected from abuse, unfairness, deception and discrimination
   
   
3. Consumers' markets operate fairly and efficiently with ample room for sustainable growth and innovation
   
   
4. Traditionally underserved consumer markets have access to lending, investment and financial services
   

The CFPA will be the "consumers' seat at the table" as regards the

• Truth in Lending Act
  
• Home Ownership and Equity Protection Act


• Real Estate Settlement and Procedures Act


• Community Reinvestment Act


• Equal Credit Opportunity Act


• Home Mortgage Disclosure Act


• Fair Debt Collection Practices Act

All those Acts were in place during the mortgage crisis. The Administration proposes to solve the lack of understanding by consumers that played some part in this crisis by creating another agency and ensuring a "consumer voice," noting that its mission is to provide "a floor, not a ceiling." This means that the Agency will represent minimum and consistent standard

Examples?

• No more "mandatory arbitration clauses."


• Requiring "plain English" disclosures.


• Holding brokers to a "fiduciary" as opposed to "suitability" standard.


• Holding companies responsible to clients, as well as investors.


• Require "non-binding" shareholder votes for executive compensation.


• Increase retirement savings incentives.

So where's the "doom and gloom" here, you ask? Well, it certainly isn't in the rhetoric.

ANOTHER Agency?

I add my voice to this groan. Government agencies are expensive, unwieldy and, judging from the number which existed prior to the crisis, ineffective. The fact remains that, even with those seven agencies listed above, the housing crisis ensued.

I hesitate to unilaterally cry, "Poor little consumer" in every case. Many borrowers who KNEW they couldn't afford a $400,000 house with a $50,000 annual salary, bought one anyway. I cringe at the thought that the we as consumers are too stupid to make up our own minds. Then, I look at my credit card statement, and pause. It's ridiculous. It's incomprehensible.

So, what's the answer? The fact is, it doesn't matter. The consumer has screamed to the top of Congress that every Tom Dick and Harry financial whatever has received a squillion dollar bail-out, and she the individual is left to mind her finances properly and pay her bills on time with no help. Consumer protection is going to be written in this proposal as a political reality.

It is my hope that we don't over-correct. It is my hope that we do not swing to the extreme of the so-called "nanny state," and attempt to hold everyone's hand, make doing business more costly, and become non-competitive in world financial markets. But, reality is reality and consumer protection is the current political reality.

As a matter of full disclosure, I come from the financial industry. As a matter of fuller disclosure, I spent years in "Regulatory Compliance," which was charged with the responsibility of taking recently promulgated regulation and integrating it into daily operations. I admit to reading regulations and thinking, "Have the persons who wrote this EVER been in an actual business?" I admit to seeing the regulatory pendulum swing wildly back and forth, and hating the tendency to over-regulate after a crisis. I predict that this legislation will be analogous to affirmative action, where administrations will use it as a political symbol as "pro-consumer" and "pro-business" stands that will result in its being more or less consumer friendly. It will undoubtedly, however, be expensive. Read on.

It Will Make Financial Institutions Less Profitable

Absolutely right. Between the increase in capital and liquidity requirements discussed in the prior post and the increase in regulation that will require new forms, new procedures, new training, etc., etc., banks will definitely be less profitable. And, since one of the stated goals of this new agency is to give access to traditionally underserved markets, i.e., the poor, non-English speaking residents, etc., the expenses inherent in this proposal will likely result in higher fees paid by the rest of us. Speaking for myself, I will pay higher fees in order that the most vulnerable of us not be subjected to the usurious rates charged by "payday loan" and "rent to own" firms, but I am speaking only for myself. Banking is going to cost more, just as health care will cost more as we insure the uninsured. This is a social, as opposed to business issue. If you think that the poor should not have access to basic financial services, this is not the time to voice your opinion. You're not in the majority

Non-Binding Executive Compensaton Shareholder Votes

Non-binding means that you are not bound by what I say. Non-binding votes by shareholders about executive compensation is a paper tiger. By this, the Administration seeks to let shareholders tell executives that they think they're getting paid too much, but stops before giving them any power to do anything about it. In some ways, I like this, as "capping compensation" is basically wage controls, and anyone who lived through the 1970's will tell you how well that worked out. Also, imagine the press you'll get if you're one of those executives. The 24-hour business channels will be all over you, forcing you to justify your compensation, and making you say why you should have your job. It's an interesting solution. I'm on the fence on this aspect of the proposal, but think public outcry a far superior recommendation than salary caps. We shall see.

That said, this part of the financial proposal has some potential land mines, and I'll be watching it very closely. Hopefully, we won't over regulate and make a bad situation worse.

Executive Pay

Lexington, Kentucky realtor Diana Nave suggested, “I think it is important for people to understand the spread between executives and workers and how far apart it has become.” Agreed. Let’s take a look.
A Little History
In 1940, executives (the three highest-paid officers in the 50 largest US companies) earned 56 times their average worker’s pay. In 1950, that ratio slipped to 34 times, and fell further in 1960 and 1970 to 27 and 25 times, respectively.
Then, in 1980, executive pay grew to 33 times their average worker, and in 1990, to 55 times, approximately equal to that of 1940. In the year 2000, executives were paid nearly 120 times that of their average worker.
So, what was the economic situation in 1940, how was it similar to 1990, and what happened between 1990 and 2000 that caused the average worker to lose so much ground?
1940
The Great Depression may have improved to a recessionary status from 1938 to early 1940, but no economic recovery of significance could take place without government fiscal intervention. The recovery would have likely taken much longer if left to the private sector.
The US Gross National Product had passed the $100 billion mark in 1940, but was just 9 percent above the GNP level of 1929. It was the federal purchases of goods and services for national defense in the pre-war period - a rise from $1.2 billion in 1939 to $2.2 billion in 1940 - when the economy felt the rise in government spending that marked the end of an economically depressed era through the injection of government funds directly into the economy. While many credit the “New Deal,” evidence points more heavily toward defense spending.
After a protracted period of 14%+ unemployment, a combination of a “take any job” mentality, and a new, somewhat underpaid female workforce during the war exacerbated the CEO vs. average worker chasm during this decade, which was not again achieved until fifty years later in 1990.
1990
After a protracted recession in the 1970’s, the 1980’s was a decade during which economic growth depended on a steady rise in consumer spending supported by both increasing debt and prices of stocks and homes. The present U.S. slump signals the end of that consumption-led growth, with an overbuilt housing market and an over employed consumption sector, from car dealers to malls. The question is whether our system can adapt to create new growth to fill the void left by embattled consumers.
The 1940s was a “boom” cycle due to government defense spending, and the 1990s, a “boom” cycle due to consumer spending. Neither was sustainable.
However, in the 1990s, a fundamental economic change took place – a “monetizing” of the financial asset growth – that largely rewarded the financing side of cash flow more than the operating side. Basically, there are three components of Cash Flow:
· Operating Activities, or producing revenue by operating the business at a profit
· Investing Activities, or buying and selling investments like property and equipment
· Financing Activities, or issuing/repaying long term debt (bonds) and issuing/buying back company stock.
As seen in both the Internet bubble in the 1990s and housing bubble in the 2000s, investors often were more highly rewarded for “flipping” their investments (or selling after owning them for a very short period) than for investing for the long-term. Both capital (stock and bond) and real estate investors saw a dramatic increase over the historic long term returns during these periods, and accepted and expected a continuation of those unsustainable returns.
Further, with the focus upon “short term” returns, management compensation became rooted in their ability to produce and sustain those returns by lessening their percentage of “salary” and increasing their percentage of “stock options” and the like, justified by their having the same stake in achieving profitability as their stock holders. Unfortunately, as seen by the collapse of the financial system, incenting management to achieve short-term profits over long-term viability can have disastrous consequences.
Now What?
It’s back to basics, now, for the capital and real estate markets. Real estate loans are again being made as they were for decades – 20% down, 30 year terms, with housing costs no more than 30% of gross income to borrowers with good credit. Stock prices are again reflecting management’s ability to turn a long term profit on the business more than their ability to buy back their own stock at a high return on investment. And executive pay is again reflected primarily in salary rather than stock options.
Are salary caps now appropriate? In my opinion, no. Any attempt to artificially cap prices, as was attempted in the 1970s, has ended in disaster. But, it has also not worked well to “let the market dictate,” as we are well aware now.
Companies must find a way to have the freedom to “bid” for talented people to run their businesses without undue interference, while recognizing that paying those talented people 120 times the salary of their average worker is a poor investment. It’s a complex problem that is fraught with both the tendency to over regulate and do nothing, both of which would be a terrible mistake.
And, while consumer consumption is severely mitigated by unemployment rates not seen since the 1980s, a return to conspicuous consumption seems, at least for the foreseeable future, passé. It is incumbent upon the US to convert the financial to the operating side of its future cash flow by innovating, i.e., producing new goods and services that address the needs of a global population in need of sustainable sources of food, housing and energy. As those businesses form, those who provide capital for their formation must demand a more horizontal business model that compensates innovators more closely to the level of their managers.
It’s a big job.

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 an Adviser - Investing (cont'd)

In the previous discussion, we discussed the issues involved in selecting an investment adviser if you require that person to do virtually all of your work for you.

This is for those of you who take more of a "hands on" approach, and are likely to do your business through a discount, or deep discount broker.

1. Research

By far the most important aspect of your investing issues is where you get your information. Any company which benefits from you taking their advice is, in my opinion, automatically suspect. You may recall the recent stories about Standard & Poor's providing the highest available safety rating for so-called "Auction Rate Securities" consisting of mortgage securities, which became unsaleable soon after the mortgage crisis. The issuers of the mortgage securities were paying S&P for the rating. Whether there was actually a conflict of interest or not, there was certainly the appearance of potential impropriety.

Moral? The more independent the research, the more reliable it is.

So, who is the author of the "research reports" provided by your broker? The best sources would be those who earn their revenue from their subscribers, like Value Line and Morningstar.

2. Fees

a. Mutual Funds

If you are a mutual fund investor, keep an eye on your fees. No-load does NOT mean no fees.

Mutual funds that do not pay a "load," or commission to a broker or planner to sell the fund, instead pay advertising and marketing fees to sell the fund directly to you. These are called 12(b)1 fees, and vary widely from company to company. Your fund will also charge you "management fees" to compensate the person(s) who manage the fund.

You will pay these fees every year, and these fees will be deducted from the return on your investment.

If you are a mutual fund investor, know your fees.

b. Brokerage

Before opening your account, get a complete fee schedule. Will there be a charge:

• To close your account?
• If you fail to keep a minimum amount?
• Annually to maintain your retirement plan?
• To talk to a representative?
• If you don't make a minimum number of trades per year?

3. A Second Pair of Eyes

In previous discussions, we talked about financial planners. They may practice similarly to a broker, i.e., charging commissions only when selling a product or "fee only," which is similar to the way an attorney or accountant charges.

Periodically, even if you are a very experienced investor, it is a good idea to have a review of your portfolio. This can be accomplished very cost-effectively by finding a financial planner who specializes in investments review and comment on your portfolio. Generally, unless you have an extraordinarily complex situation, this should be about a two hour project, and will be well worth the time and expense if you have overlooked anything critical in your portfolio.

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.

Part I -How to Find a Financial Adviser - Investing

Types of Investment Advisers

Recently I asked a group of very bright women in what subjects they were most interested in their financial lives, and one question was "how to find a financial adviser."

When thinking about that subject, that simple question became a very complex answer, so we'll discuss this in the form of a series of articles.

Personal finance is generally split into categories that include:

• Budgeting and Spending
• Risk Management (Insurance)
• Investing (capital markets and real estate)
• Estate Planning (wills and trusts)
• Tax Planning

We'll start with Investing, since that's the category most women equate with having "Financial Advisers." There are many types of financial advisers available for investors, and the first way to narrow down that huge number is to ask, "How much work do YOU want to do?"

Do you want a person to manage the entire process for you? That person will be very different from (and charge much more than) a person who just buys and sells what you tell them to.

1. Full Investment Management

This person will

• Determine your financial goals
• Determine your tolerance for risk
• Suggest a portfolio that reflects both your goals and risk tolerance
• Suggest when it is appropriate to reconfigure your portfolio
• Periodically review your progress and answer any questions you may have.

Examples of this type of manager include advisers with Investment Bankers such as Goldman Sachs, JP Morgan and Raymond James.

2. Discount Broker

A person will be available for you to ask periodic questions, but research assistance is provided primarily through source material for you to use independently. Investors who are best candidates for this type of service will know

• The type of investor she is (growth, value, modern portfolio theorist)
• The level of risk she can tolerate (maximum level of price fluctuation she will accept before being tempted to sell)
• Both when to buy and when to sell an investment, and how to best replace it when selling

Examples of this type of service are Fidelity and Charles Schwab.

3. Deep Discount Broker

Assistance is provided in the form of research material, but no advice is given. Investors best suited for this type of broker are experienced investors, generally those with at least ten years' experience in investing for themselves and make all their own decisions. Some clients of deep discount brokers will employ a "Fee Only" financial planner every year of so to review her portfolio.

Examples of deep discount brokers are Scottrade and eTrade.

Now that you have made a categorical decision about the type of advisor you may wish you employ, we will discuss the level of training you can likely expect and some questions to ask that advisor before employing her in our next installment.

Please feel free to comment and share your experiences, and we do encourage you to subscribe to this blog as well.

Welcome

Dr. Tessa Warshaw, author of "Rich is Better," titled her book after Sophie Tucker's quote, "I've been rich and I've been poor. Rich is better."
Dr. Warshaw, Mary Buffet and I all participated in developing and presenting a UCLA seminar titled "Financial Planning for Women." Why just for women, you ask?
Having developed and taught much of the Investing portion of the Financial Planning curriculum for UCLA, I noticed that a significant number of my students were male, and those few women who did attend these classes tended to sit in the rear of the auditorium and rarely participated in discussions. Yet, these women had longer life expectencies and earned less money than men. Mastering investment skills is more critical for women.
In order to attract women attendees, we developed a seminar just for them, and found every one nearly filled to capacity.
Perhaps women prefer to discuss money with each other.
This is a forum to do that very thing in the virtual world, and you are invited to ask questions, recommend content or share your experiences that may benefit others.
Welcome.
I look forward to our discussions.