Safeguard #7: Avoid Investment Advisors Who Sugarcoat Reality

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Safeguard #7: Avoid Investment Advisors Who Sugarcoat RealityWe’ve already discussed the many ways you can safeguard your money. But these methods cannot protect you from an unscrupulous advisor. My brother, who is a lawyer, has a saying we must all take to heart: “You can’t do a good deal with a bad person.”

Morality can be described as a continuum from pure altruism to unadulterated self-centeredness. All advisors have their shortcomings, of course. But excellent advisors work hard to cultivate certain traits, and among them honesty is paramount. This quality in an advisor includes communicating clearly and straightforwardly exactly how bad the markets have been and can be.

Advisors naturally want to look good, and you must overcome your own desire to have a good-looking advisor. You need the truth. You can handle the truth, and without it, you certainly can’t make realistic financial plans.

The markets are profitable. The markets are volatile. You can’t pick just one. Even in our recent financial meltdown, I believe the wisdom of rebalancing back into fallen markets will be vindicated. But you still need to know the facts.

There are certain red flags to watch for with advisors, ways they may try to circumvent the tough honesty you need. I include both what conscientious advisors should do for their clients, as well as how financial salespeople hide their mistakes.

Ask your advisor to provide a return for your entire portfolio, not just the underlying investments. Reporting how each investment did doesn’t show how you did. Your advisor can buy an investment at the very end of the quarter and then report it did well during the entire quarter. Or your advisor can sell investments that are not doing well toward the end of the quarter. These changes do nothing for you, but they help an advisor who doesn’t report a return on your entire portfolio look successful.

Also, advisors should give you an accounting of your return net of all fees and expenses. Any fund expenses, fees, commissions or trading costs diminish the bottom line of the return. Only by receiving information at the portfolio level can you measure the net effect of every expense you were charged.

Always insist on a time-weighted return (TWR). Returns can also be dollar weighted, sometimes called an internal rate of return (IRR). Often the IRR looks better. It is possible for the TWR to be negative and the IRR to be positive.

A TWR removes the effects of cash flows, which allows you to judge how your advisor’s underlying investment strategy performed. If your advisor reports both, that’s fine. But he or she should include the TWR as well, which is considered the industry standard and allows you to compare apples with apples between two different strategies.

Returns should be reported consistently over standard and preestablished time periods. In addition to the quarter that just ended, our firm reports year-to-date, the past 18 months, and the returns gained since we began to track the portfolio. We chose 18 months because it is the shortest time period that is still long enough to discern significant market trends.

One year isn’t long enough to eliminate market noise. We’ve considered adding three- and five-year returns, but whenever an advisor changes the time periods reported, it is cause for concern.

The bottom of the last market occurred in October 2002, so three-year returns started looking good in the fall of 2005 and five-year returns in the fall of 2007. The recent market downturn provides an opportunity to report these longer time periods without arousing suspicion that these intervals are being changed simply for window dressing.

Getting an accurate accounting of your portfolio’s return shouldn’t be optional. If your advisor can’t supply it, perhaps it means they don’t know themselves or don’t consider it important to their recommendations. Unfortunately, many so-called advisors in the financial services world would prefer to focus instead on how their own fees and schedule of commissions are doing.

Even if you safeguarded your money in the many ways we have suggested, you should also insist on only entrusting your money to an advisor who regularly reports what total TWR, net of all fees and expenses, your investments have made for the quarter and for longer periods of time.


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David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. Favorite number: e (2.7182818…)