Don't Let Your Investor Experience Become a Horror Show...

FINRA Fines Merrill Lynch $2.8 Million for Overcharging Customers;
$32 Million in Remediation Paid to Affected Customers...

WHY SHOULD YOU CARE?
Start by reading this news release from FINRA. Here is the punch line: "Investors must be able to trust that the fees charged by their securities firm are, in fact, correct. When this is not the case, investor confidence is threatened." That was the conclusion by Brad Bennett, FINRA's Chief of Enforcement. This article was inspired by that FINRA news release.

If you are an INVESTOR, you may be getting over-charged and/or misinformed. If you are an ADVISOR you could face similar outcomes (to the ones described in the FINRA news release) if you or your firm are over-charging or misinforming clients. Unfortunately, many investors do not know which questions to ask their financial advisors. Many advisors place blind faith in their firms and the investment managers they use. Both of these "don't know what you don't know" (or don't care to know) scenarios can lead to disastrous results.

WHAT CAN YOU DO?
Even if you were not affected by this particular incident or do business with another financial institution, you should START ASKING MORE QUESTIONS OF YOUR FINANCIAL ADVISOR. Advisors and the companies they work for use any number of software programs to handle the accounting, portfolio management and performance reporting functions of their businesses – ALL OF WHICH CAN AFFECT THE FEES YOU PAY. More importantly, advisors and the various products and services they use to manage your accounts MAKE MANY ASSUMPTIONS when it comes to the critical decisions that can directly affect your financial well-being.

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For example, most advisors use some type of asset allocation software to determine how your portfolio should be structured (stocks vs bonds vs international, etc). All of those programs use algorithms (to determine the appropriate asset mix) that are based on assumptions that may or may not be valid or realistic. One of the most important is the RATE OF RETURN EXPECTATION, also known as "capital market assumptions," that these and other financial planning programs use to crunch numbers. Think about this for a minute. If an advisor says you need to put away X dollars per year or have Y dollars in your retirement account by the time you reach 65 to provide you with a certain monthly income, there are mathematical assumptions being made. YOU SHOULD KNOW WHAT THOSE ASSUMPTIONS ARE. 

Listed below are some questions you should ask. If you do understand this, find someone who does and take time to learn it. Unless you have given your financial advisor legal discretion to trade on your behalf (which is unlikely) YOU are making the ultimate decisions when it comes to your investments. Technically speaking, your advisor is just making recommendations. I know this gets a little confusing for some people but it is VERY important since it can have a significant impact on your family's financial well being. Do NOT be surprised if your advisor cannot answer some or all of these questions. If you find that to be the case, you should re-evaluate your relationship and start looking for alternatives when it comes to financial advice. You will find some helpful resources below.

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Questions To Ask Your Financial Advisor...

Help me understand how ALL fees are calculated on my accounts? Pay close attention to fee-based accounts which automatically debit your account based on portfolio values at specific points in time (e.g., quarter end)

What other fees am I paying that may not be “visible" in my accounts? Most investment products, especially mutual funds and annuities, have internal management fees (and other fees which are used to compensate financial advisors) that are NOT visible on your account statements. Find out how much you are paying and compare that to fees on competing products. [Be sure to get some objective input on that last point]

What assumptions are you making to formulate the advice you are giving me?  Specifically, what rate of return expectations are you using to determine my asset allocation?  What are those expectations based on?  What adjustments have you made to your assumptions in the past 12 months? When and why would you make changes to those assumptions?

What software programs are you using to analyze my portfolio and prepare my financial plan? What assumptions do those programs make (e.g., capital market assumptions)? When were those software programs last updated? What steps have you taken to ensure that you are using the best tools to formulate the advice you are giving me?

How do you select your (my) benchmarks? Benchmarks are "yardsticks" that let you know how your portfolio is doing. Examples include the S&P 500 and other indices that are used to measure the aggregate price levels of certain "baskets" of securities or entire asset classes. Your investment accounts are probably being compared to several benchmarks. Those benchmarks are usually selected by your advisor and/or the product and service providers he/she employs, such as mutual funds, money managers, etc.

PLEASE NOTE: Each asset class will have its own expected rate of return assumption. In the case of asset allocation software, the algorithms also make certain assumptions about the correlation of the various asset classes (i.e., to what degree their prices move together). All of these assumption, which are used to make critical investment and financial planning decisions ON YOUR BEHALF are usually based on historical data. This is what makes them so "iffy" and why it so important that you take the time to learn this stuff. 

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The Importance of Using Realistic Capital Markets Assumptions... 

This video does an excellent job of explaining what rate of return expectations are and why they are important. It also explains how rate of return expectations are derived and how they can impact financial plans and investment portfolios.

While the concepts and process described in this interview pertain to one of the largest institutional funds in the world, they are virtually identical to the ones you and your advisor should be discussing.

Learn More

• CalPERS Asset Allocation Process
  
• Download a full transcript of this interview
  

In this interview, the chief investment officer and interim chief actuary for CalPERS discuss the process they use to review and adjust their pension fund's assumptions.

The Importance of Selecting the Right Benchmarks...

Please note that mutual funds and money managers usually select their own benchmarks. That is, they select which yardsticks they think their performance should be compared to.

A cynic might say this is like the fox guarding the proverbial chicken coop so make sure you understand what's going on here. The video to the left and the white papers below address this important and often overlooked aspect of investment management.

Do NOT be surprised if your financial advisor gets stumped here. If that happens you should view this as a mutual learning experience. 

If you do not understand the conversation in this video, you should find someone who can explain what it means and how it can impact your financial well-being. If your financial advisor cannot or will not interpret this for you, you should find one who can. That would be a very bad sign.

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Explore More...

Here are some resources you might find helpful...

• Playing To Win - Ron Surz
  
• A Test of Faith - Ron Surz
• Trust But Verify - Ron Surz
• How To Avoid Problems with Your Broker - FINRA
  
• How To Find A Financial Advisor - NAPFA
• What You Need to Know Before Choosing A Financial Advisor - SEC
• Understanding Professional Designations Used by Financial Professionals - FINRA
• Merrill Lynch Gets Fined for Overcharging Customers - FINRA
• Governance Gone Wrong, Very Very Wrong - related blog post
• Investment Planning & Policy Development - related presentation