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The 7% Solution PDF Print E-mail
Written by John D. Buerger, CFP®   
Tuesday, 05 January 2010 00:00
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John BuergerThe 7% Solution?

And Other Wealth Building Tips?

I've been following a thread on the Oblivious Investor blog site.  This article is titled "Spreading (mis)Information" and talks about conflicts of interest and how most people giving you financial advice (including me) have our own self-interests.

The challenge is that most people don't question these self-interests.  In fact, I believe that overall there is such a blind trust in the system that people never bother to assess these self-interests or determine if the advice is even remotely aligned with YOUR interests.

IT'S ALL WRONG
WE'RE NOT VERY GOOD AT THIS
THE 7% SOLUTION
WHY PAY AN ADVISOR?
LET'S BE CAREFUL OUT THERE
DANGEROUS ASSUMPTIONS

On the Oblivious Investor blog post, Mike makes the following points:

  • Mutual fund companies have a vested interest in convincing you that mutual funds in general (and their funds specifically) can beat the market.
  • Discount brokerage firms have an interest in convincing you that it’s profitable to pick stocks and trade them frequently.
  • Major financial magazines (and TV networks) receive advertising revenue from fund companies and brokerage firms, so they need to cater to the interests of those groups.

It's All Wrong

Mutual funds DON'T beat the market.  The more you pay in management fees (expense ratio) the further you will fall on average from market performance (read this from Oblivious Investor regarding Active vs. Passive)

It isn't profitable to pick stocks and trade them frequently, even when trading costs have been lowered to $9.99.  The same goes for all those stocks and mutual funds that are being hyped on the financial pornography stations by "experts" pounding the table.  There is one objective - create transactions, because when you do a trade (that's a transaction), one of the advertisers (like those discount brokers) gets paid.  They wouldn't advertise if it worked out any other way.

You spend money and they make money ... that's not exactly aligned with YOUR best interests.

Dalbar Proves It - We're Not Very Good At This

For years, the Dalbar research group has done a study of the performance of the average mutual fund investor and compared that to the performance of the average mutual fund.  Morningstar has done their own study and come up with amazingly similar results.  John Bogle (the grand-daddy of index fund investing with Vanguard) cites similar results even among index fund investors).

No matter what time period or study methodology is used, the average investor gets returns that are about 7% below the market each year.  The reasons for poor performance boil down to one thing - investors get in and out of their investments due to a number of psychological (heuristic) biases which basically make us buy-high and sell-low.  Read the Digirati Life blog for more easy-to-understand ideas on this "Cycle of Emotion" in investing.

The 7% Solution

In our online-training sessions and evening and all-day workshops, we teach the ALTUS 7% Solution which is pretty simple:

  • Have a reasonable investment strategy which includes benchmarks, scorecards and statistical reference points.
  • Execute the strategy every day ... and don't deviate.

It doesn't really matter WHAT your strategy is (within reason).  As long as the strategy is clearly defined and decisions are made based on numerical or statistical data that can be measured (or scored), you will eliminate the emotional cycle of investing.  This will improve your rate of return on your investments by 7% per year.

Why Pay An Advisor?

The inevitable path of any discussion of this material comes down to the question, "Why should I pay you (or any investment advisor) to manage my money?"

My answer to that question is, "You should only pay someone else for whatever you can't/won't do yourself!"  As Mike Piper (of the Oblivious Investor) wrote me in email:

Some people don't want to handle their portfolio on their own.

Others--as you mentioned--don't have the emotional make-up to reliably respond appropriately to volatile markets.

And then there's a third group of investors who, as Bernstein once said, don't have the "horsepower to do the math."

I will add that many times people in the Do-It-Yourself realm lose sight of the lost opportunity cost of their own time.  If you have the hundreds of hours to devote to research that I spend, by all means have at it - just realize that those hundreds of hours could be spent doing something else that may prove to be far more profitable.

Let's Be Careful Out There

If you fit into one of these categories and so you are looking to pay someone else to do what you can't or won't do yourself, then I would like to leave you with one last reminder:

Understand that we all have self-interests.  Personally, my interests are to get paid for my time and expenses and to keep you happy as possible (so I don't have to go out and find another new client to replace you).  Others may not charge you a fee per se, but get paid when you buy certain products.  Still others get paid if you buy their advice but don't care whether or not you implement that advice (investment newsletter subscriptions).

Whatever the case, any third party advisor (even your Uncle Larry) has self interests.

Figure out what their motive is ... and figure out if your advisor's incentives are in alignment with your best interests.  If they are - then you should compensate them for helping you and doing what you cannot or will not do yourself.  If NOT, keep looking until you find someone whose interests are better aligned with yours.

Dangerous Assumptions

Watch out for these assumptions ... they won't serve you well:

  • I can trust my advisor because he/she is a licensed professional - Anybody can use the title of "investment manager" or "financial planner."  In order to trade stocks on your behalf, an advisor must pass a couple of tests, but they are NOT required (unless they are a Registered Investment Advisor) to act in your best interests.  Unless they can show you a written Code of Ethics with a statement that they adhere to a fiduciary standard, they have no duty to behave as such.
  • Armed with enough knowledge, I can do it myself - Only about 3% of us is hardwired with the self discipline to manage our own investments without succumbing to the Cycle of Emotion in investing.  When it's your retirement nest egg, market fluctuations hit just a little too close to home.

Share This Article on Facebook

This is important information that is floating around the web underneath the radar of the major media.  It would be great if you could share this particular post, this website or other sites mentioned here.  Get your friends to subscribe to our weekly updates.  Friend me on FaceBook or follow me on Twitter.

We believe this needs to be a part of the national dialogue, but we have a long way to go to make that happen.

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Last Updated on Tuesday, 05 January 2010 02:57