Tuesday, November 19, 2013

investing. caveat emptor

Mapping a Path Through the Financial Services Minefield

PHOTO: The financial services industry is rigged to drain your money away, unless you take action to prevent it.
Investing successfully is an extremely difficult and complex undertaking. Those who do well at it are aware that many financial services companies make huge profits for themselves at the expense of their investors' interests. It's hard enough to get good total investment returns when you're aware of this issue; it's nearly impossible if you aren't.
The investment products and services landscape is a treacherous minefield designed to transfer your money to the gate-keepers of the capital markets and hinder your chances of investing success. This is why it's critical to know where the bombs are buried and to find the best routes around them — or to hire an advisor focused on your interests to help you navigate this terrain.
Many investors aren't aware of the minefield, nor are they concerned as a result of overconfidence in their inadequate skills. Most of these investors tend to be men. By contrast, women tend to be less confident and more risk-averse, so they may be less likely to charge across the minefield. However, once they enter that terrain, they may face gender-linked risk from the inclination of some financial salespeople (most of them men) to take advantage of what they assume to be a lesser degree of financial knowledge among women.
Yet, if you're a woman, your self-protective intuition for risk may help you navigate this perilous terrain. Further, if you become better educated in finance, this risk aversion will be better informed, possibly enabling you to discern the motives of the "guides" who offer to show you through the terrain they have helped to make so treacherous. By becoming financially empowered through education, you're more likely to find a safe path.
The reason this is so difficult is that the financial industry is generally set up to make investors fail. Large public financial service companies are run to perform for their shareholders above all else. This goal is often at odds with the goal of helping clients achieve good returns.
For example, large companies that run mutual funds are constantly incubating new funds, taking considerable risk, and operating in a manner that resembles a bait-and-switch scheme. When they guess right, they use the resulting funds to attract investors while leaving the failed prototypes to die a quiet death. After the "successful" funds gain many investors, the managers become risk averse because they already have investors. As a result, these funds start to resemble index funds — only you shouldn't have to pay managers high fees to get index-fund returns. After all, high fees are for active management, and there's no active management involved in index funds.
Thus, mutual fund companies do quite well from these fees while their investors fail to get the potential for results they thought they were buying. This selective incubate-and-pump strategy is designed to benefit shareholders at the expense of funds' long-term investors.
This is part of the larger issue of how the financial people you're dealing with are compensated. You should always find out. None of these people are working for free, and you can't know where their potential conflicts of interest lie until you learn precisely how they're paid.
Individual investors are also at risk if they follow the advice of self-appointed financial gurus. By recommending that investors buy certain stocks that often subsequently tank, these gurus indirectly generate profits for professional investors. Some hedge funds make it a practice to short these stocks, essentially betting that they will go down in value. They often do — after an initial run-up spurred by gurus' recommendations.
As they're uncovered, the most onerous conflicts of interest in the financial services industry are banned after public outrage. But don't count on regulators to protect you. The conflicts are like Whac-A-Mole: Every time a practice is banned or spotlighted with a new disclosure rule, the conflicts that fuel them can surface in other ways. If you're to handle your own investments, the solution is education.
The other alternative is to hire an advisor. People are funny about this. They'll hire a gardener for their expertise but may insist on handling their own finances, a far more complex undertaking. You hire an advisor not just for their knowledge and expertise, but for the discipline they can bring to the task — kind of like a personal trainer, except they do all the heavy lifting. Objectivity and the time it takes to handle finances are the reasons many successful financial people hire advisors. For example, many CEOs and CFOs with financial services companies have outside independent advisors.
To hire the right kind of advisor, consumer research is essential. Choosing wrong can be the biggest mistake you will ever make, so this task in itself requires consumer education.
There are many things to look for in an advisor, but most important is the absence of conflicts of interest regarding how they are paid. After all, how can they protect you from the conflicted financial services industry if they are no different?
To get the most out of an advisory relationship, you should learn the basics so you'll better understand the options the advisor presents. So whether you handle your own investments or hire an advisor, a certain amount of education is critical. For either route, resolving to learn more about investing is a key step toward financial empowerment and, ultimately, toward control of this important part of your life.
This work is the opinion of the author and not that of ABC News.
Laura Mattia is a partner with Baron Financial Group, and a fee-only financial advisor. She's aCertified Financial Planner professional (CFP®), a Chartered Retirement Plan Specialist (CRPS®) and a Certified Divorce Planner (CDFA™) and holds an M.B.A. in accounting/finance. HerInternet radio show is Financially Empowering Women™ with Laura Mattia. A professor at theRutgers University Business School, Mattia is completing a Ph.D. in financial planning fromTexas Tech University; her dissertation is on how to help women plan for retirement.
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