Don’t Try This At Home

A new study of the municipal bond market by research firm Aite Group recently concluded that “do-it-yourself-investors” could be harmed if they attempt to invest in municipal bonds without the benefit of an expert advisor.

The study’s author, Aite Group Senior Analyst John Jay, says that a lack of AAA-rated supply, decrease in the issuance of insured muni bonds, the need for specialized knowledge, and the idiosyncratic ways muni bonds can trade combine to make it inadvisable for do-it-yourself-investors to wade into this market.

I have traded muni bonds professionally at Meyer Capital Management for years and I too have watched the fundamentals of the muni bond market change dramatically since the financial crisis. Research that took me hours before the financial crisis now routinely takes days; and I know what I’m looking for. Smaller inventories, less attractive yields, and uncertain credit quality all pose challenges.

The biggest challenge, however, is discerning the creditworthiness of the issuer and its ability to successfully payoff its muni bond debt. Reporting requirements for muni bonds aren’t as stringent as they are for corporate bonds, so reliable information is scarce if you don’t know where to look and how to read what you find.

A default on a muni bond can wreak havoc with any investor’s portfolio. Jay advises private investors “without the luxury and benefit of an advisor” to forego individual muni bonds and stick with muni bond mutual funds or ETFs. That’s good advice.

Are you a do-it-yourself-investor who buys/sells muni bonds for your personal portfolio? I’d like to hear about your experiences.

Melissa Donovan
Managing Director

"Fee-Based or Fee-Only". What's the Difference?

Nathan Bachrach’s recent Cincinnati Enquirer column (“Simply Money”, April 30, 2010) sought to address the questions: “What is the difference between ‘fee-based’ and ‘fee-only’ advisors, where else do fees come from, and how is it fair that fee-based advisors get a fee on my (investment) gain?” This issue continues to cause widespread confusion among the investing public and deserves a straightforward, plain English explanation.

A fee-only advisor can only receive compensation directly from you, the client. Period. This means the advisor represents you, and only you, when giving you advice or making investment decisions on your behalf. A fee-based advisor can receive fees paid by you, as well as commissions paid to them by a brokerage firm, mutual fund company, insurance company and/or other investment partnership. These multiple revenue streams, sometimes referred to in the industry as “double dipping,” are good for the advisor but can potentially cause conflicts of interest.

Investment portfolios developed by fee-based vs. fee-only advisors are likely to look different. Fee-only advisors have a fiduciary responsibility under the law to choose investments that are in your best interest. They typically use investments that have low internal expenses, such as individual stocks and bonds, no-load mutual funds and investments with no 12(b)1 fees. Fee-based advisors may or may not be fiduciaries(See Merrill Lynch Rule Exemption) and are financially incented by commission revenue to choose higher-cost investments for your portfolio.

How is it fair that an advisor charging a percentage of assets under management gets a fee on your investment gain? In my company’s case, it’s because in our 15-year history we have never raised our prices. We charge .35-1.0% annually for active investment management depending on the size of the account. By comparison, the average actively managed mutual fund charges nearly 1.5% annually, according to mutual fund research expert ICI.

Our costs of doing business, of course, increase every year. We cover these increases by doing what our clients hired us to do -- increase the value of their portfolios through expert investment management. If we don’t do our jobs well, clients lose money, we lose money and we’re out of business in short order. The performance risk is squarely on our backs. With no commission revenue to fall back on, we have to deliver for our clients in order to survive. This is why the vast majority of advisors are fee-based or commission-based and why respected personal finance columnist, Liz Pulliam Weston wrote, “True fee-only advisors are a rare breed. The leading association for fee-only advisors, NAPFA, has fewer than 800 members.” Conversely, FINRA, the leading stock broker association, claims 665,000 representatives.

Fee-based and fee-only are not the only compensation models clients have to choose from; there are at least four others. I agree that no single approach is best for everyone, but one of those approaches is best for you depending on your particular needs. In my case, I established a fee-only investment management company for one simple reason: It’s the way I would want my own money managed.

Get Your Investment Advisor to Work for You

Your physician recommends that you undergo surgery or your attorney outlines a sensitive legal strategy. Regardless of whether it’s your health or serious complications with the law in question, most would agree that there is a lot riding on the advice we receive and the decisions we make based on it.

Since the point of going to the doctor/lawyer in the first place was to seek expert advice, short of seeking a second opinion, the trust we place in them usually sways us to accept their proposals. We believe them to be more expert than us and trust them to have our best interests at heart. Doctors and lawyers and others serve in the role of fiduciary which means to put their patient or client’s best interests ahead of their own. Without this fundamental precept, no rational person would agree to put themselves at risk.

This begs the question then as to why so many people entrust their financial well-being to a non-fiduciary; a financial professional who is not obligated (or required) to act in their best interest? The most likely answer, it seems to me, is that too many people are simply unaware of the fiduciary distinction in financial services. They mistakenly give their financial professional the benefit of the doubt based on a personal referral or some other vote of confidence. Unfortunately, this seemingly innocent omission can, and often does, lead to serious consequences.

According to Barbara Roper, director of investor protection at the Consumer Federation of America, “The average investor would be appalled to see how hard some members of the financial industry are working to avoid acting in the best interests of their clients.”

Doug Holthaus of the Cincinnati Enquirer points out that a little-publicized item in the financial reform bill currently moving through Congress would require anyone who offers investment advice to act in the best interest of their client. “That there’s a need to actually legislate this says a lot about the state of the investment business today,” he said.

So, what is the investing public to do? Simple. Take 5 minutes to become more aware. Holthaus provides a clear, concise description of the differences between investment fiduciaries and non-fiduciaries. Reading his article, Get Your Investment Advisor To Work For You, won’t guarantee success, but it could be your first, best step in the right direction.

Do you think Congress should pass legislation that mandates a fiduciary standard for all investment professionals? If Congress doesn’t pass such legislation, are you more or less likely to hire an investment fiduciary to manage your money?