Big news continues to come out of Washington. The Public Private Investment Program is the latest. For a writeup of some of the details of the program see our TUFA Views post.
posted by Roger Ward @ 9:06 AM
Investors grappling with extreme market turmoil, as we have been seeing, often question the value of financial advice. Perhaps the more pertinent question to ponder is the cost of bad advice.
That unrecoverable cost has been evident on several fronts in recent months amid revelations of multiple investment scandals in which thousands of people have been robbed of their retirement savings.
Even properly advised investors are finding market volatility difficult to deal with right now. But the pain is compounded for those who have been victim of incompetence, deceit and, in some cases, outright fraud.
Among the accused is disgraced financier Bernard Madoff, who is alleged to have swindled investors of $US50 billion in a 'Ponzi' scheme, a scam in which early investors are paid with money from later investors.
Clients are still trying to work out exactly what he did with their money after investigations revealed he never bought any of the blue chip stocks and Treasury bills he listed on their statements each month.1
No sooner did the Madoff case start to fade from the headlines than it was revealed that another wealthy financier, Robert Allen Stanford, had been charged by US regulators with an $8 billion fraud.
Stanford is accused of misleading investors by telling them their money was in unusually high-yielding certificates of deposit when in fact the vast bulk of it was in illiquid real estate and private equity investments.2
Here in Australia, thousands of average people have suffered devastating losses as a result of the $A100 million collapse of Storm Financial. Storm was an advisory group which shoe-horned clients into highly-leveraged equity investments irrespective of their age, existing assets or risk appetites.
Many of those clients have now not only seen their equity portfolios decimated, but have lost their homes and businesses. Some now owe money due to their margin loans exceeding the value of their investments.
In Japan, a flamboyant businessman named Kazutsugi Nami3 was arrested recently and charged with defrauding investors of $US2 billion in a scam that involved him making promises of a 36 per cent annual return.
A futon salesman by trade, Nami went as far as issuing his own money (called 'divine yen'). Fellow schemers are alleged to have swapped this for goods sponsored by his company.
While each of these episodes is distinctive, they share a common characteristic in that people were lulled into investing into something that in normal times might have seemed too good to be true.
That's the nature of long bull markets. People start to focus exclusively on return, rather than the risk which drives return. This provides an opportunity for purveyors of bad advice or plain scam artists to ply their wares.
So it's worth reflecting at this time on exactly what constitutes good advice and how investors can recognise it when it is offered to them.
First, good financial advice is not about providing a forecast. The smartest advisers are not those who seek to divine what will happen next in the markets, but the ones who help their clients make smart decisions about their money to secure the capital market rate of return.
This kind of advice is not based on a hunch or guesswork, but on financial principles backed by long observation and research.
Second, good financial advice is about structuring an investment strategy that is right for the individual, not one that reflects what the advisor is trying to sell or what will earn them the most fees or commissions. It has to match each person's appetite for risk, while helping them reach their investment goals.
Third, good financial advice is about ensuring clients' portfolios are structured around risks where there is an actual relationship with return. The scandals listed above largely resulted from people not understanding or not being told the sizeable risks they were taking in chasing "guaranteed" returns.
Fourth, good financial advice means ensuring investors understand what they are investing in and that the management of those assets is handled transparently and with a great deal of integrity.
Fifth, good financial advice involves advisors being upfront with their clients about what they can and can't control. If investors want to enjoy long-term equity returns, they need to be exposed to the equity market. That means they can't avoid being exposed to a market downturn. However, they can ameliorate controllable risks such as fees, taxes and their degree of diversification.
Sixth, good financial advice means keeping investors disciplined in their chosen asset allocation even when things seem hopeless. Good advisors remind their clients that falling prey to short-term anxiety and dumping their asset allocation to shelter completely in cash may not best serve their long-term wealth. It just means they forgo equity market returns and leaves them at risk of missing the bounce in risk assets when it comes.
For the victims of the likes of Madoff, Stanford, Nami and Storm there is little or no chance of retrieving their original capital, save what they might secure in a class action. Some have lost everything.
By contrast, investors who have been advised properly have plenty of reason to hope. Their diversified portfolios may be down, but they can take comfort from the fact that potential returns are now at extraordinarily high levels and that, if they keep their nerve, they are positioned for the recovery when it comes.
That is the value of good advice.
1'Madoff Never Made Claimed Investments', New York Times, Feb 23, 2009
2'Allen Stanford: the Antigua Triangle', Times Online, Feb 22, 2009
3'Japan's Bernie Madoff', Forbes, Feb 22, 2009
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