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Brian Whetten

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The Financial Industry: Who Can You Trust?

Posted: 06/03/09 08:26 PM ET

The financial industry is based on trust, and in the last year Wall Street has lost a ton of it. So what are we to do about this? In the face of all that's going on, who can you trust?

The bad news is that large pieces of the industry aren't all that trustworthy. Not because they're liars or cheats (or at least not necessarily). But because so many people have bought into a series of lies -- a set of widely held myths that cause individual investors to lose hundreds of billions of dollars each year.

The good news is that there's a terrific new book, The 12 Investment Myths by Jack Calhoun, that exposes many of these lies and gives terrific guidelines for knowing who to trust. It's short, simple, sweet and powerful. Ideally, it would be required reading for anyone with a 401(K) or stock portfolio.

From 1987 - 2007, the average stock-fund investor made 4.5% per year, while the stock market's return (as measured by the S&P 500) was 11.81%. Why the huge difference? Because so many individual investors buy into these 12 myths.

In particular, studies consistently show that a blind monkey throwing darts at a list of stocks would do better than the average mutual fund, yet much of the industry's profits are based on pretending this isn't true.

Here are three key excerpts from the book, reprinted with the author's permission.

MYTH 1: A Savvy Investor Should Be Able to Beat the Market

FACT: Hope springs eternal for investors that they can find the market-beating guru to lead them to easy riches. But active managers have a nearly insurmountable hurdle to overcome due to the high costs associated with frequent trading. Those few managers who beat their benchmarks are usually flashes in the pan and don't sustain their winning ways for long. Investors who fall prey to the siren song of the market-beating guru usually end up experiencing only disappointment and lost potential earnings as they migrate from one high-flyer to another just as the managers are poised for a return to mediocre performance.

SOLUTION: Learn to joyously accept the fact that the market is your friend to be embraced, not an enemy to be vanquished. Earning market rates-of-return is hardly accepting "average" returns, because historically the market beats more than 80% of active managers.

MYTH 2: Brokerage Firms Are Built on a Client Service Model

FACT: The big brokerage firms are not built on a client-service model; they are built on a product-distribution model. The endless, massive fines those firms keep incurring for violating their investors' best interests testify to this fact. Brokers who are compensated by the products they sell cannot claim to be objective and do not meet a fiduciary standard of care for their clients.

SOLUTION: If you want to work with an advisor, find one who is an independent, fee-only Registered Investment Advisor. Such RIAs cannot accept commissions and act as fiduciaries for their clients, meaning they are required to put their clients' best interests ahead of their own.

MYTH 3: It's All about Performance

FACT: It is one of the great ironies of investing that the more you make investment decisions based on performance, the more likely you are to experience poor performance. The reality is that the performance of stocks, funds and managers is usually attributable to what market sectors have recently been in favor. Since those sectors cycle in and out of favor quickly and unpredictably, investors who chase returns usually miss the run-up and arrive just in time for the downturn.

SOLUTION: Since you can't control which segments of the market are going to be hot going forward, select investment vehicles based on factors that you can control in the investment process: sales charges, expense ratios, and trading. Keeping such expenses to a minimum (or, in the case of sales charges, avoiding them altogether) is much more predictive of future success than chasing returns.

The bottom line? If you want to know who to trust, a great start would be to learn these 12 myths and avoid those who buy into them.

 

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