Finding Your Fiduciary Financial Advisor

The Ultimate Guide to Selecting Objective, Fee-Only Fiduciary Financial Advisors

Choosing An Advisor Special Report

Are You Drowning in Financial Advice
(While Dying of Thirst)?

Let’s face it. There’s no lack of financial advice, everywhere you turn. 

Buy this! … Sell that! … Hurry up! … Beware!

Make it past the first minute in this video, and you’ll begin to see what we mean.


Ugh. If that’s the kind of advice you’re used to, you may not be aware, there is a far more satisfying way to navigate our noisy, often nerve-wracking capital markets. It’s based on advice that begins and ends with an entirely different focus: YOU.

In the absence of fiduciary advice, you’re often left to sink or swim, parched for knowledge while drowning in a sea of sales pitches.

"Once you understand the difference an objective fiduciary advisor makes, the choice could not be more clear"

Douglas Finley, MS, CFP, AEP, CDFA

President, Founder

Real Advice vs. Real Annoying Noise

Just as Buy One, Get One Free! offers are rarely the screaming deals they’re made out to be, most of the financial “advice” you’re bombarded with daily is more likely to damage and derail your financial plans than clarify and cut through the confusion.
  • Financial noise is all about whoever is dispensing it. It’s aimed directly at your emotions and somebody else’s interests – which often have nothing to do with yours.
  • check
    Financial advice is grounded in a thoughtful understanding of you and your circumstances. It’s focused on discovering and achieving your best interests.
Above all else, the financial advice you heed should advance your own best interests. Otherwise, why heed it at all?
Finding Your Financial Advisor - Tuning out The Noise
Choosing An Advisor Special Report

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Solid Financial Advice: Easier Sought Than Found

I can’t imagine there are many people who would disagree with us so far. Why, then, is there so much noise still out there hurting people, often when they are most sorely in need a helping hand?

The challenge is, most people have not yet discovered what good advice looks like … and how readily it’s available, once you know what you’re looking for. 

Finding a Financial Advisor With NAPFA

Today, there are some 3,000 advisors across the country who are members of National Association of Personal Financial Advisors (NAPFA), each of whom is dedicated to the principles we’re about to cover in more detail. Finley Wealth Advisor is one of those 3,000 firms.

Four Essentials for Good Financial Advice

We recommend seeking – no, insisting on – four qualities from any advisor with whom you do business … or to whom you even pay any mind as you make your way through Wall Street’s continuous clamor. The advice you heed should come from an advisor who is fully committed to remaining:

The advice you heed should come from an advisor who is fully committed to

Next, we’ll take a closer look at each of these essential qualifications for Finding Your Fiduciary Advisor (independence, fiduciary, fee-only and evidence-based). We’ll also include a variety of checklists and critical questions to help you conduct your own due diligence along the way. For future reference, you may want to download our report here.

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Fiduciary

Fiduciary: A Funny Word, With Serious Substance

As integral to advisor independence as a traffic light is to a busy intersection, your advisor also should be in a legal fiduciary relationship with you. Period.

Back in 2006 when we founded Finley Wealth Management, few investors had even heard of the word “fiduciary.” The secret was that well-kept. 

These days, far more people have at least heard the term, and are vaguely aware it’s a quality worth seeking from a financial advisor. That’s progress, for sure, but, often, folks still aren’t really sure why.

You might compare fiduciary advice to the medical profession’s calling to “First do no harm.” In this spirit, no financial advisor would offer you one recommendation, when they’re aware of another that would be even better for you, right? Unfortunately, wrong. At least here in the U.S., financial advice has been subject to a double legal standard: “fiduciary” versus “suitable” advice. Worse, it’s up to you to spot the differences between them, and to heed the quality of the advice accordingly.


Fiduciary vs. Suitable: Different Incentives Drive Different Advice

Let’s begin with a light-hearted take on this serious subject. As you can see in this spoof by Canadian satirist Rick Mercer, the U.S. isn’t the only place investors have a hard time finding best-interest investment advice. Our northern neighbors and others around the globe face similar challenges.

All joking aside, this video gets to the heart of the difference between suitable and fiduciary advice. Your friendly neighborhood bankers, brokers or insurance agents may be among the most pleasant people you know – fun, sociable and easy to talk to. But it’s incredibly important to realize they are rarely if ever in a fiduciary relationship with you. Their greater loyalty often belongs to the company line.


A “Suitable” Illustration in In Action

How does suitable vs. fiduciary advice work in action? Say you’re comparing two mutual funds that are equally appropriate for your portfolio, except one entails higher fees that just happen to offer a better commission for the trader.

As long as the investment itself is suitable for you, brokers offering suitable advice can recommend the fund that compensates them more handsomely at your expense. You’d have to read the fine print to discover you’re paying more for no real reason. 

On the other hand, if all else is equal between two investment selections, a fiduciary advisor must recommend the lower-cost investment, since it represents your best interest. It would be illegal for them to do otherwise.

SUITABLE

As long as the investment itself is suitable for you, brokers offering suitable advice can recommend the fund that compensates them more handsomely at your expense. You’d have to read the fine print to discover you’re paying more for no real reason.

FIDUCIARY

On the other hand, if all else is equal between two investment selections, a fiduciary advisor must recommend the lower-cost investment, since it represents your best interest. It would be illegal for them to do otherwise.


Finding the Bona Fide Fiduciary:

One way to find your fiduciary advisor is to ask these two essential questions:

Will your relationship with me be only and always as my fiduciary advisor? 

Take no less than an unqualified “Yes,” with no ifs, ands, or buts. As touched on above, some advisors are dually registered, which means some of their advice is dispensed with a broker/suitable hat, while other advice is delivered in a fiduciary role. If someone will not or cannot agree to always act in your best interest under all circumstances, of what worth is the advice?

Will you agree to a fiduciary relationship in writing?

How reliable are verbal assurances if an advisor won’t agree to the same in writing? For example, here is a simple but powerful fiduciary oath from fi360, an advocate for excellence among financial service providers. In our estimation, any advisor worth heeding should be happy to sign such an oath.

As financial advisor Barry Ritholtz described in a Washington Post column, “The suitability standard is far more complicated – and offers much less protection to investors. The simplest way to describe this standard is ‘Don’t sell AliBaba IPO to Grandma.’”

When there are plenty of advisors who are willing and able to be in a “360 degree” fiduciary relationship with you – all the time, in all of your dealings – why even mess with anything less?
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Independent

Independent: A Declaration

If there’s one value that has been near and dear to every American’s heart since our nation’s founding, it’s independence. As such, it’s unlikely you’ll ever encounter any would-be advisor who would readily admit they’re simply parroting what corporate headquarters has scripted for them.

Unfortunately, as touched on above, that’s often exactly what’s going on behind the scenes, whether they say so or not.

2 More Suitable Illustrations in Action

Don’t believe us? Here are just two of countless examples we could share.

Illustration #1

The Toffels: The Toffels are a couple in their 70s who were featured in a 2014 New York Times exposé, “Before the Advice, Check Out the Adviser.”

The Toffels were not sold an AliBaba IPO or anything entirely unsuitable for their $650,000 life savings. But their broker did saddle them with a variable annuity that cost more than 4 percent annually. “That’s more than $26,000 per year. The annuity also included a 7 percent surrender charge, effectively trapping the Toffels into the costly holding. A typical, no-frills index fund costs less than 0.25 percent, with no surrender charge. These days, some funds are even zero cost!

The article points out (emphasis ours): “Like many consumers, [the Toffels] say they didn’t realize that their broker wasn’t required to follow the most stringent requirement for financial professionals, known as the fiduciary standard.”

Illustration #2

The Toshners: Maybe things have improved? Maybe not. In March 2019, Ron Lieber of The New York Times covered the rise and fall of popular radio personality, “America’s Money Answers Man” Jordan Goodman.

Based on Goodman’s glowing description of what eventually turned out to be an elaborate Ponzi scheme (think, musical chairs with your money), the Toshners entrusted their hard-won $510,000 accident claim settlement into an interest-yielding investment offered by Woodbridge Group of Companies.

Only after the scheme collapsed did they discover that Goodman was likely being compensated as essentially a salesman for many of those “money answers” he was offering. As Lieber reported: “After the Toshners inquired with Mr. Goodman directly, Mr. Goodman did acknowledge that he stood to make some money if they made an investment. The details, however, were not clear.”


Five Calling Cards of the Independent Advisor

1

Business structure:


Fee-only Registered Investment Advisor firm

2

Regulatory agency: 


SEC 

or

State

3

Custodial arrangements:


Separate,

arm’s length

4

Professional affiliations: 

Networked with other independent advisors

5

Investment strategy: 


Evidence-based


1

Business Structure: The Registered Investment Advisor Firm


By law, independent Registered Investment Advisor firms must provide strictly fiduciary advice to their clients across the entire relationship. In contrast, brokerages, banks, insurance agencies and other transactional businesses are more typically offering suitable advice, part or all of the time. 

On a similar theme, be extra wary of “free” advice from popular media gurus; you may pay dearly for it in the end.

2

Regulatory Agent: State or SEC Oversight


As touched on above, when a firm and its advisors are providing only suitable advice, they may not go out of their way to tell you so. A short-hand approach to sorting out the players is to determine which financial regulator oversees the firm. 

  • Registered Investment Advisor firms are regulated either by the U.S. Securities and Exchange Commission (SEC) or by their state, depending on firm size (as measured by assets under management). Again, by law, these firms always have fiduciary duty to their investor clients.
     
  • Brokerages and other transactional businesses are regulated by the Financial Industry Regulatory Agency (FINRA), and are more likely providing only suitable advice in part or full.
     
  • If you see references to both FINRA and the SEC in a firm’s disclosures, that may be the calling card of dual registration. Again, why complicate things with potentially dueling interests?

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Custody Arrangements: Insist on Independence


Even if your advisor checks out so far, there’s one more way to protect your interests. After all, Bernie Madoff looked fine on paper. In protecting yourself against scoundrels in disguise, it’s essential to ensure that your money is held in your name at a fully independent custodian reporting directly to you. This affords you the opportunity to review separate financial statements for any discrepancies. (Madoff maintained custody of his clients’ accounts at his New York brokerage house, enabling him to falsify reports.) It also lets you log into your account, to keep an ongoing, “trust, but verify” eye on your assets.

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Professional Affiliations: The Company Your Advisor Keeps


As in most other professions, advisors can join trade associations they feel best represent their interests. 

  • Brokers often belong to SIFMA.org, or the Securities Industry and Financial Markets Association.
     
  • Insurance agents are often represented by the NAIC, or the National Association of Insurance Commissioners; it’s one of many special interest groups representing the insurance industry.

  • Fee-only, fiduciary Registered Investment Advisor firm representatives often join NAPFA, or the National Association of Personal Financial Advisors; and/or the FPA, or Financial Planning Association. Finley Wealth Management is a proud member of both, plus Doug Finley is a CERTIFIED FINANCIAL PLANNER™ professional.
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Investment Planning and Execution: How Stable Is the Strategy?


Bottom line, how is your advisor managing your money? We’re going to cover this topic at greater length further on, but [omit if we don’t include an EBI section] here are some key qualities to look for: 

  • A Detailed Investment Plan: Does your advisor incorporate a written Investment Policy Statement or similar plan to document your personal financial goals and explicit strategies for achieving them?

  • Evidence-based Investing: Is your portfolio structured according to decades of robust evidence indicating how to capture long-term market growth in accordance with your risk tolerances?

  • Sensible Solutions: Is the strategy implemented with efficient, low-cost solutions that complement this same evidence?

  • Portfolio Management: Are your assets being managed as an integrated whole, including assets that aren’t directly under your advisor’s management (such as your company’s retirement plan)?
A comprehensive investment approach that you can consistently apply to your total wealth is core to your advisor’s fiduciary care of your interests, through the years and across various market conditions.

Here are some helpful tips on the due diligence you can do when considering a new advisor relationship or reviewing an existing one.

Where To Look for Hidden Insights

  • Google It – Use your favorite search engine to periodically check up on what the virtual world has to say about your advisor or would-be advisor. Search on both the individual and firm names. Make sure you’ve got the right person or firm in your hits, especially if the name is relatively common, and remember, some resources are far more reputable than others.

  • Check the Reports (Form ADV and BrokerCheck) – U.S. advisors are required to disclose a number of important details worth knowing. Whether registered with their state or the Securities Exchange Commission (SEC), Registered Investment Advisor firms must file a Form ADV. ADV “Part 2 Brochures” are meant to serve as the closer-to-plain-English version of the adviser’s full report, so you may want to start there. (Our own Form ADV Part 2 Brochure is found here.) Most current and former brokers and advisors should also be listed in FINRA’s BrokerCheck, where additional details and disclosures may be found. Sections of particular note are the advisor’s fee schedule, their investment strategy, and whether they have any legal or disciplinary actions on record.

  • Search NAPFA’s “Find an Advisor” database – Search for and learn more about the fee-only advisor firms who have signed the organization’s Fiduciary Oath and subscribed to its Code of Ethics.
  • Just Ask – Last but certainly not least, any reputable advisor should welcome candid inquiries, no matter how detailed they may be. If the response underwhelms – if it’s incomplete, confusing, defensive or otherwise lacking – consider this a warning flag. Remember, it’s not only what an advisor knows, but how comfortable you will be working with them over the long haul.

“It seems that we are almost more likely to go on Angie’s List to check out our plumber than we are to go onto the SEC's website to investigate the background of an individual to whom we’re about to entrust our life savings. There is obviously something wrong with this picture.”

Mary Jo White

Former SEC Chair

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Fee-Only

Fee-Only: Costs Count

Why do people spend more than they need to on their investments?

While spending less to earn more seems obvious, the costs themselves aren’t nearly as easy to spot. Regulations exist to combat that, but too often, the focus seems to remain on adhering to the letter rather than the spirit of the law. As the late, great Vanguard founder John “Jack” C. Bogle wryly observed, “There are few regulations that smart, motivated targets cannot evade.” [Source]

The issue does not just affect individual investors either. The California Public Employees’ Retirement System (CalPERS) is currently the largest U.S. public pension fund, with more than $336 billion in assets as of year-end 2018. [Source] In 2015, it embarked on an aggressive campaign to cut costs by seeking to eliminate its most fee-intensive money managers. According to a Pensions & Investments report, CalPERS officials “concede[d] they have been unable to determine just how much they do pay.” 

If the country’s largest public pension fund officials have difficulty assessing their all-in fees, what chance do you have?

Demanding the Numbers

Financial professionals and investors alike should insist on clarity wherever it seems lacking. Instead, there is evidence that investment costs remain “out of sight, out of mind” for many consumers. As expressed in a 2015 North American Securities Administrators Association (NASAA) report, “While broker-dealers may be complying with the technical requirements governing fee disclosures, our research shows that improvements are needed to raise awareness among investors of the costs associated with their brokerage accounts.”

The NASAA report was based on a survey that found widespread confusion among investors. The report concluded (emphasis ours): “Brokerage firms routinely charge fees to serve and maintain brokerage accounts, yet nearly one-third (30 percent) of investors said their firm had no such charges and one-quarter (25 percent) indicated they did not know whether they were being charged.” Of those who did know there were fees involved, more than half did not know the amounts.


Compensation Arrangements

In short, the first step in managing investment expenses is to know what they are how they may influence your investment experience. In particular, understanding how an advisor is being compensated – and by whom – is another, excellent way to determine how well their interests are likely to align with yours. Advisors typically earn their keep in three ways: commissions, fee-only and fee-based.

COMISSIONED

If your advisor is receiving commissions from third-party sources, suffice it to say he or she is exposed to conflicting incentives to recommend particular products or transactions that may not be in your best interests.

In addition, these conflicts and their resulting costs (which silently drag on your returns) often remain undisclosed to you, or at the very least, buried so deeply in reams of legal fine print that your eyes might give out before you find them.

FEE-ONLY

Instead of heeding an advisor who is being compensated by someone other than you for the advice they offer, we suggest engaging a fee-only, fiduciary advisor, paying them an upfront fee for their dedicated advice to you. Advantages are two-fold:

  • Transparent Costs: You can clearly see what you’re spending in exchange for what you’re receiving.
  • Reduced Conflicts of Interest: If your advisor’s only compensation comes solely from you, it enhances his or her ability to offer the impartial, product-neutral advice you deserve.

FEE-BASED

A fee-based arrangement warrants further inspection. While “fee-only” and “fee-based” may sound interchangeable, they are not.

Fee-based advisors are receiving your fees, plus potential commissions from others. If the advisor is entirely fee-only, except he or she can write insurance policies for you as needed to protect your primary investments (with full disclosure of all commissions being received for this singular activity) then a fee-based relationship may still complement your best interests.

If the commissions are coming from investment activities, the same conflicts arise as those described above for a fully commissioned advisor.


Joining the Cost-Management Movement

As financial professionals, we deserve to be fairly compensated for our efforts. But as an investor, you deserve full disclosures and clear explanations, so you can determine for yourself whether the costs are justified. We encourage you to join us and a growing community around the globe as we advocate for the importance of clarifying and controlling investment costs, including our own fees.

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Evidence-Based

Evidence-Based Investing: Objective Advice, Wise Wealth

Are you ready to become a better investor? Would you like to enhance your understanding of the most important principles that drive the creation of wealth, without it hurting a bit?

Being a better, evidence-based investor does not mean you must have an advanced degree in financial economics, or you have to be smarter, faster or luckier than the rest of the market. It means three things:


Three Aspects of Evidence-Based Investing

1

Knowing & heeding the evidence


from those who do have advanced degrees in financial economics

2

Structuring your portfolio 


so that you’re playing with rather than against the market and its expected returns

3

Understanding the “human factor,” i.e., your own behaviors


Ingrained through eons of evolution and tricking you into making the worst financial decisions at all the wrong times


You, the Market and the Prices You Pay


How do you achieve every investor’s dream of buying low and selling high in a crowd of resourceful and competitive players? The answer is to play with rat

her than against the crowd, by understanding how market pricing occurs, according to these insights:

  • Group intelligence drives efficient pricing
  • It’s not whether breaking news is good or bad, it’s whether it’s expected or unexpected
  • By the time you hear the news, the market already knows it

 Financial “gurus” are no better than you at consistently predicting the markets


The Power of Group Intelligence in Price-Setting


Before the academic evidence showed us otherwise, it was commonly assumed that the best way to make money in what seemed like ungoverned markets was by outwitting others at forecasting future prices and trading accordingly in domestic and international stocks, bonds, commodities, real estate and more – or by hiring high-priced market analysts to do this for you. 

Unfortunately for those who are still trying to operate by this outdated strategy, we’ve learned the market is not so ungoverned after all. Yes, it’s chaotic, messy and unpredictable when viewed up close. But it’s also subject to group intelligence, whereby groups of independent players (such as free market participants) are better at consistently arriving at accurate factual answers than even the smartest individuals in that same group.

Applying group wisdom to the market’s multitude of daily trades means that each individual trade may be spot on or wildly off from a “fair” price, but the aggregate average incorporates all known information contributed by the intelligent, the ignorant, the lucky and the lackluster.

Instead of believing that you can regularly outguess the market’s collective wisdom, you are better off concluding that the market is doing a better job than you can at forecasting prices.

The market effectively enables competition among many market participants who voluntarily agree to transact.

This trading aggregates a vast amount of dispersed information and drives it into security prices.

Markets Integrate the Combined Knowledge
of All Participants

In US dollars. Source: Dimensional, using data from Bloomberg LP. Includes primary and secondary exchange trading volume globally for equities. ETFs and funds are excluded. Daily averages were computed by calculating the trading volume of each stock daily as the closing price multiplied by shares traded that day. All such trading volume is summed up and divided by 252 as an approximate number of annual trading days.


The Effect Of Breaking News On Market Pricing

The next step is to understand how prices are set moving forward. What causes market prices to change? It begins with the never-ending stream of world news. Here, it’s critical to be aware of the evidence that tells us the most important thing of all:

Instead of believing that you can regularly outguess the market’s collective wisdom, you are better off concluding that the market is doing a better job than you can at forecasting prices.

How the market adjusts its pricing is why there’s not much you can do after the news is released. First, it’s not the news itself; it’s whether we saw it coming. In other words, only unexpected news alters future pricing. By definition, the unexpected is impossible to predict, as is how dramatically (or not) the market’s group intelligence will respond to it.


The Barn Door Principle

Another reason breaking news is relatively irrelevant to your investing is what we’ll call “The Barn Door Principle.” By the time you hear the news, the market has incorporated it into existing prices. The proverbial horses have already galloped past your open trading door. This is especially so in today’s electronic world, where price adjustments typically occur within the first few post-announcement trades.

“Heinz agrees to buyout by Berkshire Hathaway, 3G”−USA Today, February 14, 2013

News travels quickly, and prices can adjust in an instant.

Unless you manage to be among the very first to respond to breaking news (competing, mind you, against automated traders who often respond in fractions of milliseconds), you’re setting yourself up to buy higher or sell lower than those who already have set new prices based on the news – exactly the opposite of your goal.

Stock Prices Adjust Quickly

Prices Adjust Quickly

In USD. Source: Bloomberg
The security identified is shown for illustrative purposes only to demonstrate the investment philosophy described herein. These materials are not, and should not be construed as, a recommendation to purchase or sell the security identified or any other securities. Actual holdings will vary for each client, and there is no guarantee that any client will hold the security identified.


Financial Gurus

As touched on above, you’re also ill-advised to seek a market-forecasting, financial guru to pinch hit for you. As Morningstar strategist Samuel Lee has described, managers who have persistently outperformed their benchmarks are “rarer than rare.”

But maybe you know of an extraordinary stock broker or fund manager or TV personality who strikes you as being among the elite few who can make the leap. Should you turn to them for the latest market tips, instead of settling for “average” returns?

Bottom line, if such outperforming experts did exist in reliable numbers, we should expect to see credible evidence of it. Not only is such data lacking, the body of evidence to the contrary is overwhelming. Star performers – “active managers” – often fail to survive, let alone persistently beat comparable market returns. Across the decades and around the world, a multitude of academic studies have scrutinized active manager performance and consistently found it lacking.


Structuring Your Portfolio

So far, we’ve assessed some of the hurdles to effectively participating in efficient capital markets. We believe the best way to overcome these hurdles is to sidestep them entirely in your investing. By managing the market factors you can expect to control and avoiding the temptation to react to those you cannot, you can build and sustain an evidence-based portfolio that allows the market do what it does best on your behalf: build long-term capital wealth. 

With all the excitement over stocks and bonds and their ups and downs in headline news, there is a key concept often overlooked.

Market returns are compensation for providing the financial capital that feeds the human enterprise going on all around us, all the time.

Using financial capital and other resources, a business produces goods or services that can be sold for a profit.

As providers of financial capital, investors expect a return on their money.

Financial Capital Plays a Vital Role in Wealth Creation

Financial Capital Role

When you buy a stock or a bond, your capital is ultimately put to hard work by businesses or agencies who expect to succeed. You would think that, when a company or agency does succeed, your investment would too. But actually, such success is only one factor at best, among many others that influence your expected returns.

At first, this seems counterintuitive. It means, for example, that even if business is booming, you cannot necessarily expect to reap the rewards simply by buying its stock. Remember, by the time good or bad news is apparent, it’s already reflected in higher-priced share prices, with less room for future growth.


Market Risks and Diversification’s Rewards

So what does drive expected returns? There are a number of factors involved, but decades of academic inquiry inform us that among the most powerful ones spring from accepting unavoidable market risks. As an investor, you can expect to be rewarded for accepting the market risks that remain after you have eliminated the avoidable ones. Let’s explain.

Avoidable Concentrated Risks

Even in a bull market, one company can experience an industrial accident, causing its stock to plummet. A municipality can default on a bond even when the wider economy is thriving. A natural disaster can strike an industry or region while the rest of the world thrives. These are concentrated market risks that can be avoided by not piling all of your financial eggs into too few holdings.

Unavoidable Market Risks

If concentrated risks are like bolts of lightning, market risks are encompassing downpours in which everyone gets wet.

For example, invest in the market at all and, presto, you’re exposed to more market risk than if you had sat in cash (where it may lose value due to inflation, but that’s a different risk, for a different report).

In the science of investing, we dampen avoidable, concentrated risks with diversification. By spreading your holdings widely and globally, if some of them are affected by a concentrated risk, you can offset the damage done with plenty of other unaffected holdings. 

Concentrating in one stock exposes you to unnecessary risks.

Diversification reduces the impact of any one company’s performance on your wealth.

Every investor also faces market risks that cannot be “diversified away.”

Those who stay invested when market risks are on the rise can expect to eventually be compensated for their steely resolve with higher returns.

But they also face higher odds that results may deviate from expectations, especially in the near-term.

Diversification again steps in, acting as a “dial” for reflecting the right volume of market-risk exposure you’re seeking for your individual goals.

Diversification Reduces Risks That Have No Expected Return

Diversification vs Concentrated Risks (1)

​Diversification does not eliminate the risk of market loss.


The Essence of Evidence-Based Investing

With any risky venture, including the ones that abound in capital markets, there are no guarantees that you’ll earn hoped-for returns, or even recover your stake. This is why we so strongly favor evidence-based investing as a rational approach for staying on course toward your financial goals, especially when your emotional reactions threaten to take over the wheel.

Evidence-based investing represents the marriage between a “Who’s Who” body of scholars who have been studying financial markets since at least the 1950s, and the financial professionals who heed their findings and are tasked with an equally important charge of determining:

Even if a relatively reliable return premium exists in theory, can we capture it in the real world – after the implementation and trading costs involved?

Assessing the Evidence (So Far)

In academia, rigorous research calls for more than an arbitrary sampling or a few in-house spreadsheets designed to “prove” a convenient conclusion. Academic research demands a considerably higher standard, including a disinterested, objective outlook (no foregone conclusions); robust data analysis; repeatability and reproducibility; and formal peer reviews.

So far, this level of research has yielded five expected return premiums for patient investors:

  1. Equity – Stocks (equities) have returned more than bonds (fixed income).
  2. Small-cap – Small-company stocks have returned more than large-company stocks.
  3. Value – Value companies (with lower ratios between their stock price and various business metrics such as company earnings, sales and/or cash flow) have returned more than growth companies (with higher such ratios). These are stocks that, based on the empirical evidence, appear to be either undervalued or more fairly valued by the market, compared with their growth stock counterparts.
  4. Term – Bonds with distant maturities or due dates have returned more than bonds that come due quickly.
  5. Credit – Bonds with lower credit ratings (such as “junk” bonds) have returned more than bonds with higher credit ratings (such as U.S. treasury bonds).

Scholars and practitioners alike strive to determine not only that various return factors exist, but why they exist. This helps us determine whether a factor is likely to persist (so we can build it into long-term portfolios) or is more likely to disappear upon discovery.

Explanations for why persistent factors linger usually fall into two broad categories: risk-related and behavioral.

Risk Related

Risk Returns Factors – It appears that persistent premium returns are often explained by accepting market risk (the kind that cannot be diversified away) in your portfolio. For example, it’s presumed that value stocks are riskier than growth stocks, which at least in part explains the higher long-term expected returns they have exhibited to date.

behavioral

Behavioral Return Factors – There may also be behavioral foibles at play. That is, our basic-survival instincts often play against otherwise well-reasoned financial decisions. As such, the market may favor those who are better at overcoming their impulsive reactions to breaking news.


What Has Evidence-Based Investing Done for Me Lately?

Beyond the five key market factors described above (equity, value, small-cap, term and credit), continued inquiry has found additional factors at play, with additional potential premiums (which also seem to result from accepting added market risk, avoiding ill-advised investor behaviors or both).

Among the most prominent are profitability and momentum:

  • Profitability – Highly profitable companies have delivered premium returns over low-profitability companies.  
  • Momentum – Stocks that have done well or poorly in the recent past tend to continue to do the same for longer than random chance seems to explain.

But before we get ahead of ourselves, let’s discuss a few caveats.

Wet Paint Warning – While these “new” factors may or may not have existed for some time, our ability to isolate them is more recent. As the ink still dries on the research papers, we are still assessing their staying power.

Cost versus Reward – Just because an expected premium exists in theory, doesn’t mean it can be implemented in real life. We must be able to capture it after the costs involved.

Dueling Factors – Sometimes, it can be difficult to build one factor into a portfolio without sacrificing another. Benefits and tradeoffs must be carefully considered at the fund level as well as for your individual goals.

As a result, opinions vary on when, how or even if profitability, momentum and other newer factors should play a role in current portfolio construction. We would be happy to speak with you individually about our evolving approach.


The Human Factor – You and Your Behaviors

To name a couple of the most obvious examples:

When Markets Unexpectedly Tumble

Your brain’s amygdala floods your bloodstream with corticosterone. Fear clutches at your stomach and every instinct points the needle to “Sell!”

When markets unexpectedly soar

Your brain’s reflexive nucleus accumbens fires up within the nether regions of your frontal lobe. Greed grabs you by the collar, convincing you that you had best act soon if you want to seize the day. “Buy!”

When people follow their natural instincts, they tend to apply faulty reasoning to investing.

Humans Are Not Wired for Disciplined Investing

Not Wired For Discipline


Three Steps Toward Evidence-Based Investing

1

Understand The Evidence


You don’t have to have an advanced degree in financial economics to invest wisely. 

You need only know and heed the insights available from those who do have advanced degrees in financial economics.

2

Embrace Market Efficiencies


You don’t have to be smarter, faster or luckier than the rest of the market. 

You need only structure your portfolio to play with rather than against the market and its expected returns.

3

Manage Your Behavioral Miscues


You don’t have to – and won’t be able to – eliminate every high and low emotion you experience as an investor. 

You need only be aware of how often your instincts will tempt you off-course, and manage your actions accordingly.

(Hint: A Professional Advisor Can Add Huge Value Here.)

Choosing An Advisor Special Report

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This has been a long guide, and I'd like to invite you to download this entire guide in PDF form, so you can use it as a reference in the future.

Finding Your Fiduciary Financial Advisor: A Call to Action

So, in selecting or retaining a financial advisor, how do you know if you’re making a wise choice?

We hope you’re convinced by now that the first order of business is to review an advisor’s background and ensure that his or her advice will be of the highest, FIDUCIARY order, with the commitment confirmed in writing. An independent outlook and fee-only compensation arrangements are important as well. 

Our friends at Dimensional Fund Advisors have put together a video that speaks to these qualities.

To identify advisors who fit this “job description,” take advantage of resources such as the advisor’s Form ADV and other legally required disclosure statements that enable more apples-to-apples comparisons. Assess what trade organizations they belong to and where their compensation is coming from. Look for the additional characteristics described above, that best position an advisor to sit on your side of the table. 

After that, look for someone you get along with on a personal level. If you and your advisor don’t “click,” even good advice will be hard to take, as described by author Seth Godin:

“Good advice … is priceless. Not what you want to hear, but what you need to hear. Not imaginary, but practical. Not based on fear, but on possibility. Not designed to make you feel better, designed to make you better. Seek it out and embrace the true friends that care enough to risk sharing it. I’m not sure what takes more guts – giving it or getting it.”


Together, let’s explore YOUR financial possibilities.


If this is the kind of advice you’re seeking, we hope you’ll be in touch with us to learn more. We are proud to be a fiduciary, fee-only Registered Investment Advisor firm offering an evidence-based investment strategy and guided by your highest financial interests.

Doug Finley my wealth advisor

Douglas Finley

MS, CFP, AEP, CDFA

President / Founder

© 2019 Finley Wealth Management, Llc - Naples - Bonita Springs - Fort Myers - Estero - Cape Coral - Punta Gorda

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