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Keeping Your Money Safe in Turbulent Times

Keeping Your Money Safe in Turbulent Times

November 11, 2008


SAN DIEGO ( Ė Itís been a rough year for most investors and 2008 still isnít done.


Major asset classes like U.S. stocks (AMEX: DIA), commodities (AMEX: DBC), international stocks (NYSEArca: EFA), emerging markets stocks (NYSEArca: EEM), international real estate (NYSEArca: RWX), and U.S. real estate (NYSEArca: RWR) have all been hit.


Should you be buying or selling? And what can you do to keep your money safe during these turbulent times?


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Richard A. Ferri, CFA is the CEO of Troy, MI-based Portfolio Solutions which oversees $700 million for institutions and individual investors. (See Ferriís firm subscribes to a strict discipline of low-cost indexing using index mutual funds and exchange-traded funds (ETFs) to accomplish his clientís financial goals.


Ferri is also the author of The ETF Book (John Wiley, 2008), which takes an inside look at the dynamics of ETF investing and he offers his latest views about the stock market, the U.S. economy, and successful investing.


It's been a rough year for equity investors, what are some things people need to think about before making any knee-jerk reactions?


RF: Every equity investor knows that our economy drives stock prices, and like all global economies in the free world, we have up and down periods. At some point an economic recovery is coming and that recovery will be reflected first in a rising stock market. Trying to anticipate when the turn will occur is difficult if not impossible for even the most experienced and knowledgeable economist. A better strategy is to have a set allocation to stocks and stick with that allocation through thick and thin. That works as long as you keep the faith and don't get emotional.


Many people have been completely wiped out by bad stock picks or lousy investment decisions. What now?   


RF: Investing in specific stocks is extremely risky for individual investors because by law no single person can have more pubic information about individual companies than any other market participant. It follows that when an individual does beat the stock market it is luck, not skill. Rather than trying to pick stocks, individual investors should be using broadly diversified, low-cost stock index funds. That will ensure they get their fair share of market returns and that strategy raises the probability of meeting retirement goals. 


Individuals that are near retirement or already retired have unique financial needs that often focus on generating additional income. What should people in this situation be thinking about?


RF: Think CASH-FLOW. Currently the S&P 500 (AMEX: SPY) is providing a dividend yield over 3% and a diversified bond index fund is providing interest income of 5%. A 50% stock and 50% bond portfolio will generate about 4% in cash-flow. A retiree will sail smoothly through this downturn if they are not withdrawing too much more than the cash-flow from their portfolio allows. 


Investment advisors are supposed to be guiding their clients through thick and thin, but unfortunately, much of the professional advice being delivered today has turned out to be bad. What's the problem here?


RF: There is a misconception about the skill set held by the typical investment advisor. In this surreal world of investment advice, anyone can claim to be an expert and get paid for it. This is why most stockbrokers, financial planners, and insurance agents are in the business, and why accountants, attorneys, and bankers want in as well. The problem is, most investment advisors are borderline incompetent. Thousands of them lack the basic investment skills and knowledge of a first-year business student and that is reflected in the poor advice they give their clients.


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What are some factors that people should consider before hiring an investment advisor? 


RF: Of course an advisor needs a well rounded investment education such as holding a Chartered Financial Analyst (CFA) designation and an advanced degree in finance. Aside from that, test their ego. Ask the advisor if he or she believes that they can accurately predict stock market movements or if they believe they have the skill to consistently select superior investments. If the answer is yes, look for another advisor. Even Warren Buffett says that market predictions are impossible, and he is extremely humble about his stock selection record. What makes the confident advisor you are talking with any different? Nothing, and their big ego will eventually become your problem.


With this year's downturn in just about every major asset class - from real estate to stocks - opponents of diversification are attempting to make their point that it doesn't work. What do you say?


RF: U.S. Treasury notes (NYSEArca: ITE) are up, therefore diversification works. That said, diversification is not happening the way most advisors expected. Here is the issue, when someone says they use negatively correlated asset class in their portfolios, don't believe them. There are no negatively correlated asset classes! Correlations change. They are dynamic, not static. The data shows that ALL asset classes that have any risk can and do fall in unison during a global economic crisis. It happened in 1997 and again in 2002, and now it is happening in 2008. Only U.S. Treasury securities have recently gone counter to the down trend because there was a global 'flight to quality'. But, that was not the case in the 1970s when stock and bonds fell together. 


As bad as some of the major stock averages have performed this year, can you give us some context as to how that compares with Wall Street's actively managed mutual funds and hedge funds?


RF: The sales pitch by active managers and hedge funds is there is an actual person or committee making investment bets and that will protect a portfolio in a bear market. It is assumed by the investor that these people possess skill. That is false assumption. In aggregate, active managers have no skill. In fact, it is mathematically impossible for active managers to perform better than index funds because the fees they charge are so high. Nonetheless, active managers need not fear for their jobs. There is no lack of hope among people who will to pay a high price to search for gold at the end of a rainbow. 


Thanks Richard.

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