Investment Articles

If you are like most people, your initial reaction to the question posed by the title to this white paper is “no.” However, for many investors, the answer is “yes.” With all of the investment options available today, many investors are intimidated, confused and frustrated by the investment process. Recent studies also support the suggestion that many investors are perfect targets for investment fraud or already are victims of investment fraud. For instance,

A recent study by Schwab Institutional found that 75% of investor portfolios were unsuitable for investors given their financial situation and goals;

A recent study by CEG Worldwide concluded that over 94% of those holding themselves out as wealth managers were more product salesman than wealth manager;

The 2010 IPT Elder Investor Fraud Survey reported that investment fraud is the number crime against the elderly, affecting an estimated 7.3 million older Americans, or one out of every five senior citizens. Since that number only counts the instances of fraud actually reported, the number of victims is undoubtedly higher.

One of the problems with avoiding investment fraud is the difficulty in detecting some types of fraud due to the subtleness or complexity of the fraud itself. Another problem with detecting fraud is the personal biases and beliefs that each investor has regarding investing. The purpose of this article is to alert investors to some of the more common elements of investment fraud so that investors can prevent unnecessary investment risk and financial loss due to investment fraud.

Fraud and Cognitive Biases

The common response to investment fraud is to call for greater investor education programs. However, a recent law review article in The Elder Law Journal suggests that investor education programs may be largely ineffective due to cognitive issues such as cognitive biases and/or cognitive deficits of investors. Cognitive biases are personal beliefs that impact our decisions. Cognitive deficits are impairments in mental ability, including impairments due to aging.

In the article, “Deception, Decisions and Investor Education,” the author, suggests a model of fraud victimization, which she refers to as the “deception/decision cycle.”1 As investors are provided with investment information, they filter the information through their personal beliefs, beliefs based upon a combination of actual experience, education and first impressions. An Investor’s beliefs, or biases, may or may not be accurate, but they can become so ingrained, or “anchored,” within a person that the person resists any conflicting information.

These biases may be strengthened even further by what are known as “truth” and “authority” biases, a person’s tendency to accept a statement as true, especially when the statement comes from someone with actual or perceived authority or expertise. The individual investor, whether because of issues such as cognitive biases/deficits, the complexity of the investment information of the sheer volume of such information, may fail to recognize the deception involved in the fraud.

Asset Allocation and Cognitive Biases

A perfect example of how cognitive biases can negatively impact investment decisions is a common misperception involving asset allocation. When you mention asset allocation or diversification to most investors, they think in terms of quantity rather than quality. Consequently, a large percentage of investors have portfolios that are diversified in terms of types and numbers of holdings within the portfolio, but the portfolios are not “effectively” diversified due to the high correlation of returns, or overlap, between the investments.

Portfolios that are not “effectively” diversified are sometimes referred to as being “pseudo” diversified since they appear to be diversified, but they do not actually provide an investor with the benefits of a truly diversified portfolio. The high correlation between the investments results in an investor having less downside protection than they would have with a truly diversified portfolio.

As an example, most people would consider a portfolio consisting of a large cap fund (IWB – iShares Russell 100 Index), a small cap fund (IWM – i Shares Russell 2000 Index), an international equity fund (EFA – iShares MSCI EAFE Index) and a bond fund (AGG – iShares Barclay Aggregate Bond Index), to be diversified since it consists of four different types of funds. A review of a correlation of returns matrix for a portfolio of the four exchange traded funds (ETFs) representing the four categories over the time period 8/31/2003 to 8/31/2011 tells a different story.

IWB/IWM – 0.93 IWB/EFA – 0.91 IWB/AGG – 0.05

IWM/EFA – 0.81 IWM/EFA – (0.03) EFA/AGG – 0.11

Analyzing rolling periods of returns often provides a better picture of trends and the persistence of trends. An analysis of rolling five year periods of returns for the referenced ETFs provides the following information:

2010-06

IWB/IWM – 0.966 IWB/EFA – 0.970 IWB/AGG – (0.308)

IWM/EFA – 0.896 IWM/AGG – (0.325) EFA/AGG – (0.432)

2009-05

IWB/IWM – 0.985 IWB/EFA – 0.991 IWB/AGG – (0.282)

IWM/EFA – 0.977 IWM/AGG – (0.338) EFA/AGG – (0.340)

2008-04

IWB/IWM – 0.967 IWB/EFA – 0.999 IWB/AGG – (0.445)

IWM/EFA – 0.973 IWM/AGG – (0.518) EFA/AGG – (0.4650

The higher the matrix number, the higher the correlation of returns and performance. A negative matrix number indicates a negative correlation of returns, which means that the two investments behave differently during various market conditions.

The matrix clearly shows a high correlation of returns between the large cap and the small cap ETF, and a high, albeit varying, correlation of returns between the international ETF and the large and small cap ETFs. The matrix clearly shows a low correlation of returns between the bond ETF and the other three ETFs. An argument can be made that a portfolio consisting only of the large cap ETF (IWB) and the bond ETF (AGG) would produce similar results.

Since fees and expenses are relatively low for most ETFs, cost is not that much an issue with a portfolio of ETFs. Since many financial advisers do not use index funds or ETFs in making recommendations, the negative impact of “pseudo” diversification can be seen in a portfolio of load-based mutual funds, again representing the four asset categories used in the ETF portfolio. The mutual funds represented are American Funds Growth Fund of America (large cap equity), Oppenheimer Discovery (small cap equity), Fidelity Worldwide (international) and PIMCO Total Return (bond).

2010-06

Am/Opp – 0.922 Am/Fid – 0.981 Am/PIMCO – 0.705

Opp/Fid – 0.948 Opp/PIMCO – 0.688 Fid/PIMCO – 0.597

2009-05

Am/Opp – 0.922 Am/Fid – 0.981 Am/PIMCO – 0.519

Opp/Fid – 0.948 Opp/PIMCO – 0.636 Fid/PIMCO – 0.451

2008-04

Am/Opp – 0.893 Am/Fid – 0.989 Am/PIMCO – 0.052

Opp/Fid – 0.935 Opp/PIMCO – 0.482 Fid/PIMCO – 0.148

The data shows the correlation of returns over rolling five-year periods in order to show not only the correlation of returns, but also the trend in correlation of returns. Once again, we see the same high correlation of returns between the equity-based mutual funds, with a lower correlation of returns between the bond fund and the equity-based funds that we saw with the ETF portfolio. The results are consistent with studies that have shown an increase in correlation of returns between equity-based investments over the past decade, especially during periods of increased volatility in the markets.

The correlation of returns matrix exposes the false illusion of diversification created by the bias of assessing diversification on the quantity of funds or types of funds alone. This bias is sometimes difficult to remove, as diversification based on quantity and type seems to make sense. Unfortunately, that is exactly what unscrupulous financial advisers are relying on, as they try to exploit the “truth” and “authority ” biases.

Portfolio Optimization and Cognitive Biases

If you have had an asset allocation plan or portfolio optimization plan prepared by your financial adviser, look at the plan and see if there is anything in the plan that gives you the projected risk, return or correlation of return data on the actual investment portfolio the financial adviser recommended to you. Investors rarely see such an analysis using the investor’s actual investments, primarily because the commercial asset allocation/ portfolio optimization programs used by most financial advisers are not designed to produce such a “real world” analysis. And yet, the calculations can be done using Microsoft Excel.

In many cases this failure to provide a “real world” portfolio analysis results in recommendation-implementation gaps, often leaving investors with portfolios significantly different from the asset allocation/portfolio optimization plan provided to them by their financial adviser, especially with regard to exposure to unnecessary investment risk.

The calculations required to calculate the projected risk, return and correlation of returns statistics for an investor’s actual investment portfolio are complex. Consequently, most investors are unable to calculate the actual portfolio’s statistics themselves or to otherwise detect an investment adviser’s fraudulent behavior.

Too often an investor falls prey to the “trust” bias or the “authority” bias and just accepts the plan given to them without questioning the accuracy of the plan or the failure to provide a “real world” analysis of the actual investment portfolio that their financial adviser recommended. But you should question your financial adviser and ignore any “trust” or “authority” biases, especially since the portfolio optimizers often produce recommendations that are counterintuitive and/or contrary to existing legal standards.

Some examples may help to prove my point. Two of the most important factors in constructing a suitable investment portfolio are the investor’s risk tolerance level and the investor’s investment time horizon. With that in mind, an experiment with two popular online asset allocation calculators provides some interesting results.

The first asset allocation calculator asked about risk tolerance, but did not even ask about investment time horizon. The regulators take the basic position that anyone with an investment time horizon less than five years should generally avoid equity-based investments since they might not have enough time to recover any losses suffered in the market. With the first calculator, we ran the same set of personal investment parameters, with the only exception being that we varied the risk tolerance level in each scenario. The results are shown in Appendix A.

Two clear issues emerge regarding investor protection. First, regardless of the investor’s risk tolerance level, the calculator recommends a portfolio consisting of approximately 60% equities and 40% bonds/cash. Second, the calculator completely ignores the “low” risk tolerance entry, exposing the risk averse investor to an undesired level of investment risk due to recommended equity allocations.

With the second asset allocation calculator, information was requested on both the investor’s risk tolerance level and the investor’s investment time horizon. Once again, the same set of personal investment parameters are used in each analysis, changing only the risk tolerance level and/or the investment time horizon. The results are shown in Appendix B.

If you accept the regulators’ position regarding a minimum five-year investment time horizon for equity investments, then the second calculator’s equity allocation for the 3-5 year time horizon is questionable, as it recommends a 30% allocation to equities for the low risk investor and a 45% allocation to equities for a moderate risk investor.

Expanding the time horizon out to 5-10 years, the low risk investor get the same portfolio recommendations that the 3-5 year time horizon/moderate risk investor got, which obviously raises questions. Strangely, the moderate risk investor with the 5-10 year time horizon receives a recommendation that increases the bond allocation to 65% and lowers the equity allocation to only 45%.

Increasing the investment time horizon to 10-20 years produces basically the same recommendation for both the low risk and moderate risk investor, with the recommended equity allocation only varying by 5 percentage points. The calculator appears to overweight the investment time horizon and basically ignore the low risk investor’s preference to avoid investment risk.

The last example is just further evidence that most asset allocation/portfolio optimization software programs are highly unstable and susceptible to mistakes, so much so that they have been criticized as “estimation-error maximizers” by industry expert Richard Michaud. Investors who wish to protect their financial security would do well to replace any “truth” and/or “authority” biases with a healthy dose of skepticism and a willingness to question their financial advisers.

Investment Fees and Expenses and Cognitive Biases

Investors look to their financial advisers for advice and generally defer to any recommendations provided by their adviser. Again, this is often the results of both the “truth” and the “authority” biases. Many financial advisers limit their investment recommendations to actively managed, commission-based products, which may not be in an investor’s best interests.

The negative impact of biases grows even deeper once the impact of fees and expenses is considered. Fees and expenses on index funds and ETFs are usually low since there is little or no active management of such investments. Fees and expenses on actively managed mutual funds can vary, with some even assessing annual fees and expenses in excess of 1.0% per year. Fees and expenses are important to investors since they reduce an investor’s return.

Assume that we have two funds, Fund A and Fund B, both with relatively similar performance returns. Fund A is an index fund/ETF. Fund B is an actively managed fund that has an R-squared rating of 93, which means that approximately 93% of Fund B’s return can be attributed to the performance of a benchmark index, in this case the index represented by Fund A. However, Fund B’s annual fees and expenses are 1.0% per year, while those of Fund A are 0.25% per year.

Since most of the return of Fund B can be attributed to an index rather than the contributions of active management, why would an investor pay three times more in annual fees and expenses for Fund B? Before investing in Fund B, it is useful to see just how beneficial the active management has been and exactly what the active management is effectively costing the investor.

One commonly used method for making such assessments is known as the active expense ratio. The active expense ratio was introduced by Professor Ross Miller, a finance professor at the State University of New York at Albany. Professor Miller basically compares a fund’s R-squared rating with the excess annual fees charged by the fund to determine a fund’s “effective” annual fees and expenses.

In our example, the active expense ratio calculates to an effective annual active expense ratio fee of 3.02% for the active management of the fund, a little over 200% higher than the stated fees and expenses. For the four mutual funds in our sample portfolio, the active expense ratios were as follows.

American Funds Growth

R-Squared – 98.34

Stated Expense Ratio – 0.69%

Active Expense Ratio – 4.44%

Oppenheimer Discovery

R-Squared – 93.43

Stated Expense Ratio – 1.34%

Active Expense Ratio – 4.63%

Fidelity Worldwide

R-Squared – 97.58

Stated Expense Ratio – 0.71%

Active Expense Ratio – 3.06%

PIMCO Total Return

R-Squared – 68.43

Stated Expense Ratio – 0.56%

Active Expense Ratio – 0.53%

There are those who may argue that the active expense ratio is misleading. However, when an actively managed fund derives most of its performance from an index and an investor can obtain that same index’s performance at a much lower cost, one has to question the wisdom of reducing one’s investment returns by paying “money for nothing” and reducing one’s investment returns. Why pay three times more for essentially the same results?

And yet investors do it every day, impacted by “truth” and “authority” biases they may not even be aware of. Some investors have no choice, as their company’s retirement plan may only offer actively managed, commissioned-based investment options as a result of their plan’s fiduciary being influenced by their own “truth” and “authority” biases. Armed with the knowledge of both these biases and active expense ratios, it would not be surprising to see both plan participants and plan fiduciaries act to provide more meaningful investment options within retirement plans.

Wealth Management and Cognitive Biases

“Anchoring” is one of the strongest cognitive biases and, with regard to investing and wealth management, one of the most potentially destructive influences on wealth preservation. Anchoring can be defined as a reluctance to retreat from existing beliefs and decisions and a resistance to even consider new or opposing information.

The difficulty with addressing anchoring bias can summed up with the observation from noted economist John Maynard Keynes that “the difficulty lies not so much in developing new ideas as in escaping from the old ones” and that “worldly wisdom teaches us that it is better for reputation to fail conventionally than to succeed unconventionally.” Beliefs often become truths, regardless of whether such beliefs are valid, often resulting in unnecessary risk and financial loss.

A perfect example of the potential negative impact of anchoring can be seen in investors that adopt a buy-and-hold approach to wealth management, or, as buy-and-hold critics often refer to the strategy, the “buy, forget and regret” approach. It is interesting to note that the buy-and hold approach to wealth management is apparently derived from an ongoing misinterpretation of a famous financial study.

A 1986 study, commonly known as the Brinson-Hood-Beebower (BHB) study, concluded that approximately 94% of the variability of a portfolio’s returns was attributable to the portfolio’s asset allocation mix. The study made no representations whatsoever regarding the impact of asset allocation on a portfolio’s actual returns, only on the variability of a portfolio’s returns.

Nevertheless, financial advisers and investment companies misrepresent the study’s findings to support their buy-and-hold argument, claiming that all an investor has to do for investment success is to set up an appropriate initial asset allocation and maintain that allocation since the BHB study proved that asset allocation determines 94% of an investor’s returns. The problem is that many investors have read or heard this mantra so often that they have fallen prey to the “truth” and “authority” biases and the misrepresentations are now firmly anchored into their personal beliefs.

It is interesting to note that the buy-and-hold approach is not derived from the works of the early pioneers of wealth management, Nobel laureates Dr. Harry Markowitz, the father of Modern Portfolio Theory, and Dr. William Sharpe. In fact, Dr, Sharpe has recently stated that investors should change their asset allocation in response to changes in market values. A recent study by asset allocation expert Roger Ibbotson has rebuffed the buy-and-hold strategy, stating that active management and asset allocation have about the same impact on a portfolio’s performance.

There are many investment professionals who would argue that the buy-and-hold approach is fundamentally sound and does not constitute investment fraud. These professionals usually claim that anything other than a buy-and-hold approach, with an occasional rebalancing to restore the original asset allocation parameters, constitutes market timing, which is both costly and ineffective.

From a legal perspective, what buy-and-hold advocates fail to realize is that the buy-and-hold approach completely ignores the proven cyclical nature of the market and t the Prudent Investor Act, whose guidelines which are often used by regulatory bodies and the courts in determining questions of fraud and prudent fiduciary conduct. The Prudent Investor Act clearly states that a fiduciary should make changes in an investment portfolio when changes in the market or economy dictate such changes are necessary in order to protect the portfolio against unnecessary risk and losses.

The classic definition of market timing involves having all of one’s assets either in the market or out of the market. The potential tax implications and the difficulty in perfectly timing the stock make such a strategy practically impossible. Reallocating some of one’s resources to reduce risk exposure is not market timing, but smart, defensive investing.

Smart investors would do well to heed the advice of noted investor Ben Graham, who warned that “the essence of investment management is the management of risks, not the management of returns. Well managed portfolios start with this precept.” Various studies support Graham’s postion, with such studies documenting the fact that avoiding losses has a much greater impact than missing potential returns.

Many investors suffered unnecessary investment losses during the recent 2000-2002 and 2008 bear markets due to their cognitive biases regarding the buy-and-hold approach to investing and their refusal to objectively consider other investment approaches. Unfortunately, these same investors will likely continue to suffer unnecessary investment losses unless and until they recognize their cognitive biases and objectively examine their investment strategy. As George Santayana pointed out, those who cannot remember the past are condemned to repeat it.”

Conclusion

Investment fraud is a pervasive problem. While various statistics are often cited as evidence of the problem, the truth is that such numbers are only a small percentage of the actual cases of investment fraud, as many cases go unreported and many victims of investment fraud are unaware that they are victims due to the subtlety or complexity of the fraud itself.

An emerging theory of investment fraud is that investors are susceptible to investment fraud due to cognitive biases and/or cognitive deficits that impair their ability to properly analyze investment situations and the recommendations of their financial advisers. It is imperative that investors become aware of and overcome potentially harmful personal biases, such as “truth” bias, “authority” bias and anchoring, in order to properly analyze investment options and better protect their financial security.

© Copyright 2011, InvestSense, LLC. All rights reserved.

This article is for informational purposes only, and is not designed or intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances. If legal, investment, or other professional assistance is needed, the services of an attorney or other professional adviser should be sought.

Notes

1. Jayne W. Barnard, “Deceptions, Decisions and Investor Education,” Elder Law Journal, Vol. 17, No. 2 (2010), 201.

APPENDIX A

Low Risk Portfolio

Investment Parameters > Age: 50 > Assets: $250,000 > Risk Tolerance: Low > Tax Bracket: 25% > Economic Outlook: Moderate > Income Needs: 4%

Recommended Allocation > Large Cap Equity – 23%, Midcap Equity – 13%, Small Cap Equity – 9%, Foreign Equity – 14%, Bonds – 23%, Municipal Bonds – 18%, Cash – 13%

Moderate Risk Portfolio

Investment Parameters > Age: 50 > Assets: $250,000 > Risk Tolerance: Moderate > Tax Bracket: 25% > Economic Outlook: Moderate > Income Needs: 4%

Recommended Allocation > Large Cap Equity – 21%, Midcap Equity – 14%, Small Cap Equity – 10%, Foreign Equity – 16%, Bonds – 26%, Municipal Bonds – 18%, Cash – 0%

High Risk Portfolio

Investment Parameters > Age: 50 > Assets: $250,000 > Risk Tolerance: High > Tax Bracket: 25% > Economic Outlook: Moderate > Income Needs: 4%

Recommended Allocation>Large Cap Equity – 20%, Midcap Equity – 16%, Small Cap Equity – 13%, Foreign Equity – 17%, Bonds – 24%, Municipal Bonds – 0%, Cash – 10%

APPENDIX B

3-5 Year Investment Time Horizon

Low Risk Tolerance: Bonds – 70%, Large Cap Equity – 15%, Small Cap Equity – 5%, Foreign Equity – 10%

Moderate Risk Tolerance: Bonds – 50%, Large Cap Equity – 25%, Small Cap Equity – 10%, Foreign Equity – 15%

High Risk Tolerance: Bonds – 60%, Large Cap Equity – 20%, Small Cap Equity – 10%, Foreign Equity – 10%

5-10 Year Investment Time Horizon

Low Risk Tolerance: Bonds – 50%, Large Cap Equity – 25%, Small Cap Equity – 10%, Foreign Equity – 15%

Moderate Risk Tolerance: Bonds – 65%, Large Cap Equity – 20%, Small Cap Equity – 5%, Foreign Equity – 10%

High Risk Tolerance: Bonds – 40%, Large Cap Equity – 30%, Small Cap Equity – ]15%, Foreign Equity – 15%

10-20 Year Investment Time Horizon

Low Risk Tolerance: Bonds – 30%, Large Cap Equity – 30%, Small Cap Equity – 20%, Foreign Equity – 20%

Moderate Risk Tolerance:Bonds – 25%, Large Cap Equity – 35%, Small Cap Equity – 20%, Foreign Equity – 20%

High Risk Tolerance: Bonds – 20%, Large Cap Equity – 40%, Small Cap Equity -20%, Foreign Equity – 20%

James W, Watkins, III is an attorney, a CFP® professional and an Accredited Wealth Management Adviser®. His areas of expertise include wealth preservation, asset protection, investment fraud and fiduciary law. He is CEO of InvestSense, LLC, a registered investment adviser firm located in Atlanta, Georgia. For additional articles and information, visit the company’s website, http://www.investsense.com. Mr. Watkins can be contacted at tawj3@yahoo.com, and followed on LinkedIn and on Twitter @InvestSense.

Well… so as most of you who’ve been following the stock market already know – the bulls and bears continue to slug it out, on a daily basis. Whenever the action gets so frenetic, with no clear winner and daily jostling back and forth… the outcome is always uncertain. Think of this as a match between two very well matched competitors – Arnold Palmer and Jack Nicklaus, Red Sox vs. the Yankees… And as for us fans- this can be exciting, emotional and excruciating. We can wildly cheer our favorite team -but we also know that winning and losing-when it comes to money-has an added dimension, directly affecting our future in real terms.

Additionally, in this case, I’d rather we get a winner quickly so we can get this over and done with and adjust our portfolios to the new reality. And because you and I are so deeply vested in the outcome of this match, it’s very important that we not sit idly by on the sidelines, watching this play out. So let’s take a close look at both teams-the bulls and the bears-and see how the stats stack up.

Let’s start with the bears.

• A woeful job market – 428,000 Americans filed for first-time unemployment benefits last week – the highest level since last July. And this is on top of the 3.7 million that already collect unemployment checks. And then there’s the announcement that Bank of America said it plans to slash 30,000 jobs. A cut large enough, some say, that it may have an effect on economic optimism among consumers, and impact GDP in a big way.

• Next… over 22.5% of U.S. homes are currently underwater, meaning they are valued at less than what they were bought for. Falling prices may have a negative effect eliciting more caution, more fear and tighter spending. This could have a negative ripple effect on corporate profits and stock prices. Moreover, adding to the gloom, economists at banks like JPMorgan Chase are predicting another 5% drop in housing prices over the next few months – so that can’t be good either.

• In addition, many more Americans are falling behind on their mortgage payments. Mortgage defaults rose 33% in August over July – which will result in foreclosures and more homes on the market, which will cause downward pressure on home prices.

• The rest of the world is not faring so well either. Europe is struggling dramatically with its various sovereign credit crises. The recent downgrade of Italy and a fear of a Greek default have already affected European stocks and American stocks alike.

• Russia – a major oil exporter – sees its economy stalling because they “fear” oil may drop to $60 a barrel, almost half of current levels. Now, on this one, Russia’s drop could well be our gain – I for one am all for paying half per gallon of gas as I am sure you are too – and herein lies some good news – and a perfect segue into

The Bulls’ Point of view.

• A poor economy worldwide will naturally decrease demand for raw materials which would reduce the cost to make and deliver goods and services. This in turn may lead to a gradual restoration of the economy into a state of long-term balance.

• The trade gap, between what we import and what we export, shrank in July quite sizably – down 13.1% to be precise, from the June number, the biggest monthly drop in recent years. This was due to a surge in U.S. exports to South America and a drop in imports because of a drop in the price of oil.

• Federal Reserve Bank chairman Ben Bernanke said he’s committed to stimulating the economy. A small stimulus package could mean lower interest rates, which could boost corporate profits and drive stocks higher.

Now, back to the match… I have laid it out as I see it and frankly – we are not in pretty economic times. From my vantage point, I do not see the bulls winning this outright but I do expect some positive surprises – such as a sharp rise in the markets if the European Central Bank comes out with a solid bailout plan for debt-ridden nations, or if Federal Reserve holds interest rates flat and promises more stimulus.

At times like this, I always continue to recommend a sound asset allocation strategy – which is always a good defense against wild swings in the market. In addition, bad markets always present opportunities. As the tide goes out, many treasures are exposed. We will be there to pick them up.

And last but not the least, should the bears prevail… rejoice, because as I said in my previous commentaries, a bad market could well be your best friend over the long run.

Visit http://onthemoneyradio.org for weekly commentary and money advice that covers the entire financial spectrum which also airs on my weekly radio show, “On The Money!”

Steven L. Pomeranz, CFP is a 29 year investment management veteran and host of “On The Money!” which airs on NPR station, WXEL in South Florida. He concentrates on serving high net-worth individuals and has been named one of the Top 100 Wealth Advisors 2007, by Worth magazine (October 2007 Issue), honoring America’s premier financial and wealth strategists.

A public limited company is considered to be owned by all its shareholders and technically, each of them has a right to vote in the Annual General Meetings and Extraordinary General Meetings. In fact, the firm is legally bound to invite the stockholders for such meetings and inform them of the particulars like venue and date. However, more often than not, shareholders with minor stake in the firm refrain from even attending such events.

Many important decisions such as appointment of directors and takeover are taken in these meetings which have a huge impact on the present and future of the company. A company’s stakeholders’ financial interest is also affected by the well-being of the enterprise and they can choose to intervene in these important affairs in order to protect their interests. Besides, some shareholders may also consider it their moral responsibility to restrict the firm from getting involved in any unethical practices such as employee exploitation or hostile takeovers. Driven by such motives, a few among the large number of investors in a firm decide to take matters in their own hands when they disagree with a management decision. This is now popularly known as investor activism.

Contrary to this reformist attitude, the passive investors choose to stay invested as long as the company does well and quickly get rid of the stock if they anticipate that the management is not working in the interest of the firm. Still others do not even offload their share in the company when things are not going the right way. In the long run, imprudent management decisions may have an effect of bringing down the stock price and a depletion of shareholder value. Investor activism intends to address these issues and preserve the shareholder value.

Shareholder resolutions and proxy battles are some of the ways in which activist stockholders can express their views. But they may also take more aggressive steps like public campaigns and legal action against the management. Activism is generally an effort of the investment management funds rather than individual investors since they do not only have more motivation but also required resources and expertise in the area to undertake such activities when compared to their individual counterparts.

Investor activism is considered as a kind of blackmail by some corporations since it has, in some cases, been used by unscrupulous investors to extort money out of the management by forcing them to take a particular decision or buying back their share at a considerable premium. But such cases have been few and far apart and most of the activism is directed towards the unjustified management compensation in public companies and questionable management practices. Besides sustainability, human rights and Corporate Social Responsibility (CSR) have also been major themes of many activist endeavors.

An enlightened and active investor can add value to an organization and thereby, to many other investors of the company by exercising his/her right and keeping the management practices in line with overall shareholder interest.

Investors looking to diversify their portfolios and insure their wealth against the ravages of volatility in traditional markets, will most likely have come across a range forestry investments, promising to generate superior inflation-adjusted and risk-adjusted returns for the long-term investor.

But how have timber investments performed? And how does the smaller investor participate in this interesting alternative investment asset class?

Firstly let’s look at the past performance of forestry investments, as measured by one of the main timber investment indices, the NCREIF Timberland Index; according to this basic measure of investment returns in the sector, this asset class outperformed the S&P500 by some 37 per cent in the 20 years between 1987 and 2007. When stocks delivered average annual returns of 11.5 per cent, forestry investments returned 15.8 per cent.

At the same time, returns from investing in timberland and woodlands have been proven to display a much lower volatility, an attractive characteristic for today’s investor.

Previously, the majority of investment returns from forestry investments have been mopped up by larger, institutional investors such as pension funds, insurance companies and university endowments, who have collectively placed over $40 billion into timber investments in the past decade.

So on to the second question; how do smaller investors participate in this kind of alternative investment?

According to a study by Professor John Caulfield of the University of Georgia, returns from forestry investments are three-fold;

An increase in timber volume (biological growth of trees), which accounts for some 61 per cent of return on investment.
Land price appreciation, accounting for only 6 per cent of future returns.
Increase in timber prices per unit, delivering the final 33 per cent of investment returns for timber land owners.

So the best way to harness the performance of timber investments is to take ownership of trees, either directly, or through one of the array of forestry investment funds or other structures.

Timber REITs

One way for smaller investor to participate in timber investments is through a Real Estate Investment Trust (REIT). These investment structures are like funds, in that investors can buy and sell shares in the trust on an exchange, the REIT acquires and manages timber investment properties, but unlike normal companies must pay out 90 per cent of their earnings to investors through dividends.

Some examples of Timber REITs are:

Plum Creek Timber is the largest private owner of timberland in the U.S. and the largest timber REIT with a market cap of about $5.6 billion, many investors have chosen this as their route into forestry investments.

Potlatch is also a timber investment REIT while

Rayonier generates about a 30 per cent of its REIT earnings from timber.

Weyerhaeuser has disposed of its paper and packaging businesses and will convert to a REIT by year end.

The Wells Timberland REIT is not publicly listed but may be available for purchase through Wells Real Estate Funds.

Another way for smaller investors to add forestry investments to their portfolios is to buy Exchange Traded Funds that attempt to track the performance of timber returns. This is less direct than owing timberland, or investing in a timber REIT, as the ETF may also invest in shares in companies involved in the timber supply chain including processors and distributors. This means that investing in forestry through ETFs exposes the investor to some of the volatility of equity markets.

The Guggenheim Timber ETF owns about 25 stocks and REITs involved in the global timber and paper products industry with a 30% weighting to U.S. companies.

The S&P Global Timber & Forestry Index Fund holds 23 securities and is 47 per cent invested in the U.S.

Timber Investment Management Organisations (TIMO)

Those with more capital to spare can participate in forestry investments through TIMOs, although the majority of these investment specialists require a minimum investment of $1 million to $5 million and a commitment to tie up funds for up to 15 years. TIMOs essentially trade timber land assets, acquiring suitable properties, managing them to maximise returns for investors, the disposing of them and distributing profits to shareholders.

Many experts believe that the active management style of TIMOs ensures that they can be more reactive to market conditions than REITs, and therefore don’t tend to fall and rise in line with the market quite as much.

Direct Forestry Investments

Those with access to sufficient capital and the appropriate expert advice can invest in physical properties. Commercial timber plantations are complex operations that require skill, knowledge and expertise to manage effectively and maximise returns whilst lowering risk.

For armchair investors, or those with less capital to spare, many companies offer investors the opportunity to purchase or lease a small portion or plot within a larger, professionally managed timber plantation. Investors normally take ownership of their plot and trees via leasehold, whilst the timber investment company plants, manages and often harvest the trees on behalf of the investor.

Options for investors range from species to species and region to region, with current opportunities in Brazil, Panama, Costa Rica, Germany, Nicaragua and other, more exotic locations like Fiji.

Investors should be wary as many of these direct forestry investments are frontloaded with enormous commissions for salesmen and promoters, with many offering ‘agents’ up to 30 per cent commission for the sale of plots to investors, and in many cases, no due diligence even exits.

In some cases, the Author has seen forestry investment plots in Brazil packaged and sold to investors for over £100,000 per hectare. Investor should seek advice from an independent consultant with experience of this alternative investment asset class, and who is able to present a complete suite of due diligence material, including an independent valuation of the forestry investment property on offer.

Summary

Investors choose forestry investments due to their effect as an inflation hedge, and their ability to generate non-correlated return on investment in the long-term.

Performance of the asset class is driven by demand for timber, weighed against global supplies, and in the long-term we are using timber at a faster pace than we can grow it, making timber investments an attractive asset class for the investor seeking stable, long-term capital appreciation within their investment portfolio.

Investors looking into which type of forestry investment is right for them should consult an adviser that can demonstrate experience and expertise within the sector.

DGC Asset Management Limited is an alternative investments business, identifying opportunities to invest in non-correlated assets.

David Garner is Partner DGC Asset Management Limited.

For traders of financial markets, “timing is (almost) everything.” They need all the tools available to gain an edge in perhaps the most difficult of all market tasks: trading.

Yet a number of people associated with financial markets will not be interested in short-term trading. It does not suit their temperament or life style. There are a number of tools associated with these market timing studies that can be invaluable for investors too. Therefore, let’s refine this article into three categories of market participants, according to the strategies involving different cycles and different time frames for chart analysis. The reason for making this distinction is because investors and traders will use different technical studies and chart patterns to determine a favorable point to enter and exit into a position.

Long-Term Investor

From a cycles’ perspective, a long-term investor is one who will create an investment strategy with the four-year cycle as the central focus. That means the 4-year cycle will be used in tandem with a longer-term cycle, such as an 18-year cycle, a cycle that is “above” (longer than) the time frame of the 4-year. Additionally the investor will use the subcycles or phases that unfold within the 4-year cycle, as the next cycle of a lower degree. That will involve the two- or three-phase classical breakdown of the 4-year cycle, which may include two 23-month cycles (with a usual range of 19-27 months), and/or three 15.33-month cycles, with a range that varies according to whether it is the first, second, or third phase. As outlined in Volume 1, the mean average of a 46-month cycle would be 15.33 months. But historical studies show that the first phase has a mean cycle length of 16.5 months with a normal range of 13-20 months. The last phase, however, is shorter, with a mean cycle length of only 14.3 months, with a very wide range of 8-23 months. Because it is the last phase of a longer-term cycle, it is not surprising that 54% of the historical cases of this third phase occurred outside the “normal” range of 13-20 months that were observed in the first phase.

In my own practice, I use the 18-year cycle as the “greater cycle” containing four or five 4-year cycle phases. In other words, historically there are usually 4 or 5 four-year cycles within the greater 18-year cycle. There has been at least one instance of 6 four-cycle phases within an 18-year cycle (see Table 1). The “lesser degree” cycles I use in tandem with the 4-year cycle are the 2- and 3-phase subcycles within the 4-year cycle. These are the 23-month and 15.33-month subcycles discussed previously. I will also use the 50-week cycle to help time a long-term entry or exit point. As demonstrated in Volume 1 of the “Stock Market Timing” series, there may be anywhere from three to five 50-week cycle phases within a 4-year cycle. Half of the time (50%) the 4-year cycle will contain four 50-week cycles. The other 50% of the time it will likely contain three or five 50-week cycle phases. Thus one starts with the idea that a 4-year cycle will contain four 50-week cycles, but at the same time be aware that it might contract to include only three, or expand to include as many as five 50-week cycles. The point to understand here is that a long-term investor who is applying these methods to enhance investment performance, will use a 4-year cycle, and tie it in with at least one longer-term cycle and one shorter-term cycle.

The long-term investor will also examine charts of at least three different time frames. The primary time frame to be used for analysis might be the monthly chart. Above that, perhaps he may tie it in with the yearly or quarterly charts. Below that, he may tie in the monthly studies with the weekly and maybe also the daily charts. The point is that he wants to invest in the direction of what his monthly charts are telling him. But he wants to make sure this conforms to the trend direction suggested by the yearly or quarterly charts and their technical studies. He then wants to make sure that the weekly chart is at a point of reversal, and ready to move into the direction of both the monthly and longer-term charts.

Intermediate-Term Investor

In actual practice, quarterly and yearly charts are not that practical for investment purposes. An investor can do just fine by concentrating on the weekly and monthly charts, and then maybe using the daily chart to fine tune entry and exit points. A distinction may be made between a “long-term investor” and “intermediate-term investor.” An intermediate-term investor, in this case, may use the monthly, weekly, and daily charts for applying technical studies in the pursuit of optimal investment entry and exit points. At the same time, he may use the 50-week cycle as his primary frame of reference, and tie it in with the 4-year cycle and its phases (a level above the 50-week cycle), and the primary cycle (one level below the 50-week cycle). This type of investor may be most comfortable holding a position for several months, and maybe even 1-3 years.

Position Trader, or “Trader”

The term “position trader” will refer to one who intends to be in a position less than one year but usually at least two weeks. This trader will primarily be focused upon the daily chart. But in assessing an entry or exit point, he will tie this in with the weekly chart (one time frame above), and quite possibly an intraday chart (one time frame below the daily chart), such as a 60- or 30-minute type. In reality, it seems that most position traders are not concerned about intraday charts. They use mostly daily and weekly charts, and perhaps some will use monthly charts, just as investors will.

In terms of cycles, this type of market participant would be advised to use the primary cycle as the central point of analysis, and combine it with both the 50-week longer-term cycle (one level above the primary), and the major and/or half-primary cycle phases within the primary cycle (one level below the primary). If entering the first primary cycle within the greater 50-week cycle, the trader may elect to hold onto this position for several months. If entering the final primary cycle phase of the greater 50-week cycle, he may elect to hold onto the position for only 2-8 weeks.

Short-Term Trader

Most professional traders are short-term or even aggressive traders. Their basic goal is to enter a trade that – according to their studies – has maximum profit potential with minimal market exposure. Their average duration in a trade may range from one day to three weeks, sometimes more.

The short-term trader will use the same time frame charts as the position trader. But he will tie in different multiple cycles in choosing his entry and exit points. That is, the daily chart will likely be the primary chart for reference. Against that chart, he will integrate studies from the weekly chart (one level above) and perhaps a 30- or 60-minute chart (one level below the daily). He wants to trade in the direction of the trend indicated on the weekly chart. If the weekly chart studies suggest rising prices, then he wants to enter the market when the daily chart signals are bottoming and exhibiting signals that it is ready to turn up. He will then use the 60- or 30-minute charts to fine tune his entry point.

In terms of cycle studies, the short-term trader may use the 6-week major cycle as the central point of focus. The level above the major cycle to use in this endeavor would be the 18-week primary cycle, and the cycle to use on the next lower level would be the 2-4 week trading cycle, or even the 4-9 day alpha-beta cycles. If the primary cycle is in its early stages, the short-term trader will look to buy on any corrective decline to a major or trading cycle trough. He may use the alpha and beta cycles to help him make this decision.

Aggressive Short-Term Traders

In my daily and weekly market reports, parameters are provided for both “position traders” and “short-term aggressive traders.” These suggestions for aggressive traders are for those willing to go against the trend of the primary cycle. Or, in some cases, it will refer to those who wish to be in a trade for perhaps only 1-4 days on average.

An aggressive short-term trader is going to use a host of intraday charts to find the right technical set up for entry and exit. He may be most focused upon a 30- or 60-minute bar chart. The next level up to tie his analysis in with may be the daily chart. He should always try to trade in the direction of the daily chart, except when he believes the daily chart is about to reverse. Because he is willing to “bottom pick” or “pick the top” of a move before the reversal is confirmed, he is an aggressive short-term trader. He is picking the top or bottom of a move before it has actually reversed. He understands that the sharpest price moves in the shortest amount of time occur when the market reverses its trend and starts a counter-trend move. This is especially true in bull markets when prices are making a crest. The decline is usually sharp and vicious at the end of the rally to the cycle’s crest. However, the decline is also brief in comparison to how long it took to reach the crest. That is why the most successful traders are willing to sell short at certain points in a bull market. Investors would never think of such an unconventional and risky approach. But aggressive short-term (and professional) traders know that the greater the risk, the greater the profit potential as well.

Below the 30- or 60-minute chart, this aggressive trader may use a 5- or even 1-minute chart to fine tune entry-exit points, and maybe even a “tick chart,” which records each and every trade as it is being made. This trader studies the technical signals of these very short-term charts, and waits until they are also ready to turn against the trend of the daily chart, as well as the 30- and/or 60-minute charts.

There are no three cycles to tie in with one another for this type of aggressive speculator, unless one uses intraday cycles, like 50-minute, or 3-hour cycles, which are not within the scope of this book. However, an aggressive short-term trader may use the fast-moving solar-lunar phases, within the field of geocosmic studies, to help determine days when 4% or greater reversals, lasting 1-4 days, are most likely. The Sun-Moon combination changes every 2-3 days, and many of these combinations have very high historical correlations to 4% or greater price reversals in various stock indices. These studies were reported in Volume 4 of this Stock Market Timing series, titled: “Solar-Lunar Correlations to Short-Term Reversals.” For the aggressive short-term trader, the studies in this book are invaluable for knowing when to enter and exit a 1-4 day trade that has a higher than normal probability of success, assuming the very short-term technical studies are set up properly. Once again, the primary purpose of this book is to know how to identify such a compatible technical set up.

Summary

The importance of using multiple time frames and multiple cycles to establish a successful trading plan cannot be underestimated. It is the most important factor in determining the trend. It is only through an understanding of where the market is in terms of its trend that one can consistently realize profitable trades or investments. But trend means different things to different people. It means different things to a cycles’ analyst too. The trend to a short-term trader may be completely opposite the trend to a long-term investor. The key to understanding trend is to focus on a particular time frame or cycle, and to tie it into a time frame or cycle that is “above” that level, and also one that is “below” that level.

The idea is to first of all determine when the “up one level” chart or cycle is in a clearly defined trend. Then patiently wait for the next lower time frame or cycle to finish a contra trend move (i.e. retracement) and indicate it is ready to begin a thrust in the direction of the “up one level” chart or cycle. When it appears the lesser cycle is ready to move in the direction of the greater cycle trend, then time the entry (or exit) to coincide with the “below one level” chart entering an oversold (if buying) or overbought (if selling) technical pattern. The central and “below one level” time frames or cycles should also be in a time band when a cyclical trough (if buying) or crest (if selling) is due. It should also be in a time band when appropriate geocosmic signatures correlating with a reversal are present. This concept will be repeated over and over again, for these are the steps within the methodology of this series that make the market timing studies work. These are the steps that provide the structure in which market timing can be a very valuable tool to the success of any investor or trader, regardless of one’s market temperament. But as with all successful endeavors in life, it requires work. It requires planning and proper analysis, and the correct implementation of these rules, plus perhaps a few of the reader’s own. But the rewards are worth it, and it is an exciting process.

The following list represents suggested time frames and cycles to use in this endeavor for each type of market participant. The first time frame or cycle listed in each group represents the next “higher level” type to use. The middle time frame given will be highlighted in bold. It represents the suggested primary time frame to use for trading or investing. The last time frame given represents the suggested “lower level” type to use to fine tune one’s optimal entry and exit point for maximum profit potential.

Buy and Hold Long-Term Investor (6+ years)

Cycle:72- or 90-year, 18-year, 4-year
Charts:Yearly, monthly, weekly – concerned with percentages.

Long Term Investor (2+ years buy and hold):

Cycle:18-year, 4-year, 50-week
Charts:Yearly, monthly, weekly

Investor (1-3 year position):

Cycle:4-year,50-week, primary
Charts:Monthly, weekly, daily

Position Trader (2 weeks – less than one year)

Cycle:50-week, primary, half-primary or major
Charts:Weekly, Daily, 30- or 60-minute

Short-Term Trader (3 days – 3 weeks, sometimes as long as 6 weeks)

Cycle:Primary, major, trading
Charts:Daily, 30- or 60-minutes, 5- or 15 minutes

Aggressive Short-Term Trader (1-4 days, sometimes longer, sometimes shorter)

Cycle: None. This speculator looks for contra-trend moves based on technical set ups, but may use Sun-Moon studies as a leading indicator.
Charts: Daily and perhaps 60-minutes, 30-minutes, 5-minute or 1-minute, and even tick charts.

Determine which of these best fits your own psychological temperament and life style. It is possible to utilize more than one of these types. It is possible to utilize all of these types for various purposes and at various times. I do. But make the effort to define which approach you are taking with each investment, with each trade. Once that is determined, apply the suggested time frames to that type of investment or trade for the best and most consistent results.

Well… the seesaw continues in the markets – down 200 points one day, up 275 points the next… a sharp fall, inevitably followed by an equally sharp rise… and funnily, for me at least, it’s often the same news that causes swings in both directions. For example, the European sovereign debt crisis led to sharp market declines, then recently, that very issue – but this time with a positive spin – led markets higher… amazingly amusing, if you have it in you to see humor in such things.

As I keep saying, who can say where markets are headed? It’s almost as if the bulls and bears are in a constant tug of war, violently jerking control away from one another, to and fro.

I’m sure many of you are concerned that markets could tank even further. And I don’t blame you – because there is a lot of media chatter about economic weakness and markets dropping even more, especially in light of zero job growth in the U.S. in recent weeks.

So – let’s assume, for a moment, that the bears do win-out in the near term. Then what? Does that spell the end of your retirement portfolio… and your way of life as you know it??

Well… on the contrary… a downturn could be just the thing you need to get back on your feet. Here’s why:

1. Bad markets may make you feel terrible and take your portfolio to new lows… but guess what… they also make you the most money. Because, as I said in an earlier commentary, you must take the market’s bumps, peaks and valleys in stride, and as Jerry Garcia said… just keep truckin’ on… which, in Pomeranz-speak means – keep investing, through highs and lows.

2. Because a down market is a great opportunity to buy good companies at great, bargain-basement prices. Over time, such stocks deliver astounding returns when the market recovers, as it inevitably does even from its darkest depths and often within a few years – sooner than predicted. So, as long as you keep buying through downturns, stay invested for the long run, and do not exit, time or otherwise attempt to outsmart the market – you could do very well by simply buying low, holding long enough, and selling high.

3. Another one of my favorite stock market expressions is… to succeed at the investing game, investors must climb a wall of worry. What I mean is that when markets are down, and your portfolio is all beaten up, it is only natural to get disenchanted. This is also the time when your loved ones may chastise you for not getting out when the going was good (believe me, many investors have been on the receiving end of that line) and urge you to abandon the stock market because it resulted in colossal losses. At such times, anti-stock market sentiment is at its peak. And at very such times, it takes tremendous courage to stick to your convictions, to continue to see the big picture, to rationally understand that stocks are the best investment over the long run, and to keep on the path of regular investing.

4. Here’s another mind trap: After a long market rise, whether it would be in Gold, Real Estate, or Stocks, past performance will always suggest that the best performing investment during that particular time will seem like the best investment to make NOW! And the worst investment during that period would only be suitable for idiots to invest in. Ironically, the exact opposite is true.

5. In fact, while you are in the accumulating and savings phase, you should cherish bad markets, just as you cherish good friends – because they nourish you for long-term success. The time to want high prices is when you are in the distribution phase – taking money out of your portfolio for retirement, college tuition, etc. Now granted, at all points in time, there are folks in both categories – investing and withdrawing – so the key really is to keep investing through good markets and bad. Now, some of you may think that Steve wants you to buy even when stock prices are high… not so – all I want you to do is NOT abandon the stock market through highs or lows; when markets are high, you will find, by the very nature of a broadly diversified market place, sectors and assets that are underpriced when indexes are at or near all time highs – buy them! So, in a nutshell, consistently buy stocks at reasonable prices at all times, and diversify your portfolio with stocks that are not correlated with each other or the market.

6. Lastly, Steve doesn’t want you to give up your morning lattes at Starbucks or wherever – but he does want you to cut them down from seven days a week to maybe two or three. In other words, I want you to do everything in moderation, not give up your lifestyle choices but understand that saving and investing will always serve you well than spending with little thought for the future. Ironically, the battle is between the accumulators (the savers who’d rather accumulate and invest their wealth) and the spenders….you have just have to know which one you are and act accordingly.

Visit http://onthemoneyradio.org for weekly commentary and money advice that covers the entire financial spectrum which also airs on my weekly radio show, “On The Money!”

Steven L. Pomeranz, CFP is a 29 year investment management veteran and host of “On The Money!” which airs on NPR station, WXEL in South Florida. He concentrates on serving high net-worth individuals and has been named one of the Top 100 Wealth Advisors 2007, by Worth magazine (October 2007 Issue), honoring America’s premier financial and wealth strategists.

The abundance of investment products and investment information available today can be intimidating and confusing to many investors, both novice and professional. Over my twenty-plus years as an attorney and investment adviser, I have tried to help others focus on some of the critical information in order to avoid unnecessary investment losses, to help level the playing field against some of the ne’er-do-well that continue to defraud the public and plague the financial services industry.

Speaking with a colleague the other day, he commented on the fact that a lot of the important information we get through trade publications such as InvestmentNews rarely seem to get mentioned in the mainstream media and press. And when we mention such information to clients, they often comment on how useful such information would have been.

After my conversation with my colleague, I started thinking about some of the “inside” information I have shared with my clients that produced the most reaction and appreciation. In hindsight, I think three numbers have stood out the most to me and my clients. The three numbers every investor should know are as follows:

1. “75″ – The number “75″ is actually important for two reasons. First, a study by Schwab Institutional found that approximately 75% of investor portfolios were poorly structured and unsuitable for their investors given the investors’ financial needs and goals. I believe that this is primarily a result of the fact that (1) stockbrokers are not required to act in a client’s best interests, and (2) investors are often mislead by portfolios that appear to be diversified because they hold a number of different types of investments, but such portfolios are often not truly, effectively diversified.

The second reason that the number “75″ is important is because research and history have shown that approximately two-third, or 75%, of stocks follow the general trend of the market. This simply supports the popular Wall Street adage, “don’t confuse brains with a bull market.”

2. “94″ – While there are many firms and individuals in the financial services industry calling themselves wealth managers, a study by CEG Worldwide, a well-respected financial services consulting firm, concluded that only 94% of those calling themselves wealth managers or claiming to provide wealth management services failed to meet the criteria used to qualify as wealth managers. The criteria that CEG used in their study to determine true wealth management was based primarily on advisers who practiced wealth management as a process as compared to those who simply used “wealth management” as a marketing ploy to push product. This is the same criteria that investors and fiduciaries should use in choosing a financial advisor to work with.

Secondly, one expert has suggested that this number (OK, actually 93.6, which rounded off is 94), and the study that produced it may have caused more damage to investors than any other number/study. The number comes from the famous 1986 Brinson, Hood and Beebower (BHB) study that stated that 93.6% of the variation of a portfolio’s returns could be explained by the portfolio’s asset allocation.

The study did not say that asset allocation explained 93.6% of the portfolio’s actual returns, but rather the variation of the portfolio’s returns. Nevertheless, dishonest brokers and advisers misrepresented, and still do misrepresent, the BHB study’s findings to convince investors to choose an asset allocation and rigidly adhere to it, despite the proven cyclical nature of the markets. This is the mantra of the” buy and hold” approach to investing, an approach that some have suggested is better described as the “buy, hold and regret” approach to investing. Just ask investors how well that worked during the 2000-2002 and 2008 bear markets.

Unfortunately, given the current budget issues that exist at the time I write this post, static asset allocators may soon get yet another costly education. Dr. William Sharpe, a Nobel laureate for his work in the area of investment management, now stresses the need to be proactive and adjust portfolio allocations when changes in the economy and/or the market dictate such moves.

3. Zero – This number represents the number of variable annuities (VA) and equity indexed annuities (EIA) an investor should own. As a former compliance officer and a current securities attorney I have heard all the convoluted and conniving justifications for these atrocities. I have written posts and articles warning investors about these products. While there may be a few limited instances where they may make sense, such as wealth preservation for high net worth investors, the way they are marketed to the masses is extremely questionable.

One Wall Street Journal article reported that variable annuity salesmen were told to treat potential annuity clients as “blind twelve-year-old,” and to “put a pitchfork in their chests,” and provide questionable responses to potential client’s questions. VA salesmen and VA advertisements often tout that by purchasing a VA the investor will never run out of money.

What is often not made clear that in order to guarantee that lifetime stream of money, you give up all rights to the money invested in the VA. Once you annuitize your VA, the balance goes to the insurance company once you die, not to your heirs. In most cases the insurance company offers various choices for payout, such as joint survivor and a guaranteed period, but these options generally result in lower periodic payouts and, in some cases, additional fees.

One of the most onerous aspects of VAs is the excessive fees that most VAs charge, especially with regard to the so-called death benefit. VAs typically guarantee that in the event the VA owner dies with out having annuitized the VA, the owner’s heirs will receive either the accumulated value of the VA at the time of the owner’s death or the amount of the owner’s actual investment in the VA, whichever is greater. So the VA issuer is only insuring the amount that the VA owner actually puts in the VA.

Meanwhile, the insurance company assesses the VA’s annual death benefit fee not on the basis of their actual legal obligation, which is the amount of the VA owner’s actual investment, but rather on the accumulated value of the VA. One study estimated that the actual expense of the annual was approximately 0.10-0.12, but that the insurance companies often charged approximately 1.50%, or approximately fifteen times the estimated value, resulting in a nice windfall for the insurance company. The additional fee also cost a VA investor by reducing this investment return.

EIAs are also problematic. EIAs are generally sold with the pitch that investors can earn the same return that the stock market does, with the guarantee that even if the market is down, the EIA investor is guaranteed a minimum return. What many investors are told is that the potential return is usually capped at a relatively low number, say 10%, and then is reduced even more by a “participation rate,” usually an additional 2-3% reduction. In short, the EIA investor is looking at annual rate of between 2-7%. If the market is up 20% or more for the year, just who is getting the benefit of the excess over the investor’s return?

There may be other significant numbers that I have omitted. However, investors and fiduciaries that remember these numbers and the reasons for their significance will be in a better position to protect both their financial security and/or their clients’ financial security.

James W. Watkins, III is an attorney, a CFP professional and an Accredited Wealth Management Adviser. His areas of expertise include wealth management, wealth preservation, wealth protection and fiduciary law. He is CEO of InvestSense, LLC, a registered investment adviser firm located in Atlanta, Georgia. For additional articles and information, visit http://www.investsense.com. Mr. Watkins can be contacted at tawj3@yahoo.com, and followed on Twitter @InvestSense.

If recent stock market activity does nothing more, it shows us that volatility continues to be the name of the game when it comes to investing, as £120 billion is wiped off the value of UK shares alone in the course of four days.

Investors have traditionally employed a number of strategies such as asset allocation and diversification in an effort to reduce risk. But more recently than ever before, the big investment players such as Pension Funds, Hedge Funds and Sovereign Wealth Funds are turning to alternative investments to generate returns that are not dependent on the performance of traditional assets such as equities and bonds.

A recent report by Morningstar and Barron’s; the 2010 Alternative Investment Survey of U.S. Institutions and Financial Advisers, has revealed that institutional investors have allocated more than 25% of their assets under management to alternative investments.

Barclay Capital also recently stated that pension funds have added substantially to their farmland and commodity holdings, with institutional investors expected to hold up to $1 trillion in agricultural assets by 2015, way up from a mere $6 billion held in this asset class ten years ago.

Both institutional and private investors are hoping to generate superior returns in order to boost the performance of their portfolios without dramatically altering the over risk profile, and many see farmland and timber as ideal assets in the current economic climate.

Forestry investments generate profits from the production and sale of timber, so investment returns rely on the biological growth of trees, rather than the performance of financial assets. And with farmland, growth in demand for food, feed and fuel is pushing up the price of food, which bolsters farmland incomes and in turn makes productive land a more valuable asset, capturing capital growth.

There is most certainly an appetite for simple, transparent and tangible assets that are unlikely to depreciate as they are supported by solid long term fundamentals nod remain in high demand, and where investment performance is not dependent upon the decisions and choices of Fund Managers or economic or political news. Many investors consider that owning assets within the food, energy, water and commodity markets are likely to prove more profitable than investing in companies as demand for these essential commodities will continue to grow as the population expands at the fastest pace in history.

China recently invested $1.5 billion dollars into a farmland development project in Argentina, bringing investment capital for infrastructure, and technical expertise in large-scale irrigation, in exchange for long-term leases of farmland from the Argentine Government virtually rent free.

Swedish and American Pension Funds have recently committed hundreds of millions of dollar in investment capital to farmland purchases in order to capture inflation in the capital value of the asset, whilst also generating income streams, useful for meeting commitments in the short term to member of their schemes.

So alternative investments may be the order of the day, but barriers to entry do exist for smaller investors, and those considering such investments should seek advice form experienced Consultants.

David Garner is Partner at boutique alternative investment boutique DGC Asset Management Limited.

Download the agriculture investment and forestry investment reports at: http://www.dgcassetmanagement.com

U.S. debt currently stands at over $14.5 trillion (which, by the way, works out to roughly $130,000 per U.S. taxpayer). That’s a massive amount of debt.

And if you’ve been listening to the news lately, you’ve likely heard that the Democrats and Republicans are deadlocked over something called the debt ceiling.

I will attempt to explain how this impacts you and your portfolio, but first, let’s start by understanding a few terms.

Government Budget Deficit
Just like you and me, our government too has sources of revenue and uses for that revenue.

In 2010, Federal revenue totaled $2.16 trillion – from income tax (41.6%), payroll tax (40%), corporate tax (8.9%), and custom duties, excise, and estate and gift taxes (9.5%).

In 2010, Federal spending totaled $3.46 trillion – on Medicare (23%), social security (20%), defense (20%), interest payments on debt (6%), and other discretionary expenses such as education and environment protection (31%).

Net-net, in 2010, the government spent $1.3 trillion more than it took in.

Every time a government spends more than it takes in, it runs what is called a budget deficit. In fact, we’ve had budget deficits for each of the past 10 years (well, actually, we’ve had budget deficits every year since 1970 except for four years from 1998 to 2001).

In an unfortunate continuation of over-spending, the Congressional Budget Office estimates a 2011 deficit of $1.5 trillion – the largest ever in U.S. history.

Federal Debt & Debt Ceiling
You might ask, how can our government continue to spend money it does not have, year after year?

Simple… they borrow it, year after year, which is how we’ve racked up $14.5 trillion in debt.

Logistically, the government needs authorization from the Senate and the House of Representatives (collectively, the U.S. Congress) on all borrowings. And total debt cannot exceed a $ limit – the debt ceiling – set by Congress.

The Current Crisis
Traditionally, the Democrats and Republicans have used the debt ceiling to further their partisan causes – be it an increase or decrease in government spending, taxes, etc. -cobbled together a budget compromise both parties can live with, and raised the debt ceiling before the government ran out of money to pay its various mandatory and discretionary obligations.

However, this year, the debt ceiling has become a major point of leverage between the Republicans (who want big cuts in government spending) and the Democrats (who are resistant to certain cuts and wants to raise taxes).

In response, the Treasury Secretary has imposed an August 2nd deadline by when the debt ceiling must be raised to keep the government solvent.

Impact on U.S. Credit Rating
High U.S. debt, escalating political tension on the budget deficit, and the impending August 2nd deadline for the debt ceiling also have credit rating agencies (such as Moody’s) concerned that the U.S. may miss payment of interest or principal on outstanding U.S. government bonds.

As a result, there is some risk that our nation’s credit rating may be lowered a notch from the highest Triple A rating it enjoys today.

Consequences
Now… a $1.5 trillion budget deficit cannot be erased overnight. High unemployment and predictions of continued near-term economic weakness will likely reduce tax inflows and create a situation where the government has to spend more to support the unemployed – sort of a no-win situation.

Twenty years back the government could have borrowed its way out of its woes, but with our debt as high as it is, we really do not have much room left for maneuvering.

If ratings agencies actually do lower U.S. credit rating below Triple A, the psychological impact may well be worse than the $ impact.

Higher Interest Rates
A lowered rating would mean that the U.S would pay higher interest on future borrowings (same as how you’d pay a higher mortgage rate if your credit was bad). This will flow down and raise rates for individual and corporate borrowings, and adversely impact GDP growth and employment.

Weaker Dollar
High debt levels and continued deficit spending will also weaken the dollar. A weaker dollar means higher prices for all our imports – automobiles, apparel, commodities, computers, electronics, food, gasoline, industrial equipment, toys, wine, and so on.

That means higher gas prices, grocery bills, plane fares, and so on – we will either spend more and save less, or spend less and save more – neither of which are good options because we will have less disposable income… less eating out, fewer movies, trips to the mall, vacations, etc.

All this translates into lower corporate profits, which may dampen stock prices, especially of companies that depend on domestic spending and consumption for most of their profits, such as restaurants, retailers, and domestic airlines.

On the flip side, foreigners may start flooding back to the U.S. on vacations and may step up their purchases of U.S. exports, which could result in related stocks doing well.

Summary
In a nutshell, a weakened economy, high budget deficits, sky-high debt, and an impending credit downgrade can adversely impact your savings rate and your portfolio. On the flip side, if you prepare your portfolio for such an event, it could emerge stronger over the long run.

I am pretty confident that neither the Democrats nor the Republicans would want to be blamed for not lifting the debt ceiling. So I believe the ceiling will be lifted by August 2nd.

Before then, investors will have to climb a wall of worry, but an August 2nd deal could see stocks soar into perhaps another rally.
Additionally, the current budget impasse will likely result in reduced government spending and a commitment from both sides to bring down our national debt. This will structurally benefit the US economy over the long run – so stocks, the dollar, Treasury bonds, and our economy as a whole, could well see happier times ahead. So now is a good time to position yourself – while we may get hit by the worst near-term, the best may be yet to come.

Visit http://onthemoneyradio.org for weekly commentary and money advice that covers the entire financial spectrum which also airs on my weekly radio show, “On The Money!”

Steven L. Pomeranz, CFP is a 29 year investment management veteran and host of “On The Money!” which airs on NPR station, WXEL in South Florida. He concentrates on serving high net-worth individuals and has been named one of the Top 100 Wealth Advisors 2007, by Worth magazine (October 2007 Issue), honoring America’s premier financial and wealth strategists.

Individually Managed Accounts (IMAs) and Separately Managed Accounts (SMAs) both offer investors a highly transparent managed share portfolio while avoiding the tax distortions that come with pooled investment vehicles such as managed funds.

However, there are some important differences between individually and separately managed accounts and while they may sound very similar, these differences can have a significant impact on investment performance, suitability, and tax effectiveness.

In General, Separately Managed Accounts are a good alternative to managed funds for many investors, while investors with $1 million or more, are likely to find the features of an IMA more compelling.

Key differences between the two types of managed accounts rests in their approach to building an investment portfolio.

SMAs are constructed with a ‘model portfolio’ where each investor receives precisely the same portfolio, based on a template created by the fund manager. IMAs however, are constructed individually for each investor, although each account will share some common holdings. These two approaches have some important differences:

* Investors in a SMA may buy stocks that have already enjoyed most of their returns, but remain in the model portfolio to avoid realising capital gains tax. IMA investors however will receive a portfolio that is assembled incrementally, as attractive opportunities arise.

* For the same reason, new investors in Separately Managed Accounts will receive a larger position in stocks that have already performed well, while IMA investors are likely to receive larger holdings in stocks the investment manager believes will perform well in future.

* IMAs also provide the ability to tailor the portfolio to the investor’s circumstances. For instance, an IMA manager may place more weight on generating franked dividends for a SMSF, while long term capital appreciation could be more valuable for an investor with a high tax rate. These differences in investment management help produce good after tax results for each investor. Since every investor in a SMA receives the same portfolio, the Separately Managed Account manager cannot factor individual considerations into their management.

* Both structures will allow the transfer an existing portfolio, with the IMA providing some additional flexibility and tax advantages. When importing an existing portfolio into a SMA, only those shares contained in the model portfolio will be retained and only to the proportion held in the model portfolio. Therefore, investors may still realise capital gains when entering an SMA. Conversely, a diligent IMA manager will adapt the existing portfolio over time and with consideration to tax events.

* For investors wishing to exclude individual stocks or sectors, an Individually Managed Account manager will hold alternative positions, while the SMA will generally hold cash in lieu of the excluded positions. This can have a significant impact on the portfolio’s overall returns.

In executing trades, SMA investors will generally receive ‘at market’ prices on their transactions, while an IMA manager may attempt to get best execution and/or exercise discretion over the timing of buys and sells.

Service levels are also different, with Separately Managed Account investors receiving a service akin to a managed fund. while Individually Managed Account investors have ongoing access to the fund manager responsible for their portfolio and will likely receive personalised reporting.

PPM