Category Archives: Investing

Are future returns only available to private investors?

Amazon Jezz BezosWhat happens to the returns of your clients’ portfolios when more and more companies go public later and later? Will returns be privatized and kept in the hands of the few?

Staying Private

As the Wall Street Journal noted Amazon went public at a market cap of $440m and it now stands at $174bn. Uber, the on demand taxi service is still private at a $40bn valuation. It only has to multiply 19 times before it is the most valuable company in the world while Amazon has gone up 395 times since it’s market debut and is not even in the top ten.

Increasingly the best companies can stay private for a longer period, getting their funding from venture capitalists, hedge funds and private equity. As a result the general stock market investor misses out on the growth of these companies.

A few months back I was reading the biography of Sam Walton and came across his IPO experience. Essentially Wal-Mart had been built on bank loans and was maxed out. Going public was their only option to get out of debt and fund their growth. Thankfully, the public benefited from having this company in public hands. But I wonder how many “Wal-Marts” we are missing out on, because of increased periods of private ownership.

Is it impossible to believe that the Wilshire 5000 index will one day no longer be representative of American business? I don’t think so and if it is not representative will it produce the returns people need to meet their retirement goals? That’s a scarier question with no answer.

Investing Private

The Canadian Pension Plan Investment Board have publicly stated that about 40% of their portfolio will be in illiquid private investments. They believe that the short termism of public markets hurts long-term returns and runs contrary to their goals. It makes you wonder whether “buying the index” is best path to financial security for those in the early years of accumulation. Sure it worked for the last 50 years but as the saying goes, “past performance is not indicative of future results”.

Admittedly, buying public securities is the best we have and from where I sit today likely the best course of action, however I believe having alternative investments will become more important for the average investor.

Alternative Investments?

What do I mean by “alternative” investments? I mean real estate, startups, peer to peer lending and others. Thanks to platforms like Angel List and Realcrowd people can invest for as little as $1,000 avoiding some of the high minimums that have characterized investing in these industries.

Is alternative investing risky? Well, Warren Buffett says risk comes from “not knowing what you are doing”. So clients will probably need to become more savvy investors, start small and expand where necessary.

Historically, the cost of successful index investing has been patience and limiting bad behavior. This has been a good deal for many investors over the years but I wonder if it is a sufficient cost for the next generation of investors to meet their retirement needs. They may have to become more active.

What Benjamin Graham Would Do With Bonds Today

Benjamin Graham10-year treasuries are at 2%. High-yield bonds dance around historical lows and you are probably wondering if there will be anything left after inflation. Welcome to today’s bond environment where safety of principal is being exchanged for the most minimal of returns.

When speaking to advisors, their concern about today’s fixed-income environment is a recurrent topic of conversation. Just like them you are rightly worried about the returns your clients can expect and whether they will meet their retirement goals.

I wanted to find some sort of solution (or a least some solace) regarding this problem, so I turned to Benjamin Graham. The so-called “Dean of Wall Street” and mentor to Warren Buffett. Below is an old copy of Graham’s Intelligent Investor with my notes scribbled across the pages.

Intelligent Investor

Graham On Bonds

Graham was a fan of U.S. government bonds stating their safety is “unquestioned” this is because of the protection of principal they provided. On taxable vs non-taxable bonds Graham believed this was largely a matter of “arithmetic” in which high earners (and thus likely high tax payers) should gravitate towards non-taxable bonds. On high-yielding junk bonds Graham stated that the ordinary investor was “wiser to keep away” from such issues largely because of the individual risks. Given the development of high yield bond funds where risk is diversified Graham would probably not be so against them.

Graham In 2015 

So what would Graham do in 2015 given the current environment? Two items come to mind based on Graham’s works.

  • Firstly, there is Graham’s “fundamental guiding rule” – Never hold more than 75% of a client’s portfolio in bonds or stocks. Always balance between 25% on the low end and 75% on the high-end.
  • Stocks are usually attractive if the earnings yield is twice the Aa corporate bond yield. Today the earnings yield of the S&P 500 is 5.11%, 80% above the 2.83% Aa corporate bond yield.  This means stocks are preferred but they are not a bargain.

So the conclusion is that in this environment Benjamin Graham would have preferred stocks marginally. There are probably still bargains to be had for the “enterprising investor” (active). However, for the passive indexing investor, the market as a whole is not cheap. Unfortunately, Graham doesn’t talk too much about holding cash therefore I took a look at his disciple Warren Buffett’s current cash allocation at Berkshire Hathaway. At the end of 2014, 12% of the company’s assets were in cash or cash equivalents. Worthwhile food for thought.

What Tony Robbins REALLY Says About Financial Advisors

Tony RobbinsTony Robbins needs little introduction. The personal development guru has touched millions of lives around the world through his ability to “awaken the giant within”. He released his first book in 20 years – Money: Master The Game which tackles the issue of financial advice.  To summarize the book in a sentence Robbins advocates becoming an investor instead of a consumer, paying yourself first, having winnable goal, avoiding fees, choosing the right advisor, knowing your risk tolerance and learning from experts money makers (e.g. Icahn, Buffet, Bogle, Templeton, and others).

You can find a great summary of opinions on the book here.

So why does this matter to you? Robbins’ 600+ page tome is already an Amazon Bestseller and NY Times Bestseller. It will be a favored holiday gift and some of your clients will undoubtedly come across it.

Isn’t it useful to know what one of the most respected life and business coaches is saying about you? Here is a short summary.

1. Don’t Trust Brokers – If there is one rallying cry from the book regarding financial advice it is that you should not trust brokers. They often funnel you into expensive actively managed mutual funds, that don’t beat the market (over a sustained period), don’t perform as advertised and favour their own interests.  Robbins’ goes on to say the suitability standard is “pre-engineered to be in the best interests of the “house”” and what individuals need is the fiduciary standard.

2. You Can Trust A Fiduciary or Can You?  –  Robbins’ says the best way to “solidify yourself as an insider” is to “align yourself with a fiduciary”. However, he goes on to say, “not all advice is good advice” and a fiduciary may not be “fairly priced”.

 He recommends individuals find advisors from NAPFA and ensure they are…

a)    Registered with the SEC.

b)   Compensated as a percentage of your assets under management.

c)    Not compensated for trading stocks and bonds.

d)   Not affiliated with a broker-dealer. Robbins says “This is sometimes the worst offense when a fiduciary also sells products and gets investment commission as well!”

e)    Ensure your investments are custodied with a third-party like Fidelity, Schwab, or TD Ameritrade.

Robbins then goes on to make a final point….

“The added cost of a fiduciary may only be justifiable if they are adding value such as tax-efficient management, retirement income planning, and greater access to alternative investments beyond index funds.”

This aligns with a consistent theme throughout the book that individuals should avoid fees at all costs unless they are justifiable and most fees are not justifiable. However, Robbins falls short of calculating the value of a fiduciary.  After all it’s not a simple calculation and depends on the skill of the advisor. To wrap up, Robbins somewhat disappointingly champions his own financial advisor’s robo-advice platform Stronghold Financial in which he is in talks to become a partner.

3. Conclusion – Overall Tony Robbins is a supporter of fiduciary financial advisors. He believes they can make investors insiders and give them the advice they need to meet their goals. However, more than a supporter of fiduciary financial advisors, Robbins hates fees including expense ratios, transaction fees, cash drag, soft dollar costs, redemption fees, and countless others.

The book gives a lot of mathematical examples of how fees can eat into your returns but it does little to show how a fiduciary’s fees can help you. If you are fee-only financial advisor this book is generally supportive of your work. If you are not, I’d be wary.

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3 Lessons on Growing your Financial Advisory Practice from Warren Buffett

Warren BuffettI recently finished reading Warren Buffett’s Letters To Berkshire Hathaway Shareholders 1965-2013 as well as Michael Kitces’s recent blog posts about the threat of robo-advisors.  Having read these pieces it made me think….

What would Warren Buffet do if he were the owner of a financial advisory practice?

Many of the stories about Warren Buffet’s success focus on his investing prowess but little is dedicated to him as a business owner.  After reading his shareholder letters I’ve come to believe there is a lot the advisory community can learn because let’s face it – things are going to get tougher.

Competition from traditional advisors is rife. According to Cerulli Associates there are about 310,000 financial advisors of one type or another. In the U.S. there are about 5.2 million millionaires.  That makes about 17 millionaires for every advisor. Not exactly a lot when you factor in salaries for support staff, marketing and technology expenses. If we add robo-advisors on top it gets even more competitive.

So how can you grow your business using the wisdom of one of the greatest business owners of the 20th century? Let’s find out.

Lesson 1: “…producers of relatively undifferentiated goods in capital intensive businesses must earn inadequate returns except under conditions of tight supply or real shortage.” – 1978

When Buffett wrote these words he was talking about the textile industry and you are probably thinking financial advisory is not a “capital intensive” business but work with me for a second. Think about the cost to find, hire, train and support a new advisor. It’s certainly not cheap. Then think how long it takes for them to develop a book of business that supports them and generates profits? Is it a year or longer?

If we compare financial advisory to other service businesses such as software development consultancy, accounting, advertising you will find these other businesses tend to hire when they have too much work (meaning a new employee can usually earn their keep within 90 days). It’s a lot more transactional and easier to scale.

But with advisors hiring a new employee is more of an upfront investment, which pays off over a longer timeframe.  This is because advisors must build trust to win clients and that typically takes longer than completing a tax return or managing an ad campaign. Thus I believe within the service economy financial advisory is capital intensive.

If you agree with my logic then the only conclusion (given the large supply of advisors) is that differentiation is the key to growth.  As Kitces says “building a well diversified passive strategic portfolio is on it’s way to being totally commoditized”.  So if you fall into that group you must differentiate. This would require something that goes beyond portfolio-only solutions and is a lot more comprehensive or specific/niche.

So lesson number one from Buffett is differentiation.

Lesson 2: “The primary test of managerial economic performance is the achievement of a high earnings rate of equity capital employed.” – 1979

One of the most remarkable things about Buffett is that he chose one metric that matters for his business and stuck with it for years. In his case ROE/ROCE. Other metrics matter too but they are of secondary importance.

What’s the one metric that matters in your business and do you watch it on a weekly or monthly basis?

Let me give you another example. For Pocket Risk our one metric that matters is the % of customers who complete a questionnaire each month. This is because the value of Pocket Risk is in completed questionnaires advisors can assess and use to determine a financial plan. Customers who complete many questionnaires are happy and do not churn. We could have used a vanity metric like logins (which is higher) but value is not derived from logging in, it is derived from client engagement.

At first thought you may think AUM is your one metric that matters but we know that all AUM is not created equally. You will need to determine the metric or metrics that matter to your business. If I were an advisor I imagine it would be a formula that calculates the profit per customer (accounting for acquisition and support costs) on the front end and client churn on the backend.

So lesson number two from Buffett is find the metric or metrics (I doubt you need more than three) that are most important in your business and measure constantly. As Peter Drucker says “what gets measured gets managed”.

Lesson 3: “It is impossible to overstate the how valuable Ajit [Jain] is to Berkshire. Don’t worry about my health: worry about his.” – 2000

“If Charlie [Munger], I and Ajit [Jain] are ever in a sinking boat – and you can only save one of us – swim to Ajit.” – 2008

How many of your employees do you speak of in such terms? Buffett’s brilliance is also in his ability to find and nourish great people. Sure he wants them to be hard working, smart and honest but he also wants them to be self-directed. He wants them to have the mindset of a business owner. Micromanaging your team means you cannot scale therefore you cannot grow without adding layers of management. To avoid this you need your employees to have the mindset of a business owner.

Judging from his letters Buffett didn’t spend much time trying to train people to think this way, he found people who already had this mindset.  However, I think you can train people to think this way if you give them the power to make important decisions. You have to trust them. Trust however, has to be earned and you will probably need to do this over time.  Just remember there has never been a great organization without great people.

So lesson number three from Buffett is find employees with a business owner mindset who can be almost totally self-directing.

Concluding Thoughts 

Given Warren Buffett has been one of the most successful business owners in the 20th and early 21st century it pays to listen to his advice. As a financial advisor I encourage you to think more about differentiation, the one metric that matters in your business and improving your team.

I’d love to get your thoughts in the comments below. What do you think advisors can do to grow efficiently, effectively and sustainably in the years to come?

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Why The Average Investor Doesn’t Match The Average

Average InvestorNow and again I like to rummage into the academic tomes of finance. Today I give you a paper by Philip Maymin and Greg Fisher.  It looks into how the “performance of the average investor in an asset class lags the average performance of the asset class itself by an average of one percent per year over the past fifteen years.”

Given how people love to chase returns this is not entirely surprising. But it’s good to have some data to back up intuition.

You can dip into the paper over here.