During my career I’ve been interviewed several hundred times by potential clients. In almost every case during the interview the prospective client runs out of questions very quickly. Investors just don’t know what to ask. You can find many good questions with the aid of a Google search and every advisor will be able to answer them. But what about questions that could separate the good from the exceptional?
It would not be an exaggeration to state that skill and knowledge of your investment advisor can have a significant impact on your future. Ideally what you’re looking for is someone who can guide your assets smoothly in good times. Then, not be surprised and unprepared during the bad times. You’re not looking for perfection as it doesn’t exist.
Take most sales pitches with a grain of salt, the interviewee may sound convincing but how do you really know? You have to ask the right questions and below are a few that should help your process.
These questions are really designed to be directed to professionals who actually manage client assets such as RIA’s or portfolio managers. If you’re interviewing a Financial Planner they may not be able to answer one or more. FP’s are commonly generalists and defer client assets to products such as mutual funds, insurance or Exchange Traded Funds so they may not have the necessary expertise.
- “Are you a fee based advisor or do you work on commission?” Commission-based advisors or brokers may not follow your investments performance as compared to a fee-based advisor. In general, they’re salespeople who represent a brokerage firm. Fee-based advisors should work to protect your assets in down markets and grow them in good times, since their fees are based on total assets under management.
- “Of the assets you have under management are they mostly allocated to mutual funds, ETF’s (Exchange Traded Funds) or individual stocks or bonds?” If the advisor answers mutual funds, ETF’s or the basket approach used by FolioInvesting or any other Robo (Betterment) the odds are very high that the advisor is a generalist. Generalists are not prepared to get granular regarding your portfolio. Maybe you believe single digit long term returns are fine. But if you’re looking for long term returns in excess of 10% or more you’ll need an advisor with talent and expertise.Not every active portfolio manager will beat the major indices even though it’s really not that hard to do. Just don’t assume they all do well, most don’t. The good ones can answer the questions below and why wouldn’t you want a good one?
- Assuming you’re looking for an advisor familiar with Socially Responsible Investing: “Tell me your philosophy about socially screening a potential investment?” At some point the advisor should ask what your boundaries are or how pragmatic you can be. Be advised that the only way to be sure you have a diversified portfolio that is free of objectionable investments is via individual stocks and bonds. With individual securities you’ll have input.
- Once you’ve screened out the objectionable investments: “Please tell me how you select companies that pass the screen into a portfolio?” Or, “Do you have an investment style that you can tell me about?” Advisors who use individual stocks should have a proven method or algorithm to select their client investments. Without a systematic approach the returns will be more luck than skill and you’ll probably be better off with an Index fund. Beware of the advisor who tells you their system is extensively back-tested. Extensive back-testing leads to curve fitting or confirmation bias. These heavily tested systems will likely fail in the future. The best systems are relatively “loose” and have some discretionary room for the advisors experience and judgement.
- Ok, I’ll admit this next question is a “gotcha question” but every good advisor should be able to answer this one correctly: “Is the position size of a new position in portfolio based on a % of account assets or volatility?” Position weight should always be based on volatility. The most volatile investments should have the lowest % allocated to them. For more information on position sizing see Van Tharp.
- The classic: “Can you demonstrate a long term track record?” The SEC and state regulators frequently frown upon stating track records under the assumption that all returns by advisors are random. Managers and styles can run hot and cold but the best ones learn to adapt and evolve. If they can produce a track record ask if the use of margin or leverage was employed in the portfolio. Margin or leverage can increase the rate of return but it comes with exponentially rising risk.
- Every great investor or advisor has an insatiable curiosity and is a reader. We always want to improve which will be reflected in our client accounts. Ask “What is the last good book or white paper you’ve read regarding investing and what did you learn from it?”
- This is a simple question but it’s also the most revealing and the important on this list. Most advisors or financial planners fail their clients regarding long term risk. They fail their clients by either lack of knowledge or failure to understand risk. “How will you protect my assets during the next recession?” It’s been 9 years since the last major recession induced bear market. That means many advisors have never actually experienced a bear market with client assets under management. If the planner or advisor tells you that bear markets can’t be predicted or you get a disorganized word salad then reject the advisor. Learn to understand what an Inverted Yield Curve is. Otherwise be prepared to lose 35% or more of your portfolio some point down the road. Remember the law of numbers: If you lose 35% of your portfolio it will take a 50% return to break even again and that takes years.
When is a good time to sell?
(Answer: not now)
March 2017
Summary: US equity markets remain in a strong uptrend which shows no signs of abating. Markets that have broken out from multi-years of trendless behavior can last for quite a while and deliver significant returns. So at this point we need to sit tight and let the rally continue and grow our equity. I will continue to allow our good performing stocks run as far as they’re trends remain intact. Almost all the activity in your accounts is related to the laggards and losers as I have minimal patience when better options present themselves. Our focus remains on the two best performing industries: Semiconductors and Finance.
In addition, I’m seeing a change in character in two industries thought to be in the dumpster: Solar and phones companies (Specifically, Canadian Solar -CSIQ, America Movil -AMX and Nokia -NOK). If any of these stocks are genuinely in a new upward long term trend they would likely be home run stocks, but time will tell.
Treasury bonds and interest rate related securities continue to act poorly and are to be avoided. This poor action is a positive sign for stocks as they’re a sign of a healthy economy.
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Markets and economies are cyclical and you can add recessions/bear markets to the death and taxes mantra of sure things we’ll experience. In these letters in the past I’ve generally focused on the economy or interest rates as a tool to identify high risk environments. So, in this letter I want to spend a little time on what I call our “Primary Trend Filter”.
The primary purpose of having a Primary Trend Filter is to eliminate emotions and avoid the big loss from the investment process. It’s too easy to fall prey to emotions in a rising or falling market where you lose objectivity to the prevailing trend. In addition if you’re over 50 years old time becomes an issue as you have fewer years to recoup the loss.
Just about every study I read regarding losses assumes the investor is “buy and hold” with the silent assumption that it’s impossible to “time” the market. Not only is this wrong but it’s highly biased based on the compensation plans of the mutual fund industry. Funds are paid top dollar when you’re invested in equity mutual funds and receive minimal compensation when you’re in cash or Treasury funds.
Investors are bombarded with subjective media. Today, 3.13.2017 I received an email from the investor service Zacks titled “The S&P will double in 5 years.” To quote; “Sounds like a Herculean task on the surface, but it’s really not. In fact, the market only needs to gain on average of 14.9% per year in order to do so. That’s not such a stretch given the market has been averaging 14.9% per year since the bull market began in early 2009”……..
“My 5 year doubling thesis also means that we won’t see another recession until stocks double again,nor will we see another bear market until stocks double again. Got it?”
At no point his article does he even mention interest rates, the effect of past Quantitative Easing on the “14.9%” returns or the Federal Reserve. Why interrupt a good story with the thought of higher interest rates.
Predictions like the market will double in five years have no basis in a serious investment conversation and are meant to sell memberships and generate publicity. And, there is no accountability if the author is wrong.
On the flip side of the markets is this generations Dr. Doom, Mark Faber. He sells his version of fear with almost an annual prediction of a crash. He’s right about once a decade and he never changes his tune but how objective can he be with https://www.gloomboomdoom.com/ as his domain?
Will either be right, who knows? But these kinds of calls are common and best ignored. Prediction odds are always a coin toss although some are 50-50 and some are 1 in 10. But they’re all guesses and nothing more.
Rather than basing a strategy on someone’s subjective opinion, I’ve found that objective mathematical systems are far more accurate and profitable. They make far fewer mistakes and can prevent an investor prematurely buying or selling. Many pundits can only wish their calls were as accurate. These
systems will never get you out at the absolute top or bottom but they will have you correctly positioned for the bulk of a new trend.
These types of systems are especially valuable to those of us who can’t afford a 30% decline (as if anyone can) but still need the returns generated by stocks. Unfortunately for most investors these tools are generally not utilized by most financial planners, brokers and absolutely not used by the mutual fund
and robo-advisory industry. These outfits rely on “buy and hold” with the inevitable risk of big downdrafts.
But they are in various forms utilized by some of the best independent advisory firms, independent and institutional proprietary traders.
The following two graphs are my primary exposure filters for stocks. I also use several monetary and leading economic data for confirmation. When they give a green buy signal we know the odds are heavily in our favor. I only want to have stock exposure for my clients when the odds are in their favor
otherwise cash or Treasury bonds are a better alternative.
Primary Trend Filter #1
This is a system I created with Cesar Alvarez of Alvarez Quant Trading. It’s a simple (simple is good) moving average crossover system that in testing since 1986 delivered a higher annualized rate of return than buy and hold. Using this system the CAR (compounded annualized return) was 9.7% versus 7.9%
for buy and hold since 1986. Best of all, it lowered the maximum downside risk significantly.
The worst calendar year for this system was 2008 when followed strictly generated a loss of -9.39% but compared to buy and hold the loss was -38.49%.
In reality I don’t often wait for a system like this to trigger if the downside momentum is too great as was the case in late 2015 and 2016. The rapidly falling momentum in those instances told me that a break of the 200 day moving average was inevitable and the poor economic data backed up the sell
signal. So I didn’t wait for the formal signal to keep any losses to a minimum.
I’m not interested in market timing systems that increase return, what I’m primarily interested in is reducing downside risk. The by-product of reduced downside risk is a higher rate of return. Profits will take care of themselves but big losses are to be avoided.
Primary Trend Filter #2
The MACD indicator shown was developed by Gerald Appel of the old Systems and Forecasts in the late 1970’s. In most cases this indicator is used for short term time periods but I think it’s of special value when looked at on a monthly basis. It’s a very slow moving indicator whereby the buy and sell periods
tend to last for at least a year. It also caught the tumultuous 2015-2016 period and flipped to a Buy last summer.
One might ask when looking at the Sell signals whether it’s a good time to short stocks in anticipation for a prolonged bear market. I’d say yes but for only a small percentage of capital since bear market volatility can be huge. Better yet, the sell signals happen to be great signals for buying long term
Treasury bonds. The price appreciation of long term Treasuries tend to move into their own bull market as a “flight to safety” from stocks to bonds emerges.
Lastly, as you can see in both charts now is not the time to sell. Market tops take time to develop frequently a year or more in the making. Considering that we just broke out from a 2 year sideways trend our current rally could last quite a while. Eventually it will end and that will likely coincide with
peaks in employment and an aggressive Federal Reserve and the behavior of the stock market will be reflected in the charts above.
In the meantime market pullbacks will likely be shallow in the 5% to 8% range before prices launch the next leg higher.
Cheers,
Brad Pappas
Perhaps that I feel some works of charity should not be hyped. I’m very old fashioned in that regard and view that charity should not come with strings nor attention but times are changing. I’ve always admired when an athlete or celebrity engages in some charity but demands there be no publicity. May the angels come to your rescue if you publicized all-time hockey great Bobby Orr spending an afternoon with a Cancer stricken child and family in his own home.
That being said, I’ve been asked to mention that since April 2015 a portion of our client fee’s have been donated to Kiva.org
The current administration’s view of withdrawing financial aid to needy countries and causes places everyday people and organizations to fill in the gaps. I expect we’ll see some form of activist funding to fill in the gaps voided by new administration policies for the Arts, Planned Parenthood, school lunches, homelessness, military family support, climate change and technology, LGBT rights, etc.
We’re just doing our bit.
If you never heard of Kiva.org they’re a non-profit micro lender for small borrowers around the globe. They offer funding to vast array of borrowers and purposes in some of the most dangerous and remote parts of the world.
Quarterly, we allocate a portion of our collected client fees and assign them to Kiva for loans. When the loans are repaid (some do default) the funds are recycled to new loans. In my mind there is no “profit” in these loans and we don’t intend to ever reclaim the funds. We intend to let them recycle through the Kiva system indefinitely.
We’ve made 44 loans since 2015 and rank in the top 8% on Kiva for loans made with just 3 defaults and only 4% delinquency rate. Our loans have been apportioned to 22 countries. I generally have a theme to our loans: Education, small business support like Taxi’s, transportation and clean water. The loan destinations won’t be making Travel and Leisure’s hot list of cool countries to visit anytime soon. More likely to be found on the list of “most dangerous countries to visit”.
Anyway, it just feels good.
Brad Pappas
I should get around to doing this more often as we are in the minority when it comes to investment advisors willing to post portfolios and returns. I’ve advocated for years that retail investors don’t have to settle for the returns offered by indexers and robo-advisory firms. Robo’s are cheap but you won’t receive what we offer in terms of returns and bear market protection.
The Vegan Growth Portfolio is a name we use to describe the concept of investing with Vegan perspective. Its a diversified portfolio that usually has about 30 holdings when fully invested. When our indicators tell us that when stock market risk in unacceptable due to the potential for recession we reduce our stock holding and focus on Treasury bonds or cash.
Collective2.com offers a unique opportunity to create a mirror portfolio of our client holdings in the Vegan Growth Portfolio. In other words, the same day we buy or sell a stock for our clients we also buy or sell it in the VGP. The price may differ by a small amount but the Vegan Growth Portfolio shown on Collective2.com is close approximation to our client accounts.
As you can see we are soon arriving to the important 5-year return milestone. As of 2/24/2017 the compounded annualized rate of return is 17.3% which is net of all fees and expenses. The gross (before fees) return is 18.8% per annum.
We respectfully ask when a potential client’s first question revolves around fee’s is which would you prefer: Make 4%-6% net at a indexer or robo-advisor like Betterment or our returns which charge more?
This example assumes and account size of at least $100,000. And, as we always have to say past performance is no guarantee of future performance. VGP is only suitable for investors who appropriately seek growth.
In loving memory of our dear girl Alexei who passed away today from cancer at just 5 1/2 years old. Many thanks to Dr. Boo and the caregivers at Colorado State University Veterinary hospital, we did all we could to help her.
Our ranch and family will never be the same.
In loving memory Alexei
