Ben Carlson, institutional portfolio manager and popular investment blogger, discusses his new book A Wealth of Common Sense explaining how simplicity trumps complexity in any investment plan. Nate, Conor, & Jason also spotlight the Schwab U.S. Broad Market ETF (SCHB).
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Nathan Geraci is President of The ETF Store, Inc. and host of the weekly radio show “The ETF Store Show“.
Much has been written about the remarkable growth of Exchange Traded Funds (ETFs), along with their potential benefits. Lower costs, tax efficiency, and transparency are just a few of the possible advantages of using ETFs in your investment portfolio. However, a benefit that is sometimes overlooked is the simple fact that ETFs provide you with options.
Consider a relatively moderate investor in the 1990s. Back then, a well-diversified portfolio might have been comprised of 60% stocks and 40% bonds, the bulk of which represented U.S.-based companies. However, this common mix of primarily U.S. stocks and bonds was not necessarily used because it was deemed the best way to build an investment portfolio. Instead, other factors were at play, none of which had to do with determining the optimal mix of investments to provide the best risk-reward scenario for your portfolio.
For example, it has been well-documented that international stocks can provide diversification benefits to your portfolio. But 20 years ago, the ability for investors to invest in developed international economies, let alone emerging economies like China and India, were limited – and expensive. The same held true for broad-based commodities and precious metals – investments like gold, oil, and agriculture. If you wanted to own oil in your portfolio, you either had to buy (and store) barrels of oil in your backyard or play oil futures contracts – neither of which was a particularly attractive option. The end result was investors simply found U.S. stocks and bonds more accessible and cost effective to invest in. Therefore, most investor portfolios looked a lot like the aforementioned 60/40 U.S.-centric one.
Fast forward to today where the proliferation of ETFs has changed the game for investors. Currently, there are over 1,700 Exchange Traded Products spanning seemingly every asset class imaginable. Want to invest in mainland China? There’s an ETF for that. Silver? Of course. Emerging market bonds? Yep.
A wonderful aspect of ETFs is that they can allow you to easily express your longer-term views on the market. Concerned about inflation? You might consider an ETF holding Treasury Inflation Protected Securities (TIPS) or maybe a physically-backed gold ETF. Think frontier markets such as Kuwait or Nigeria are the next up-and-coming economies and future drivers of global growth? You can invest in an ETF offering broad-based exposure to these early-stage economies.
When it comes to successful long-term investing, two of the biggest drivers are proper asset allocation (i.e. being in the right mix of investments for your situation) and diversification (i.e. owning a variety of investments). Since different investments will take turns outperforming in any given year, these are both critical to achieving positive investment outcomes. ETFs have made it significantly easier for investors to allocate assets and build a diversified portfolio in an efficient manner. And, as additional benefits, you might just lower your investment costs, reduce your tax bill, and have greater visibility into exactly what you own.
We answer your ETF questions and Ric Dillon, CEO & Portfolio Manager at Diamond Hill Capital Management, spotlights the Diamond Hill Valuation-Weighted 500 ETF (DHVW).
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Nathan Geraci is President of The ETF Store, Inc. and host of the weekly radio show “The ETF Store Show“.
If you work with a financial advisor, you might be surprised to learn they may not have a legal obligation to place your interests ahead of their own. Let me repeat that. Your financial advisor may not have to act in your best interests!
As it turns out, many “financial advisors” are simply brokers who get paid commissions based on the investments they recommend to you. These brokers can legally steer you into expensive investments that pay them big dollars, but may end-up costing you big dollars. Furthermore, they do not have to disclose this fact to you.
Surprised? The issue comes down to the difference between a fiduciary standard and a suitability requirement. Luckily, you do not need a law degree to understand the differences here. A fiduciary standard requires an advisor to put your interests ahead of their own – they have a duty of care and duty of loyalty. Registered investment advisors, or RIAs, operate under the fiduciary standard which means they must avoid conflicts of interest and ensure they are always acting in your best interests. Meanwhile, a broker simply adheres to a suitability requirement, which means the investments they recommend must be suitable given your general risk profile.
Why might this be an issue? The potential problem with suitability is that a broker can satisfy this requirement by actually recommending the least advantageous of all the suitable options. Consider a situation where a broker believes that a growth stock mutual fund is suitable for you and they have two funds they are considering recommending. The first one charges you 1.3% annually and it pays the broker a commission (or load) of 5% of your total investment. Remember, this load is coming directly out of your pocket. The second fund only charges 0.3% annually – so it is a full percentage point cheaper – but it only pays the broker a commission of 2%. Both of these funds do the exact same thing from an investment standpoint. They both have the same benchmark index. Can you see the potential conflict here?
A broker might be tempted to invest you in the more expensive fund that pays them a bigger commission, even though the less expensive fund would likely be a much better option for you. There is another issue as well. Once a broker recommends a suitable investment to you and they receive their commission, they may have little incentive (or legal obligation) to continue monitoring that investment. If the investment is underperforming or perhaps your situation has changed, the broker might not be all that concerned. Unfortunately, the next time you hear from the broker could be when they are ready for another commission check and they need to sell you another lucrative (for them) investment.
If you are surprised or even confused by this, you are not alone. Unfortunately, the financial services industry has made it difficult for investors to discern what type of advisor they are working with. A broker will often refer to themselves as a financial advisor, investment advisor, retirement planner, or some other similar title. It can be very challenging for you as an investor to know exactly who you are dealing with. The financial services industry is even spending millions of dollars lobbying to keep this arrangement intact!
So what can you do as an investor? There are a two very simple steps you can take to protect yourself:
There are other steps you can take including asking about the types of investments your advisor uses (for example, ETFs do not pay brokers commissions and therefore, they are less likely to use them) and asking about their investment philosophy (an advisor constantly churning positions is likely doing so to rack up commissions). However, the two steps above will weed out most brokers.
It is important to note that just because an advisor gets paid commissions and operates as a broker, that does not automatically make them a bad advisor. Consider an advisor who puts together an individual bond portfolio for you where the bonds are going to be held until maturity and no changes will ever be made to the portfolio. It would likely make more sense to work with a commission-based broker for these bond transactions rather than pay an on-going asset-based fee. The key is that you as the client should be aware that the broker is receiving these commissions and how much they are receiving – because, again, this is money coming out of your pocket. There are other situations where a broker may make sense, but the key is this: there needs to be transparency and disclosure.
A recent report released by the White House indicated there is currently an estimated $1.7 trillion dollars in individual retirement accounts that are invested in products that pay fees or commissions to brokers. The report also said investors who receive investment recommendations from advisors who may have potential conflicts of interest had a 1% lower return annually. That equates to $17 billion dollars a year – and that is without adding in any effects of compounding year-over-year. This is real money that can make a significant difference in your retirement. The lesson here is to make sure your advisor is working for your retirement, and not theirs.
Dan Thornton, former Vice President and Economic Advisor at the Federal Reserve Bank of St. Louis, explains the role of the Fed and how their policies are impacting the economy and financial markets. Nate and Conor also spotlight the iShares TIPS Bond ETF (TIP).
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