Thursday, April 30, 2015

Department of Labor Proposed Fiduciary Rule Interpretation

These days, everyone has an opinion and I have one on the recent release of the Department of Labor's (DOL) proposed rule that affects just about anyone with a retirement account or IRA. The document that they released is 120 pages long and I went through it page by page. In order to understand it, I prepared a slide show or presentation on it. This presentation is primarily aimed at anyone who offers investment advice, but if you are an investor, then you will see how it looks from this side of the fence. Rather than reading the 120 pages, I think you will find this presentation of mine a lot easier to understand.

Click the link to view as a .pdf file. DOL Conflict Rule

My opinion is that it is primarily a good rule, but I question some of the exemptions in it. All of the lead up to this proposed rule revolved around the differences between the labels or titles of financial advisors. However, the DOL threw financial advisors a curve ball and ignored the labels altogether. Instead they focused on the activity of the financial advisor. In other words, if you are giving advice to a plan, a plan participant, a plan fiduciary, a plan beneficiary, or an IRA, then you are a fiduciary. If you are a fiduciary, then you are held to their new DOL 2510.3-21 definition. (See page 8 & 9 of the .pdf file.)

Under this new definition in DOL 2510.3-21, there are three things I find interesting in this proposed rule. One impact will undoubtedly change compensation methods drastically going forward. For example, if you give a "verbal recommendation to buy, sell or take a distribution from a plan or IRA", then you are a fiduciary. So, if your insurance agent tells you verbally that you ought to take your old 401(k) and roll it over to his/her variable annuity that pays him 8% commission, then he/she is going to have an awful hard time explaining how earning that 8% commission was in your best interests. Personally, I do not sell commission based variable annuities, so this will not affect me in the least. However, it will force insurance companies, (who can now be sued in a class action) to reduce or cap their commissions. It will also do the same to mutual fund companies who charge 5.75% up front commissions, too. There are exemptions in this rule to allow commissions, but I doubt that any insurance company or mutual fund company is going to jump out there on a ledge and be the one who keeps their 8% or 5.75% commissions in tact after this rule goes into effect.

Another part of the rule that I thought was interesting was that you are a legal fiduciary when you give advice to a beneficiary, too. What is interesting about this is that there is no agreement that has been signed between a financial advisor and a beneficiary. (It will not matter if there is an agreement or not. See next paragraph.) Nonetheless, as result of this rule, a financial advisor, even if giving advice verbally, will have to accept the fact that they are a fiduciary like it or not when they give advice to beneficiaries. This is great protection for beneficiaries going forward.

Finally, probably the best part of this proposed rule is the elimination of the two hats situation with Wall Street brokers. The two hats situation is where stockbrokers say, "I was acting as a broker, not a fiduciary." Up until now, they could sell pretty much anything to you not in your best interests, then disclaim it all away in their long and tedious legal documents. Thus, the two hats syndrome. Well, the DOL has put an end to this by saying that you can no longer skirt the fiduciary liability by disclaiming it away in legalese. This is a great thing in my opinion. Remember, the DOL looks at what activity is taking place. It doesn't matter if you work for a bank, an insurance company or a Wall Street firm. Neither does it matter what you have in your legal documents with clients. If you are doing the activity of investment advice as defined in DOL 2510-3-21, then you are a fiduciary, plain and simple. This is great for investors.

You may wonder what a plan is and what an IRA is, so rest assured it is all in the presentation file link above. I added a few comments throughout to help people understand the impact of the proposed DOL rule. If you have any questions, then feel free to contact me 904-547-2913.

Monday, April 6, 2015

ETF Portfolio Review

The S&P 500 was pretty flat for the first quarter of 2015. Personally, I do not like comparisons against the S&P 500 and our ETF Portfolios, because they do not account for risk adjusted returns, dividends and equity allocation percentages. The S&P 500 is an index of the nation's top 500 U.S. companies. It is 100% allocated to equities or stocks. For the first quarter of this year, it ended up at 2,067.89. It started the year at 2,058.20. This represents a growth in points of 9.69 and a very meager return of 0.47%.

If you happened to be considering investing in an S&P 500 index fund right now and you found out that the first quarter of 2015 only returned 0.47%, then would you still invest in it? Not with all of your money, but a portion? This is the mistake that most investors make in regard to investing. They will look at the performance of a particular fund which represents a recent time period, then decide based on that limited information whether to invest in it or not. Then, they repeat this process for several positions. In the end, they may have a dozen different positions that they have chosen based on "good" past performance. The problem with this is that they have not analyzed the overall 12 positions to see how they will react together.

Anytime that you put a portfolio of positions together and make a "good" portfolio out of them, then there are several other things that need to go into your analysis. First of all, what level of risk are you taking? What is the standard deviation? What was it in 2008 the year of the big crash? What is it today? What is the Beta today? What was it in 2008? What is the Alpha today? What was it in 2008? Did you know that these figures can changed drastically from year to year?

Just like performance changes from year to year, so does the statistics of Standard Deviation, Beta, Alpha, R-squared, Sharpe Ratio and others. Don't forget other important items like Credit Quality of the Fixed Income portion of the portfolio, assuming you have a Fixed Income portion. How many are AAA rated? AA rated? A rated? Junk rated? What about the duration of your Fixed Income portion? What is the Maturity of the Fixed Income portion?

Of course, don't forget about valuation multiples of the stocks like Price/Earnings, Price/Book, Price/Sales and Price/Cash Flow. Then, there is profitability of the stocks in the portfolio. What is the Net Profit Margin? Return on Equity? Return on Assets? How much is their Debt to Capital Ratio? What about Potential Capital Gains Tax exposure? What about the overall expense ratio?

I can tell you all of the above in regard to our portfolios, but I doubt any self-directed investor could do the same. Most people who invest on their own do very poorly. Hiring a professional advisor who not only knows how to invest, but also is a financial planner, real estate agent and insurance agent just might make more sense than trying to invest on your own.

When you look at becoming a client with our firm, we educate you on all the items described above. You will know how your current portfolio looks and what you can expect from it if you did nothing. Then, we will show you how to improve it with our professional expertise. It is simple really. You can continue to kid yourself into thinking that you are just as competent as a professional like me, or you can realize that hiring a professional like me is a very smart decision. The choice is all yours.

Please visit one or both of my web sites. Marian Financial Services, Inc. or for First Coast Planning, LLC.