One of the primary reasons that investors are reluctant to hire an advisor is perceived cost. Interestingly, investors are unaware of some of the more punitive hidden costs. When we think of cost, the first one that comes to mind is commissions. Commissions are fees paid to investment sales professionals for selling you an investment. We will limit our focus to mutual funds for the sake of this article. Five percent (5%) is a typical commission for the purchase of a retail mutual fund. Sometimes commissions are hidden in the form of surrender charges and 12b-1 fees but they are present nevertheless. Of course do-it-yourself investors buy “no-load” mutual funds. These are mutual funds that are sold directly by the mutual fund company without the help of a sales representative so no commissions are charged.

When considering whether or not to hire an investment advisor, you should always ask how the advisor is compensated. Where possible you should opt for an advisor who is paid a fee for advice rather than a commission, that way you will know that the advisor won’t be tempted to move you in and out of investments for the sake of generating commissions. Keep asking questions. There is often a big difference between what the advisor is paid and what you actually pay in costs. The better question would be “What are the total costs of the investment strategy?”

There may actually be three different costs associated with an advisor managed investment portfolio. The first is the advisor’s fee which is generally quoted as a percentage of assets under management. At many of the larger firms this fee may be as high as 3% per year. One way to determine an advisor’s maximum fee is to consult their Form ADV (Part II and Schedule F). This is the disclosure document required by the federal government for all Registered Investment Advisors.

The advisory fee is just the tip of the iceberg though. In addition to paying the advisor, you will pay the mutual fund company, even if you are buying no-load mutual funds. The mutual fund costs paid by the investor typically include the fund’s internal expense ratio which according to Morningstar averages 1.32% per year and the mutual fund’s trading expenses which according to a recent study by Virginia Tech, The University of Virginia and Boston College averages 1.44%. Total investment costs could easily top 4%.

You will want to make sure you get a clear answer to your question about costs. Amazingly, many investment advisors are unaware of a fund’s trading costs and this component of expense can be a big one. If the advisor doesn’t know they exist he/she is unlikely to quote them to you. Trading costs are the variable costs paid by a mutual fund to brokerage firms which place securities trades on behalf of the fund. One of the reasons that so many advisors and investors are unaware of these costs is that they are not usually disclosed in the prospectus. You will find them only in the fund’s Statement of Additional Information (SAI).

So when you ask an advisor what his/her fee is, be sure you get the complete answer, not just “My fee is one percent”.

First, the election of Scott Brown in the Massachusetts Senate race served to illustrate that voters have become dissatisfied with something. Of course, it depends on which pundit you ask but the possible culprits could include healthcare, unemployment, the economy or the environment. Whatever the cause, it cannot be denied that the tenor of the administration’s populist rhetoric was stepped up after the election. The markets have historically voted against this sort of political talk by selling off.

Second, the President announced his intention of limiting the size of big banks and reducing the potential for systemic risk by banning proprietary trading operations, ownership of hedge funds or private equity operations, forcing banks to sell these assets at fire sale prices.  Even the President’s own Barney Frank argued against this rapid fire re-regulation of the banks. You can’t put the Glass Stegall genie back in the bottle so fast! Not surprisingly, the markets hated the President’s comments and sold off.

Third, international news is not good. There is growing evidence that Greece’s fiscal problems are spreading to other vulnerable European countries such as Spain and Portugal. Further, China, which recently  initiated a massive stimulus plan is talking about raising interest rates in an effort to slow its economy down. 

These news items helped send the S&P 500 index to a weekly loss of 3.9%. While we may be out of the heat of the financial crisis that engulfed us in the fall of 2008, last week’s action shows that risks remain and we always have to remain vigilant.

Aren’t the markets supposed to be “efficient” and “rational?”

These massive swings seem to happen with frightening frequency and investors who are unprepared for them will likely pay a heavy price. Benjamin Graham, arguably the “father” of security analysis and author of a classic book by the same name, said the price of a stock reflects two components. The first component, investment value, represents the discounted cash flow of all the company’s present and expected future earnings. The second component, speculative value, is driven by sentiment and emotions such as fear and greed.

It is not much of a stretch to suggest that an oscillation between investment value and speculative value may help explain the head-spinning volatility of the past few years. In other words, as markets rise or fall rapidly in short periods, speculative value may take prominence. Conversely, when markets are stable or moderately trending, investment value may take the lead.

Keeping this idea of investment value versus speculative value in mind can help us do a better job of maintaining a disciplined perspective on market volatility. It can help us better understand and potentially profit from the market’s periodic “inefficiency” and “irrationality.”

Meanwhile, the Obama administration pitched that this was the best report since 2007. Don’t get me wrong, any good news on employment is great with me. I’m just not confident that the whole story is being told. I have read estimates that put real unemployment rates at 21 percent. Of course these estimates include workers who are underemployed or have just given up looking for a job.

If I lost my job as an investment advisor and took a job as a sales clerk in a retail shop, I would be underemployed and would want to be counted in the report.

Could We Learn a Lesson from Wiley?

Remember when Wiley Coyotte would chase  Roadrunner off the edge of a cliff? There was always that awkward passage of time as he sheepishly tip-toed back to the edge only to plunge to the valley below. Recently, I have heard our economy’s current state described using this cartoon from our childhood. Why is it that Wiley never has a parachute?

It is likely that our economy will experience a double dip recession and investment portfolios should recognize this potential. As we enjoy this record recovery in securities prices, one cannot help but think what will happen if the economy slips into recession again. Now is the time to have your strategy in place.