John Wasik

CHICAGO, August 2 (Reuters) – Most experienced long-term
investors know stocks are volatile and can deal with it. But
what if you want to stay in stocks and at the same time reduce
your downside risk and avoid a cyclonic year like 2008?

You might be tempted by funds that bill themselves in a “low
volatility” category, though “volatility” is a red herring. A
“low-beta” approach might be better.

Beta is a measure that portfolio managers use to determine a
portfolio’s sensitivity to a major index. A perfect match with
the index is 1.00, and stocks are measured in a percentage
against it. The lower the beta, the less a portfolio tracks a
market average, such as the S&P 500 index.

From 1926-2011, according to Ibbotson Associates,
large-company stocks had a standard-deviation of about 20
percent. Small-company stocks were much more volatile over that
period: 32 percent. When you look at long-term government bonds,
though, volatility drops to 9.8 percent, and with a portfolio of
U.S. Treasury bills, it drops to 3.1 percent.

Keep in mind that I’m referring to historical volatility;
flash crashes and technical glitches such as the one that
occurred on We dnesday with Knight Capital are another
matter. Volatility is often unpredictable in a market
increasingly dominated by high-frequency robotic trading, which
often amps up market movements.

RISK VS. REWARD

Most investors can take some risk – 20 percent doesn’t sound
like much to most seasoned long-term investors – in exchange for
beating inflation and building a decent retirement portfolio.
The question then is what funds to choose.

You can be easily befuddled, since a wave of new funds
emerged over the past year touting low-volatility, high-dividend
stocks and lower market risk. The “low-vol” funds tend to
conceptually overlap with equity-income, high-dividend and
balanced offerings, which are categories of funds that have been
around for years. So it’s a bit of a marketing gimmick to claim
that the new class of funds is any less risky than the
stalwarts.

The “low volatility” moniker, especially, loses some of its
punch when global market downturns happen. In those cases, since
every market is reacting to what’s going on in Europe,
Washington and Beijing simultaneously, volatility can bruise any
stock portfolio at any time. Having a portfolio of
dividend-paying stocks is better than non-dividend payers, but
it often skirts the fact that stocks are still much more
volatile than bonds.

Low-volatility funds typically are portfolios composed of
mature companies that pay consistent dividends. They are often
in established industries such as utilities, healthcare,
consumer staples and durable goods. You won’t find many
high-flying technology stocks in this pack.

When you look at popular, low-volatility offerings, though,
they may reflect high correlations to the overall market. The
PowerShares S&P 500 Low Volatility Portfolio ETF, for
example, has a beta of 0.66, which means it’s less volatile, but
moves closely with the market average for large stocks, with a
correlation of 0.95 (through June 30).

THE BETA DIFFERENCE

A new, emerging class of low-beta stocks does not entirely
eliminate market risk – no stock fund will – but is less likely
to move in lock step with the S&P 500 when it declines. The
Russell 1000 Low-Beta ETF, for example, has a beta of
0.71, which means it’s more than one-quarter less volatile than
the Russell 3000 Index. The fund tracks an index of large-cap,
low-beta stocks.

But sometimes, fund names don’t always tell you the whole
story on market risk. The Vanguard Dividend Appreciation ETF
, with a 0.82 beta, focuses on “achievers” that have
raised their dividends for at least 10 straight years.

While this is one of the lowest-risk funds in its category,
it’s not immune to downturns. In 2008, it lost about 27 percent,
compared with a 37 percent loss for the S&P 500. The Guggenheim
Defensive Equity Fund has an even lower beta – 0.57 -
but lost 30 percent in 2008.

No matter what it’s called, any stock fund will move with
the overall market in some way. There are also other gauges that
are better at measuring overall risk, such as the Sortino Ratio,
which distinguishes between upside and downside volatility. So
if you really want some idea on how a fund might perform in a
swoon, you’ll need to do some more homework.

If risk measurement is still a muddle to you, look at assets
that are usually uncorrelated to stock movements, such as money
market funds, U.S. bonds, metals and commercial real estate.
Commodities also may be in that camp, but like Real Estate
Investment Trusts, they traveled the same road south as stocks
in 2008.

Want to keep it simple? Boost your bond mix while reducing
stock holdings in line with what kinds of losses you can
stomach. While fund names can often be confusing, straight
allocations are pretty good barometers of how much stock-market
risk you’re taking.

CHICAGO, July 30 (Reuters) – I have a pretty good idea of
what drought looks like after recently traveling more than 1,400
miles from Chicago to Utah: Vast patches of brown where there
should be green. Cornstalks that look like desiccated
scarecrows. Wilted soybeans. Forested Colorado canyons
devastated by wildfires and pine beetles.

Whether this is the brutal impact of climate change or a
short-term cycle, I can’t say. Regardless of your scientific or
political persuasion, though, what is certain is that water is
going to be an increasingly valuable commodity and a worthwhile
long-term investment.

The short-term nightmare is that the United States is
experiencing its hottest year on record. States from Ohio to
California — 53 percent of the contiguous United States — are
in drought, according to the National Weather Service. Many
breadbasket states that have traditionally been blessed with
summer rains in the Midwest are parched.

As a result, 45 percent of the corn crop and 35 percent of
soybeans are rated “poor to very poor,” according to the U.S.
Department of Agriculture. The produce manager at my local
supermarket heard that farmers are close to plowing under their
fields and seeking crop-insurance payments as drought is
expected to intensify across America’s heartland. More than
1,200 counties have been declared disaster areas. Futures prices
on corn have already hit a record high.

As a result, look for higher prices on everything from bread
to steaks.

WIDESPREAD DISASTER

Globally, the long-term picture is worse. Rising water
demand due to population increases, industrialization and higher
standards of living in developing countries is exceeding supply.

According to the United Nations (UNESCO), not only is water
being wasted around the world, the infrastructure for producing
and recycling it lags the demand. Nearly 1 billion people do not
have access to clean water while another 3 billion are expected
to join the world’s population in the next 40 years. China alone
is planning to add some 500 new cities, each housing 100,000 or
more people. Also consider the big industries that are major
water consumers: electric power, metals, petroleum and food
production. Some 70 percent of all fresh water is used by
agriculture.

Where will the water come from to quench the thirst and feed
some 10 billion souls? The ocean is one answer, since it covers
most of the planet as freshwater sources are being rapidly
depleted. Yet that calls for quantum leaps in technology since
desalination requires tremendous amounts of energy to take the
salt out of seawater. Currently there are more than 7,500
desalination plants in use globally — a number that is
expected to double by 2025, estimates the United Nations.

Conservation and treatment technologies are also a partial
answer, which means better filtration, conservation and
water-treatment systems — infrastructure that costs trillions.
If growing countries are committed to supporting their
burgeoning populations, they will need to make these
investments.

A handful of global conglomerates already have these
concerns in their sights. General Electric Co, for
example, has a water and process technologies unit. Dow Chemical
Co, Siemens AG and DuPont also have
water-treatment units.

If you are looking for more specialized leaders in the water
industry, consider Modern Water Plc, which has pioneered
a new “forward osmosis” desalination technology, or the Korean
company Doosan Heavy Industries, which makes water
treatment and desalination systems. The French company Veolia
Environnement VE SA provides drinking and wastewater
services.

More diversified baskets of water-related companies can be
found in exchange-traded funds (ETFs), which are the preferred
approach for most investors. PowerShares Water Resources ETF
invests in an index of water companies as does the
Guggenheim S&P Global Water Index.

Water has often been called the new gold or oil. That is
not an appropriate comparison, though, because our bodies are
mostly water and we cannot live without it. Still, water demand
will create new business and technological challenges to
produce, store and recycle it. Conservation will become even
more important to protect run-off and topsoil. Agricultural
productivity will also need to improve. We will probably see
even more “vertical farms” that employ skyscrapers and solar
power to grow food in cities.

What is needed is something akin to the “green revolution”
that took place in the mid-20th century that vastly boosted
agricultural productivity. A new “blue” revolution will employ
more efficient use of water resources and re-use water so that
billions may thrive. It will take a universal global commitment
that will reshape everything from soft-drink manufacturing to
taking a shower. It is long overdue and an essential technology
investment. After all, you can’t drink a smartphone or
flat-screen TV.

CHICAGO (Reuters) – Do you have a lingering memory of motion sickness after last summer’s debt storm? I do.

Before another cyclone hits, it’s a good time to check your portfolio mix of stocks and bonds as a way of securing your financial ship.

A sensible portfolio review deals with your fears first.

What will be most harmful to your standard of living if your portfolio comes up short? Have you taken a look at how your portfolio performs in the worst markets?

If there’s another summer swoon for global stocks, now’s the time to ask these questions. Here are five suggestions:

1. Reduce tail risk.

Forget about daily ups and downs, which can be irrelevant. Tail risk — or the probability of an extreme event such as a 2008-style meltdown — is a storm tide for your portfolio.

You don’t want to be mostly in stocks before you retire and then face a 2008-style tanking. Last summer was bad enough. You certainly don’t want that kind of volatility if you need to preserve what you have.

Managing risk is a matter of balance. Ratchet down stock market exposure and your potential to lose money drops. While you may get the highest possible returns with stocks, your exposure to the extreme tails is lower if you add bonds.

Also keep in mind that you only get the “average” return if you hold your allocation for a long time. Most people jump in and out when they get spooked, so their performance is much lower.

2. Benchmark.

If you have an all U.S. large-company stock portfolio, how did it compare to the S&P 500 Index? The index is up 7.6 percent through July 25, when you include dividends. Did your stock funds do at least as well as that?

If you hold U.S. bonds, use the Barclays Capital Aggregate Bond Index or the iShares exchange-traded fund (ETF) that tracks the index as a proxy. The fund currently has about a 2.5 percent yield (I hold it in my 401k).

Now that the U.S. Labor Department will start to require employers to tell you how much your retirement funds cost, you can easily see if you’re being charged too much.

Because fund managers charge expenses, you will never get the return of the index. But the more you lag the index return, the more you should be reducing management expenses — especially in your 401(k) funds.

If you are trailing the index by more than 0.25 percent, then transfer into low-cost ETFs or index mutual funds. Every bit of extra return goes into your pocket.

3. Revisit your investment policy statement.

First of all, do you even have one? This is a stated list of goals for your portfolio. Do you want to retire early? Save for college? Keep on working and live off the interest?

Write it down and check your progress. You should state how much you want to invest in stocks, bonds and alternatives to reach your goal with the amount of risk that will allow you to sleep at night.

4. Rebalance.

As part of your investment policy statement, your mix should reflect what you want to achieve. But with stocks or bonds moving with the market, your percentage in each asset class will shift. In order to keep to your goals, rebalance by selling winners and reinvesting to get back to your ideal mix.

This also allows you to buy low and sell high to take advantage of market dips. I know this sounds counterintuitive, but it will keep you on track.

5. Be Flexible.

Things change. You may have gotten divorced. Maybe your children moved back in after college because they couldn’t find a job. You may have to care for an aging parent. Make sure your portfolio plan can accommodate life changes.

When it comes to a sound portfolio review, keep in mind that it’s not all about return. You need to project how much money you will need in the future to sustain a comfortable lifestyle, however you define that. Risk should be foremost on your mind now, even if you have plenty of time to invest.

And while inflation isn’t quite a problem now, you should protect your bond holdings from rising interest rates with inflation-protected securities or bonds you hold to maturity.

If you need help, most large mutual fund companies, banks and brokerage firms can help with portfolio reviews and rebalancing. Some even offer certified financial planners to aid in the process.

If your needs are more complex, seek the guidance of a registered investment adviser or chartered financial analyst. But don’t get into a situation where you feel obligated to buy commissioned products. Keep your costs low and objectives in clear view.

(The author is a Reuters columnist and the opinions expressed are his own. For more from John Wasik see link.reuters.com/syk97s)

(Follow us @ReutersMoney or here. Editing by Beth Pinsker Gladstone and Jeffrey Benkoe)

CHICAGO, July 24 (Reuters) – While there’s some debate over
whether the U.S. residential market is in recovery mode, there’s
a stronger case for a rebound in commercial properties.

Real Estate Investment Trusts (REITs), which invest in a
variety of income properties and mortgages and are listed on
stock exchanges, often serve as a bellwether of consumer and
commercial economic activity, as they will show earnings growth
in a general recovery.

Aside from the economic recovery narrative, REITs make sense
for investors who are hunting for yield. Although REITs often
march in lockstep with stocks during recessions, they can move
in different cycles, dictated by movements in commercial real
estate. REIT managers also are able to buy more properties when
interest rates are low.

REIT exchange traded funds have recovered smartly over the
past three years. The S&P Global REIT index, which includes
properties from developed and emerging markets, was up 12.56
percent year-to-date through July 23. That compares to 8.67
percent total return for the S&P 500 stock index during the same
period.

That lends credence to the theory that the U.S. and
developed countries are slowly limping toward an upturn – at
least in property markets. A stronger economy and job market
translates into more people shopping, renting, traveling and
moving – and storing their stuff.

A large portion of the residential gains may be due to
increased building of apartment buildings as more people have
decided to rent rather than own. Increased commercial building
doesn’t precisely track general economic activity, but it may
indicate that investors are more confident. And increased travel
activity helps the hospitality industry.

HOW TO INVEST

There’s a range of exchange-traded or mutual funds that
invest in real estate stocks and REITs. For instance, some REITs
specialize in just shopping malls and retail outlets. But while
you can find a REIT that specializes in any property sector from
apartment buildings to health care, I recommend portfolios that
invest in a variety of properties.

Diversified REIT ETFs can give you a sampling of real estate
from across the world. The SPDR DJ International Real Estate ETF
, with a 4 percent yield, invests globally. The First
Trust S&P REIT Index concentrates on U.S. properties.
Still skittish about the American market? Then consider the
Vanguard Global ex-U.S. Real Estate ETF that invests
globally and avoids the American market.

REITs must distribute nearly all of their taxable income to
shareholders. They are traded as stocks on exchanges, but hold
multiple properties in their portfolios. Some are highly
diversified while others may focus on a specific sector such as
warehouses or office buildings.

For income investors, REITs offer higher yields. The yield
on the Vanguard REIT ETF was 3.25 percent, for example.
In contrast, the US 10-year Treasury note has been yielding
under 1.5 percent lately.

A note of caution: REITs are no substitute for bonds that
you hold to maturity. Their returns are not guaranteed and they
can be just as volatile as stocks. They declined in 2008 and
early 2009. If the recovery scenario does not play out, they
could drop in value again.

Be particularly careful with non-listed or “private” REITs,
which are typically sold through brokers and contain high fees.
Regulators have been scrutinizing them over the past year. I
recommend avoiding them unless you have them fully vetted by an
independent adviser such as a certified financial planner,
accountant or chartered financial analyst.

One more wrinkle: Lately the U.S. bond market has been
reflecting the possibility of another economic slowdown and euro
zone angst – 10-year yields are still near all-time lows – so be
careful. REITs are best for long-term investors who plan to hold
them. They should comprise no more than 10 percent of your
income portfolio. Property cycles can be just as fickle as
general stock market movements and take many years to play out.

CHICAGO (Reuters) – I’ve always had mixed feelings about gold. Is it an alternative currency? A speculator’s refuge from political or fiscal instability? A reliable inflation indicator? Turns out it’s maybe all of the above.

What role should gold play in your portfolio? Certainly it’s no substitute for bonds, which held up well in 2008 and rarely lose money in low-inflation periods. As an inflation hedge, though, you may be better off holding dividend-paying stocks and inflation-protected securities (TIPS). Inflation will return eventually, which means you need to start protecting yourself now from bond-price declines.

Whatever view you take on gold, most financial savants suggest it should occupy no more than 10 percent of your portfolio; and don’t try to time its price movements. And while it can fulfill many roles imperfectly, its appeal changes with the moods of the market’s animal spirits. And here’s why:

ALTERNATIVE CURRENCY?

For one thing, gold’s worth in a portfolio depends on how it reacts to market sentiment. Does it go up in price when the threat of inflation is imminent or present? According to new research by Eric Weigel of the Leuthold Group in Minneapolis, he’s confirmed that there’s a positive link between gold prices and inflation expectations. That makes sense since higher costs of living and over-printing of money by governments tend to devalue paper currencies.

Yet if you look at the relationship between the dollar’s value and gold, the relationship isn’t quite that clear. When Weigel looked at gold returns and dollar movements over the past dozen years, gold occasionally rose when the dollar declined, showing a “marginally statistically significant” link. That backed the argument that gold behaves as an alternative to dead-tree money, but only since 2010.

The debate that gold is an alternative currency continues to be contentious. It is not a replacement for the dollar, euro, yen or yuan. Until stocks, bonds and consumer goods are denominated in gold bullion prices, gold may have some store of value, but it’s not readily exchanged. You can’t drop a gold coin into a vending machine and get a transit ticket or pay a bill from Macy’s – yet.

GOLD AS A STOCK MARKET HEDGE?

What about stock market volatility and gold? Here the picture is muddy. From 2006 to 2007, Weigel found, gold “behaved more like a risky asset” and moved in lock step with stocks. Yet after the 2008 meltdown, that was no longer the case and gold often moved independently of stock prices.

So to say that gold is a consistent hedge against U.S. stocks or the dollar is on weak ground. You also have to keep in mind that pundits have been warning of soaring inflation for several years, although it’s failed to materialize in any significant way in the U.S. and is virtually absent from most of developed Europe as the continent deals with recession and its unresolved fiscal crisis.

What does gold do well in terms of market tracking? I had to turn to some charts from the Chicago Board Options Exchange, which started a gold volatility index (GVZ) in August 2008 (click on link.reuters.com/cad49s). The index measures the “market’s expectation of 30-day volatility of gold prices” and tracks options on the widely traded SPDR Gold Shares exchange-traded fund, the largest ETF that owns gold bullion. The volatility index is basically a gauge for where traders think gold prices are headed.

Although the gold volatility index doesn’t have much history – which makes it tough to see any long-term patterns – it pretty much parallels crude oil prices and euro volatility. Even more telling is the gold index’s inverse movement against the S&P 500 index last summer, when stocks plummeted during the height of the U.S. debt ceiling/euro crisis. At that time, gold seemed to be a refuge – at least in terms of traders’ expectations.

INDICATOR OF INFLATION?

Maybe gold, as Weigel suggests, is playing different roles at different times. During periods of dominant worries about currency devaluation in the absence of other mega-downturns, it acts as an indicator of coming inflation. When crises emerge out of Washington or Europe, it’s a bulwark against stock and currency declines.

But when global stocks tank as they did in 2007 and 2008, the metal is no safe haven at all. It could be that when nearly every market is tanking, investors are selling their gold, too, to cover other losses and margin calls.

Still, there’s a reason why central banks from Europe to China and major hedge funds like Soros Management continue to stock up on bullion – often more than quadrupling their holdings. Do they fear currency collapses? Inflation roaring back? Or are they buying on the dips?

Maybe all of the above apply, which is why it has a place in your portfolio if your fear the worst for stocks or currencies. It serves a unique role when dealing with the fearsome animal spirits of the market.

(The author is a Reuters columnist and the opinions expressed are his own. For more from John Wasik see link.reuters.com/syk97s)

(Follow us @ReutersMoney or here. Editing by Beth Pinsker Gladstone and Steve Orlofsky)

CHICAGO (Reuters) – A friend recently asked me to vet several financial advisers he was considering to manage his retirement portfolio. As one who hates to see people getting fleeced, I’m cautious of Madoff-like malefactors, the latest of which cropped up in the case of the PFGBest brokerage in Cedar Falls, Iowa. So I curbed his enthusiasm a bit about money managers who had impressed him with their initial pitch.

Despite two years under the Dodd-Frank financial reform law, millions of investors are still highly vulnerable when it comes to advisers. Buffeted by relentless lobbying by the financial services industry, the strongest pieces of Dodd-Frank have yet to be implemented. Here are key questions you need to ask a prospective financial adviser before you sign up:

1. How are you compensated?

I have no problem with paying advisers what they’re worth, but often they are overcompensated at your expense. Most of them can’t beat the market after fees and inflation in risk-adjusted terms. Generally, advisers who hold broker-dealer licenses are paid by commission. The more transactions or products they sell, the more money they make.

While there are plenty of honest brokers out there, this has been, for me, the greatest conflict-of-interest for investors. The temptation to churn accounts to generate commissions is always there. How do you remove the temptation? Compensation by flat fees, hourly rates or a combination.

If they manage money directly, they will charge you a sliding percentage scale based on assets under management. Generally, 1 percent annually is a starting point and should drop the more money you have to manage. In any case, ask them all of the ways they will get paid. They may layer on fees within mutual funds and insurance products or receive “revenue sharing” from those funds. All registered investment advisers must provide you a “Form ADV” that spells out their compensation schedules and possible conflicts (see Part II of the filing). If they dodge full disclosure, move on.

2. How are you licensed?

If they sell securities, insurance, mutual funds, futures or options, they must pass several tests and be a registered representative. I prefer advisers who are certified financial planners (CFP), which requires several years of education and experience. Certified public accountants (CPA) and chartered financial analysts (CFA) are also worth considering – if they have specific experience in preparing financial plans. Avoid advisers who place “senior specialist” in front of their title. They have come under scrutiny from regulators for various abuses.

For money management, registered investment advisers (RIAs) and CFAs generally have the most experience, but CFAs have the most rigorous training and have to pass one of the toughest tests in the business before they receive their designation. Check the backgrounds of any registered investment advisers or brokers through your state securities agency (www.nasaa.org).

3. What products do you sell?

If they start pitching you before asking you detailed questions about your life and financial goals, turn around and leave. The best advisers just sell their time and expertise. They can recommend lower-cost products, such as mutual and exchange-traded funds they don’t manage. Ideally they don’t receive a commission from recommending them. If you do your own investment research, use online deep-discount brokers to fill your orders.

4. Can you prepare a comprehensive financial plan?

You may not need this service, but you should consider it if you have to integrate portfolio, tax, college, estate, insurance and life planning needs. Brokers and insurance agents who are not certified financial planners may not have the training.

If your needs are specialized, find a CFP who has done the kind of plan you need. The Certified Financial Planner Board of Standards provides a free search service (see link.reuters.com/hyc49s). Take your time if this is the route you choose. A workable financial plan may take several months to a year to customize, so don’t get snookered by the idea that a few mutual funds or stocks will fit the bill after a brief meeting.

5. Are you a fiduciary?

A fiduciary firm takes full legal responsibility for their services. By law, they must put your interests first and you can sue them if they wrong you. Brokers, in contrast, are regulated by less-stringent “suitability” standards. In the event of a dispute, you usually have to go through their arbitration forum and sign away your ability to sue.

If you’re dealing with a broker, keep in mind that their suitability guidelines were tightened last week by FINRA, the industry’s self regulator. Brokers “must perform reasonable diligence to understand the nature of a recommended security or investment strategy…as well as the potential risks and rewards” while considering your “age, investment experience, time horizon, liquidity needs and risk tolerance.”

While this is a big step forward, it’s no substitute for the black-and-white language of fiduciaries. The SEC is considering making all brokers fiduciaries, but has dithered on completing the rule and putting it into force. Nevertheless, every adviser should also be crystal clear on how they plan to manage your money, employ risk management/hedging techniques, disclose conflicts and use of derivatives. Of course, having a fiduciary designation is no guarantee. They still have to account for how your money is being invested and any unusually high returns should be suspect.

More importantly, forget their sales pitch and glossy literature and focus on what you need before you even approach them. Do you need them to preserve principal? Can you afford to take market risk? Based on their management style, what’s the worst-case scenario?

And don’t hesitate to keep asking hard questions, especially in light of the fraud stories hitting headlines. How will your money be held? Who has access to it? If it’s in an independent custodial account with a brand-name brokerage that has protection from the Securities Investor Protection Corportation (SIPC), that’s a good sign. If they’re earning above-market returns, be skeptical. How are they doing it?

The right questions should keep you out of trouble. (The author is a Reuters columnist and the opinions expressed are his own. For more from John Wasik see link.reuters.com/syk97s)

(Follow us @ReutersMoney or here. Editing by Beth Pinsker Gladstone and Andrew Hay)

CHICAGO, July 9 (Reuters) – A recent New York Times story
quoting a former JP Morgan broker who said the company urged its
financial advisers to sell its own commissioned funds over
less-expensive outside products should not have surprised any
educated investors. It has been well-known in academic finance
circles for years that when you add up the fees that brokers
layer on, the value proposition often evaporates.

I have yet to find independent evidence that shows that
broker-sold products outperform noncommissioned index funds over
time on a regular basis. There are, of course, exceptions from
year to year. And of course, some brokers may provide a useful
service if the funds they recommend can equal or top market
returns and meet investors’ needs and goals. But generally the
opposite is true over the long haul.

A comprehensive study conducted by researchers Daniel
Bergstresser, John Chalmers and Peter Tufano, published in 2007,
examined broker- and direct-sold (when no broker was involved in
the transaction) funds from 1996 through 2004. The broker-sold
funds delivered lower risk-adjusted returns – even before
“distribution” costs were subtracted. The results were
consistent across different fund objectives, with the exception
of foreign-stock funds (see).

Investors pay far too much for these underperforming
broker-recommended funds – more than 4.5 percentage points over
direct-sold funds, the researchers found. They even offered a
less-charitable interpretation that brokers “put clients’
interests behind their own interests and the interests of the
fund companies that pay them.”

Building upon this research, one of the largest studies on
this topic ever conducted examined 524 mutual fund families for
the National Bureau of Economic Research, which was published in
2010 (see). The researchers
found that broker-sold funds not only needed to charge higher
fees to cover compensation, they invested less in portfolio
management and earned lower before-fee returns. Could it be that
brokers pitch these funds because they are paid more to sell
them than off-the-shelf, commission-free index funds?

MORE EVIDENCE

To pour even more salt on investors’ wounds, high-fee,
broker-sold funds may diminish total returns over time. Say you
invested $10,000 in a fund charging 1.5 percent in annual
expenses. If that fund returned 10 percent, you would have
roughly $50,000 after 20 years. Cut the fees down to 0.50
percent, which is easily doable with an exchange-traded or index
mutual fund? You would have about $10,000 more in the same
period. But don’t take my word for it. Run a comparison with the
SEC’s online mutual fund cost calculator ().

If it’s a badly kept secret that broker-sold funds are
unlikely to outperform their direct-sold cousins, why do
investors still buy them? In the July 2 New York Times story
quoting the former JP Morgan broker (see),
the bank defended its strategy, stating it has “an in-house
expertise.”

But in reality, the reason likely has more to do with the
handholding and perceived peace of mind in a broker/adviser
relationship. Our need for a human connection and assurance
overrides our rationality. Trusted advisers can form an
invaluable buffer between our financial goals and the madness of
markets, but we can place too much trust in them.

Jason Hsu, a finance professor at the University of
California, Los Angeles, who also oversees investment management
for Research Affiliates in Pasadena, California, put it nicely
in the company’s June newsletter: “We nonetheless sleep easier
knowing we have employed a high priest. And for sure, the high
priest will charge, and charge dearly.”

GO YOUR OWN WAY

There are so many alternatives to the high-priest syndrome
that there is no need to be snookered by broker-sold funds.
Consider a host of direct-sold fund families that charge no
commissions. There are hundreds of funds that fit this bill from
the Fidelity, Schwab, T. Rowe Price and Vanguard Groups.

For self-directed investors, it would be worthwhile to spend
the time to create ready-made portfolios from direct-sold funds.
You can build a portfolio with investment-ready funds suggested
by Folioinvesting.com, MyPlanIQ.com and 7Twelveportfolio.com.
You not only eliminate conflicts of interest – you build the
lowest-cost portfolio that is right for you – there are no
commissions involved.

Don’t want to fly solo on fund selection? If you choose to
work with an adviser, ensure that they operate as a fiduciary
and place your interests above those of their firm. Until
brokers are forced to abide by these principles – the U.S.
Securities and Exchange Commission is currently sitting on a
rule that would force them to do this – you will be subject to
endless broker conflicts of interest.

CHICAGO, July 5 (Reuters) – Bill Bernstein is both a
neurologist and a money manager, which gives him a unique
perspective on the human impulses that he says typically
short-circuit people’s portfolio decisions. Author of six books,
including “The Four Pillars of Investing,” he says we need to
rewire our brains to do the right things at the right times.

Long a rare voice of wisdom in an increasingly bi-polar
market environment, Bernstein says the trick to smart investing
is “learning how to behave. You have to fight your worst
instincts.”

Here are some behavioral guidelines he suggests:

1. Be careful with advisers.

It’s perfectly understandable if you don’t want to go it
alone in investing because there’s a lot to know and only a few
people are experts. If you choose an adviser, make sure that
they are a fiduciary; they must put your interests above that of
their firm. They also shouldn’t overcharge you, meaning annual
fees of less than 1 percent.

And if they aggressively push loaded (sales commissions
charged), hedge funds, alternatives or actively managed funds?
“Make a 180-degree turn and run,” says Bernstein.

2. Buy and hold is okay – then rebalance.

With market volatility soaring in this young century, you
have to evaluate how much risk you can take. You need an
investment policy statement, which is a roadmap to what kind of
stocks/bonds/alternatives allocation is best for your time of
life, vocation and personal goals.

Yet you also need flexibility. Maybe a 60 percent stocks, 40
percent bonds allocation is too risky for you. If your plan is
working, keep it and rebalance every year to stick to your
allocation goals. At the very least, be flexible if your plan
isn’t working.

“Anyone who says buy and hold is dead should have a neon
sign on their head that says `I don’t know what I’m talking
about,” Bernstein says. “It’s not buy and hold, it’s buy, hold
and rebalance. Anyone who’s done that over the past 20 years has
been mightily pleased with the results, since that person did a
lot of buying in the early 1990s, early and late 2000s; and
selling in the late 1990s and before the recent crisis.”

3. Keep educating yourself.

History is important to Bernstein as he advises his clients.
His book “The Birth of Plenty,” for example, provides an ample
history of capitalism and prosperity. He also posts a reading
list on his website. One of his favorites is Fred Schwed’s
“Where are the Customers’ Yachts?”

You should also sample basic online portfolios that employ a
handful of mutual or exchange-traded funds. One of the most
boiled-down portfolios, which Bernstein recommends, is Scott
Burns’s “couch potato portfolio,” which consists of one-half
Vanguard Inflation-Protected Securities and one-half
Vanguard Total Stock Market Index fund. There are
several other iterations at Assetbuilder.com, which are
combinations of low-cost index funds from the Vanguard group.

4. Avoid hot new stocks.

As the recent Facebook initial public offering
demonstrated, millions of investors got singed on the notion
that they could do a “quick flip” of the stock for easy gains.
“How many investors do you think have exerted the considerable
effort of estimating Facebook’s future advertising revenues?
Using the word `investor’ to describe these folks is akin to
calling Tony Soprano a ‘Catholic,’” Bernstein wrote earlier this
year on his Efficient Frontier Web site. He figured that
Facebook would have to grow its per-share earnings of at least a
factor of eight to justify a triple-digit price-earnings ratio.
It pays to listen to analysts who sound warnings about stocks
and have done sober analyses.

“If neighbors are talking about a stock, stay away from it.
If everybody owns it, sell,” he says. Bernstein has noticed that
the worst investors are empathetic – they feed off of other
people’s emotions. Investing should be more analytical. Look at
the numbers: What’s the stock’s dividend growth rate? What’s its
cash flow? What are its business prospects?

5. Admit your ignorance.

Perhaps the best emotional insight you can make is to admit
that there’s a lot you don’t know about investing. It’s okay to
say this to yourself because you can avoid much stomach-knotting
financial anxiety. Make the time to learn what’s best for you
and your family. Turn off the TV and try to ignore the
headlines. You can’t be an expert at something that baffles even
the most seasoned professionals.

“We don’t expect people to fly their own airplanes or take
out their kids’ appendixes, and yet we expect them to manage
their retirement portfolios. In my careers I’ve done all three,
and investing is by far the hardest,” he says.

CHICAGO (Reuters) – I turn 55 today. As a member of the baby boom generation who hopes he’s aging like a fine wine and not turning into vinegar, I abhor the idea of losing money again in a 2008-style meltdown.

If I’ve learned anything, it’s that I’m a lousy psychic, so I don’t try to guess what any market will be doing in the future. Having speculated in precious metals, tech stocks and bought and sold at the wrong moments, I’ve made plenty of mistakes and run off the cliff with the flock far too many times. Here are some lessons I learned along the way.

1. Being liquid is golden

Hewing to Ben Franklin’s advice, savings is my top priority. When we hit a family health crisis in 2009-2010, I was glad we had cash reserves and an investment club portfolio of established dividend-paying stocks that I could liquidate.

We were able to cover huge out-of-pocket expenses, which were more than double our out-of-pocket health-insurance deductible of $6,000. Now, I’m gradually rebuilding our cash in a federally insured money-market account and a short-term bond fund. At the same time, we are also saving for our two daughters’ college educations in a low-cost 529 college savings plan and funding our retirement savings.

2. Healthcare concerns need even more savings.

I’m 10 years away from qualifying for Medicare – maybe. I’ve seen proposals in Washington that range from privatizing the popular program to raising the eligibility age to 67. In nearly every scenario I’ve seen from some of the best minds on the subject, if the program is to remain solvent, it will have to cut benefits, raise taxes and demand higher out-of-pocket contributions from beneficiaries. According to the 2012 Medicare Trustee’s Report, the hospital insurance fund will be exhausted in a dozen years if nothing is done to reduce costs. Translation: That means I – and all future retirees – need to save even more to cover healthcare costs in the future.

3. The details of downside risk are critical.

I’ve already lived through 10 bear markets, which normally occur only about once every decade. This young century has seen two bubble-bursting downturns so far. The average duration, as calculated by Strategas Partners, has been 21 months, with an average decline in value of investments of about 40 percent.

I never again want to be in the situation where I’m looking at having lost that much of our portfolio, as was the case in 2008 (it’s mostly recovered, but we rebalanced to more than 50 percent fixed-income). I’m working to rebuild a lower “beta” portfolio, that is, one that isn’t as closely correlated to the S&P 500 large-stock index.

4. Human capital is my best investment.

As I strive to learn more about risk, I’m learning as much as I can about emerging areas of growth: healthcare, alternative/non-U.S. investments, derivatives and global resource allocation. So I look at opportunities with a vigilant eye on downside risk measures, like Sortino Ratios and correlation, focusing on the likelihood that different asset classes will head south at the same time (as they did in 2008).

Yet I’m still interested in risking some capital on the future: Alternative energy, international development and climate change strategies are on my radar screen. Knowledge is the commodity I want to keep investing in as I get older. Is there an index fund for that?

5. Back to the future

In my birth year at the peak of the baby boom, the yearly inflation rate was 3.34 percent and a gallon of gas cost 24 cents. Who would’ve thought that inflation and mortgage interest rates now would be less (on a nominal annualized basis) than at the end of the Eisenhower era?

I see opportunities that present themselves as I watch the world spin faster and faster. The earth’s population has more than doubled in my lifetime, a rate of growth unprecedented in human history. All of those new souls will need food, water, places to live and the amenities of daily living. We’ll need new tools to meet the demands of population growth so that we don’t wreck our planet. That’s why it’s still a good time to buy global stocks and reduce debt on the personal – and national – levels.

And it’s never a bad time to learn something new. I want to know how the global supply chain works, the latest technology/media and the evolving political situation in Washington, China, India and the Middle East. Travel, reading, cooking, making music and taking long walks or bike rides are much more important to me going forward.

My goal? To get to the point that I don’t have to worry about investing at all and spend more time with my family. The only inevitable truth about history is that change is a river that never runs dry. I’m just trying to avoid getting tossed on the rocks while navigating the rapids.

(The author is a Reuters columnist and the opinions expressed are his own. For more from John Wasik see link.reuters.com/syk97s)

(Follow us @ReutersMoney or here. Editing by Beth Pinsker Gladstone and Kenneth Barry)

CHICAGO, June 29 (Reuters) – Portfolio volatility is your
sworn enemy if you’re nearing retirement or market downturns
make you nauseous. But if you’re a buy-and-hold investor – and
believe that stock market risk diminishes over time – you still
need a new course of action.

With high-frequency robotic trading, exchange traded funds
and global news hitting markets at the speed of light, there’s
no reason to believe volatility is going away.

Recent research by Lubos Pastor of the University of Chicago
and Robert Stambaugh of the University of Pennsylvania confirms
this view. In a forthcoming piece in the Journal of Finance,
they examined 206 years of stocks returns and confronted the
conventional wisdom that stock risk declines over time.

“We find that stocks are actually more volatile from an
investor’s perspective,” they concluded, citing “uncertainty
about future expected returns” as a major factor. The
Lubos-Stambaugh paper seeks to refute earlier research by
luminaries such as Jeremy Siegel, also of the University of
Pennsylvania, who claimed that stock market risk is reduced over
long holding periods. His book “Stocks for the Long Run” was a
bestseller before the dot-com crash.

In the wake of the 2008 meltdown, there’s ample evidence
that volatility has been increasing. You need only look at the
calamity of the past few years to know that conventional
investing has been a gut-wrenching roller-coaster ride.

The CBOE volatility index (VIX), which measures short-term
volatility of S&P stock index options, has hit its highest level
in the last 20 years three times since 1998, and has closed
above 25 – a notable high point linked to market declines – five
times during that period.

One way to reduce market risk is to lower the overall
allocation of stocks in a portfolio. If that doesn’t appeal to
you, add specialized exchange traded funds to the mix. You can
buy inverse ETFs from the PowerShares, Direxion or FactorShares
groups, for example, that gain when stocks lose. Have a large
position in single stocks, particularly those of your employer?
Buy put options on them to protect against downside risk.

Also keep in mind that asset classes that typically don’t
move together can fall off the cliff at the same time during an
extreme market crisis. That was the case in 2008 with U.S.
stocks, emerging market stocks, commodities and real estate
stocks, or REITs. This unexpected correlation blew the
traditional thinking of Modern Portfolio Theory diversification
out of the water.

WARNING SIGNS

Many portfolio managers have developed an early-warning
system that tells them when an asset class is due for a fall.
Under a “tactical asset allocation” model, they will rebalance
into less volatile investments when they see a market storm
brewing. Another approach is “Adaptive Market Hypothesis,” which
combines behavioral investing, derivatives and active management
to target and reduce volatility.

One fund, the Natixis ASG Global Alternatives,
managed by AlphaSimplex in Cambridge, Massachusetts, employs
hedge fund-like strategies to “maintain a targeted level of
volatility.” Jerry Chafkin, a fund manager and president of
AlphaSimplex, says his firm uses algorithms to monitor market
activity daily – and makes adjustments automatically to stay
within a preset volatility range.

Chafkin’s fund held up during the market tsunami in late
2008 – it was launched Sept. 30 of that year – and early 2009.
It posted only a 0.62 percent loss in the first quarter of 2009,
compared with a negative 11 percent for the S&P 500.
Year-to-date, though, it is down 3.80 percent, in contrast to a
7.04 percent total return for the S&P.

“Volatility was unprecedented in the most recent financial
crisis,” Chafkin told me. “And we expect the volatility of
volatility to continue. But now instead of knowing how much risk
to expect, investors have uncertainty.”

Managing volatility isn’t free, though. The more involved a
hedging strategy – especially those involving “absolute return”
funds that seek positive returns in any market – the more you’ll
pay a fund manager. These specialized funds also can lag when
the market is flat or rising, and can be costly. The expense
ratio for the ASG fund (A class) is 1.60 percent annually with a
5.75 percent sales charge, for example, compared with 0.55
percent for the average exchange traded fund. While that’s a
relative bargain for most hedge funds, it’s quite pricey for an
ETF.

If you don’t want to buy an off-the-shelf fund, you’ll need
to find an advisor who understands derivatives. Any
sophisticated hedging strategy should be done with a trained
registered investment adviser, certified financial planner or
chartered financial analyst, since you can still lose money with
these strategies.

You can also find pre-allocated portfolios at sites like
MyPlanIQ.com and Folioinvesting.com. But if you come from the
ultra-risk-averse camp, you may not even need them if you can
reduce your stock holdings and replace them with single U.S.
Treasury, municipal or inflation-protected bonds. They are among
the simplest answers to market volatility and are generally the
most effective if you don’t want an active strategy to fully
replace your buy-and-hold objective.