Rose-Tinted Glasses

While Ron’s View is generally written to appeal to financial professionals, this Update is focused on consumers and their protection.

For this week’s Update, All names have been changed.
I recently had lunch with a friend who informed me that he had lost $100,000 in a local investment scam. I found this shocking because Larry is a very successful entrepreneur who has been around the block more than once.

Another friend, Sebastian, chose an advisor who was well known in the community to manage a portion of his savings. After several months, Sebastian asked the advisor why he hadn’t received any statements. Several days later, he received a hand-delivered statement that had been typed up on the advisor’s computer. Soon after, Sebastian requested a small withdrawal from the advisor’s account in the form of a personal check, which bounced!

To make a long story short, Sebastian and many others lost their investments, and the advisor was eventually taken to court.

Last summer, I was playing golf with an acquaintance, John, who began talking about investments. Since we didn’t know each other very well, he strongly recommended that I talk to his advisor because I would be able to generate around 15% in down years, and over 20% annually in bull markets.


After listening to John’s pitch for a while, I made the following statement:

“If this fifteen to twenty-plus percent performance data comes directly from your advisor, he or she should be immediately reported to regulators. And if I were you, I’d move my savings out of this person’s control as quickly as possible. On the other hand, if these returns are based on your calculations, you should buy a new calculator.”

Needless to say, we really didn’t talk much for the remainder of the round.

A few weeks ago, the Boston Globe published an article titled, “Going, Going, Gone” about a local, well-known businessman who attracted eighty investors into a scam that lost $20 million. He also had predicted returns of 15% to 20%.

Here’s my advice to this week’s Update readers: scams of this nature may be uncommon, but you must always be alert and vigilant.  If an advisor promises returns significantly above market averages, it’s a red flag.

The following is a breakdown of average annual returns for the Dow Jones Industrial Average and the S&P 500 during two separate periods of time.

Period Return
Dow S&P
2012 to 2016 10.2% 12.4%
2005 to 2016 5.2% 5.1%

It is important to note that equity returns cited in the table above are raw returns. They do not account for commissions, advisory fees, trading costs, expense ratios, or the percentage of assets allocated to fixed income securities and cash equivalents.

How could you outperform the indexes? You can carry more risk than the indexes, which would likely lead to higher upside returns, but greater losses during pullbacks.

Here’s an example examining how much an investor would have generated over the past five years in a 60% stock/40% bond portfolio applying the variables below. (Note that the positions in this portfolio could be populated in capital market or insurance products.)

By the way, aggregate bonds returned approximately 2.1% annually over the past five years.

Equity average annual return 10.2%
Bonds average annual return 2.1%
Blended average annual return 7.0%
Annual advisory fee 1.00%
Expense ratio 0.30%
Net return 5.7%

As you can see, exceeding raw benchmarks after expenses is difficult, and consistent 15% to 20% returns?  I don’t think so. (It is worth mentioning that around 50% of fund managers do not achieve their category benchmark goals.)

So when it comes to investing, you must refrain from looking at the world through rose-tinted glasses.  If something seems to good to be true, as my friends found out the hard way, it probably is.

Here’s another takeaway: choose advisors carefully.  Before employing an advisor, at minimum, I would want to know the following information:

    • Their work history
    • Their brokerage firm affiliation
    • Information about their practice
      • Number of clients
      • Assets under management
      • Specialization
        • Products and services
      • Historical performance by asset allocation
        • 1, 3, 5-year performance
        • Performance in 2008
      • How often are meetings scheduled with clients?
      • Will I have direct phone access to the advisor?
    • Background check information
      • Legal issues
      • FINRA and SEC violations
    • References
    • Designations
      • Series 7 broker
      • Insurance license
      • Registered Investment Advisor (RIA)
      • Certified Financial Planner, Retirement Management Analyst (RMA), etc.
    • How does the advisor get paid?
      • Commissions, fees or both
        • Commissions are an optional payment structure and should not be viewed negatively.
      • Conflicts of interest
        • An RIA must disclose conflicts, such as awards for selling a particular product.
      • Does the advisor use an independent custodian and clearing firm? (You do not want an advisor to have custody of your assets.)

It is clearly in your best interest to rigorously interview multiple advisors prior to making a final selection.  When you finally choose one, take time to review statements in detail, schedule regular meetings to evaluate holdings, and become engaged in the decision-making process.

Your retirement depends on it.