As an advisor who's done the rounds for over 20 years, here are a few things to watch out for:

1. Over-diversification - yes, there is such a thing, and it can really hurt you.  If you're so well diversified that none of your investment positions have any umph you're not going to make any money in either the short or the long-run.  Diversification is a tool for spreading the risk in anyone investment over many.  I personally find it really frustrating when I sit down with clients and find that the largest stock holding in their mutual funds is less than 1% of a stock.  So if this stock went up or went down, would it matter?  of course not.

2. Overlapping investments in mutual funds - A lot of times clients own the same stocks in different mutual funds, so when they think they are diversified, in reality they are not.  I don't think you need to own too many mutual funds in one portfolio.  The only reason you should add a fund is if you are trying to emphasize a particular sector of the economy or a particular geography of the world, or companies in particular growth cycles.  Your advisor should be able to tell you the reason for each mutual fund position.

3. Basing mutual fund choices on MERs - Many investors and advisors shy away from mutual funds that carry high MERs. They see this as reducing the direct return to the client.  My view on this is a bit different.  I don't believe in completely ignoring MERs however, pay attention to what the MER applies to.  It is the cost of running the mutual fund, and in most cases staff salaries constitute almost 60% of the cost.  Seriously, would you want the people who command the lowest salaries in the financial industry to manage your money for you?  How good do you think they are at what they do?  And if they are good people with good reps, how much of their time is being spent on managing the mutual fund if the fees they charge to the mutual fund is well below the market value of their time.  Would you pick the cheapest heart surgeon to perform your heart transplant?

4. Rebalancing - this is a process by which you mindlessly sell investments that are making money and buy the one that are under-performing.  Typically, rebalancing is conducted in a closed universe, which means that there are a finite number of investment choices included in the exercise.  I don't think that rebalancing ought to be conducted at regular intervals with complete disregard to what is happening in the markets.  Moreover, I don't believe in rebalancing using a finite universe of investments.  I believe that investment choices should be continuously added and/or truncated as times dictate.

5. Investing in Balanced funds - By definition a balanced fund incorporates equal parts of fixed income and equity.  Typically, when equities or stocks move up, bonds or fixed income securities move down: they are inversely related.  This means that the return on a balanced fund would theoretically be a flat line.  And it mostly is.  I am sure that there are advisors out there who can make a case for these investments, I'm just not one of them.

6. Investing for yield rather than total return - in terminology, yield and return are two very different things.  Sadly, most advisors do not make the distinction between the two - and without this clarification most clients use the terms interchangeably.  Total return over a defined period of time includes income and capital gains, where as yield is current income in ratio to current price.  At different stages in the life of an investor they are investing for growth while building their investments and on income when they are drawing on their investments.  I find that financial lingo helps to confuse the issue rather than to simplify it.

8/13/2012 12:11:29 am

Thank you, this is a good overview - could you please explain further about balanced funds

8/13/2012 12:12:17 am

Thank you - this is good - could you please explain further about balanced funds


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