“Fiduciary” is an odd word. In law, a fiduciary is a person whom the law obligates to act solely on behalf of the person he or she represents and in good faith.  The origin of the word comes from the Latin word “fiduciarius” meaning confidence and trust. The first known use of the word “fiduciary” was about the year 1641.

You may be wondering how the word “fiduciary” fits in a blog about personal finance. Just this: not all financial advisors are fiduciaries when it comes to their clients. That’s right. Your financial advisor may NOT be obligated to act solely on behalf of you or in good faith.  If your financial advisor works for an insurance company or a big financial company like American Express, Edward Jones, Wells Fargo, RBC, Merrill Lynch, or Smith Barney, they are not fiduciaries. His or her first obligation is to do what’s best for their employer AND NOT YOU!

On the other hand, if your financial advisor is a fiduciary, she/he is legally obligated to work on your behalf and in good faith. Ask your advisor if she/he is a fiduciary. You might be surprised to find out for whom they work.

Note: the advisors at Juetten Personal Financial Planning, LLC. are fiduciaries and we have always taken this role.

On May 17, 2012, public investors could buy shares in this hugely popular social media company for the first time. People were lining up to buy shares. Some investors were upset that brokers were limiting the number of share they could buy. It was a “can’t miss” opportunity. Shares sold for $38 on that day.

Facebook shares closed yesterday at $26.82 a share — a 30% decline. Try to remember this the next time you are tempted to fall in love with a stock and/or get swept up in “the next great thing/can’t miss” stock euphoria. Stock picking is gambling, pure and simple. I wish I could get people to understand that.

This is from a story reported by Reuters earlier this week.

“Hedge fund billionaire John Paulson is emerging as one of the biggest losers in this year’s gold rout, further tarnishing his once legendary status in the $2 trillion hedge fund industry.

Paulson’s $700 million gold fund lost a whopping 27 percent in April, when the price of the metal plunged 17 percent over a two-week stretch, according to performance figures provided by a person familiar with the fund.

The jarring one-month decline in the Paulson gold fund brings the year-to-date loss for the fund to about 47 percent, the source said. The fund’s losses were magnified by the fact that its bullish bet on gold was enhanced with leverage, or borrowed money, and derivatives tied to the price of gold.

Paulson rose to fame after he made $15 billion for his firm in 2007 by betting against subprime mortgages before the housing collapse. Since then, however, he has struggled to duplicate that success, and several of his portfolios have lagged in recent years.”

Here is what I take from this story. With all of the resources at his command – the best “experts” money can buy, numerous bright, young MBAs from the best schools, the most sophisticated computer software – Paulson proves again that luck is not a long-term plan for investment success. My advice: stick to an age/risk tolerance asset allocation plan. Complete it with diverse passive investment vehicles and focus on the things you can control: your work, your relationships, how much you save and spend.

Last week, the Investment Company Institute (a mutual fund industry association) published their annual look at mutual fund expenses. The ICI noted that mutual fund expense ratios are trending down. This is good news for mutual fund investors because investors get to keep what’s left over after costs.  Still, it’s distressing to see that the average mutual fund expense ratio is 1.36% (more for funds that invest in stocks and less for funds that invest in bonds).

And that’s only part of the total cost of owning a mutual fund. Commissions and transactional costs are in addition to a fund’s expense ratio. According to William Bernstein, a fund’s trading costs are roughly double its expense ratio. In other words, the total cost of owning a typical mutual fund is 2.72% (1.36% X 2). Those costs are subtracted before the investor gets paid.  If the total return for a fund is 7%, the investor actually gets 4.28% (7% – 2.72%).

Compare these numbers to the total cost of owning a passive investment like an index mutual fund. The Vanguard Total Stock Market Index mutual fund (VTSMX) expense ratio is .17%. If we double the expense ratio, then its total cost is .34%. This probably overstates the total cost because an index fund has much less turnover compared to a typical mutual fund. However, to be fair, I wanted to use the same methodology. Again, assuming a total return of 7%, the investor gets to keep 6.6% (7% – .34%).

You choose: which is better, a 6.6% or 4.28% return?

In their excellent book, Investing for Change, Augustin Landier and Vinay B. Nair divide Socially Responsible Investing (SRI) investors according to their interests. These authors suggest there are three types of SRI investors:

Yellow investors want their portfolios to be exempt from “wrongly earned money.” They don’t want to be part of activities they disapprove of or from businesses they consider unethical. For this, they are willing to compromise financial performance.

Blue investors typically want to know how much it will cost them to invest responsibly, and whether it will ultimately have an impact. They are the more practical and less “ethical” of the responsible investors. If blue investors were persuaded that SRI would not affect the way companies behave or that its impact on their portfolio performance would be large, they would look for another way to participate in changing the world.

Red investors’ sole goal is to maximize their returns. If that means being responsible, they will promote corporate responsibility. However, if that means ignoring social obligations, they support that, too. They are not “amoral” or cynical, but they usually express their values through other aspects of their lives.

The good news is that you can have a sustainable portfolio no matter what color investor you are. In the most recent data published by DFA on their two core sustainable investing funds, the U.S. sustainable fund achieved a comparable five year rate of return as the broad Russell 3000 index 6.32% per year vs. 6.72% per year for the index) and the International sustainable fund return was slightly better than the broad MSCI World (except U.S.) index.

If you’re interested in creating a sustainable investing portfolio using our “Better Planet Investing” service, please give us a call at 425-373-9393 and visit the tab on this website by that title to learn more.

Earth Day was on Monday and it kicks off Earth Week. This is a special time for us to think about and act in ways that are better for the planet. As financial advisors, we support clients who want to invest in a way that is consistent with their earth-friendly values. We call this “Better Planet Investing” and you can read more about our approach to sustainable investing under the tab with the same name elsewhere on this web site.

Today we’re going to discuss the challenges of creating a sustainable investing portfolio. For this blog post, I am indebted to my good colleague Sheldon McFarland, Vice President of Portfolio Strategy and Research at Loring Ward. He pointed out these challenges in an article and I’m liberally borrowing from his thoughts. Thanks Sheldon.

McFarland points out that there are at least three challenges to creating a Socially Responsible Investing (SRI) portfolio:

Active Management: This refers to the practice of creating a portfolio by buying or selling a stock based on a projected value. In other words, active management is guessing which stock to buy or sell and hoping that the stock does what the guesser assumed. Unfortunately, many academic studies have shown, each year about two out of three actively managed mutual funds do not meet the performance of their comparable benchmark. (By the way, the statistics stay about the same, but the specific mutual funds that beat their index change just about every year.) Because 90% of the SRI mutual funds are actively managed, an investor that wants to create a sustainable portfolio is faced with the prospect of poor investment returns.

Concentration Risk: Diversification is a cornerstone in creating an effective portfolio. Most investors want a mutual fund that holds a large number of stocks in order to reduce the risk of owning too much of any one stock. Unfortunately, the average SRI mutual fund holds 120 stocks if it holds U.S. stocks and 174 if it holds non-U.S. stocks. Compare this to a good index fund that holds 2,000 stocks. You can see the risk that comes with owning a typical SRI mutual fund.

Management and Turnover Expenses: The costs of running a mutual fund matter to an investor because the money a mutual fund charges comes out of the return the investor receives. In other words, higher expenses in a mutual fund means lower return to the investor. The two biggest factors of the total expense of a mutual fund are the management fees and the costs associated with the turnover of the fund. (Turnover refers to how often a fund buys and sells a stock holding. There are costs associated with trading.)

The average net expense ratio for a typical SRI mutual fund is 1.21%. The average net expense ratio of an index fund is .54% (45% less). In other words, an investor in the typical SRI mutual fund will pay 45% more for the likelihood that the mutual fund will not match its benchmark. Not a pretty thought, is it?

And the same goes for turnover ratio. The typical SRI mutual fund has a turnover ratio of 60% (meaning that 60% of its holdings are bought or sold in a year). The average index mutual fund has a turnover ratio of 25%.

William Bernstein, a noted author on personal finance, suggests turnover costs are roughly equal to the management fee of a mutual fund. In other words, the total cost of owning a typical SRI fund is about 2.42%. The average cost of an index based mutual fund is 1.08%. On a $100,000 investment in an average SRI mutual fund, an investor would pay $2,420 a year. The investor who chooses and index SRI mutual fund would pay $1,080 (again, 45% less).

Next Time: What Color SRI Investor Are You?

Today is Earth Day for 2013. This is the annual event to honor our connection to Mother Earth. Earth Day was begun in 1970 in the U.S. and is now celebrated by over 190 countries in a variety of ways. There are Earth Day Walks, festivals, and Earth Day education campaigns that kick off today to help children become more aware of the planet. Earth Day is also the start of Earth Week so we will have a series of blog posts this week on the topic of sustainable investing to honor and celebrate Earth Day. (As I write this blog post, a robin just pranced across my patio outside my office door. How appropriate!)

What is Sustainable Investing?

Sustainable investing is part of the growing Socially Responsible Investing (SRI) approach to investing. Sustainable investing increases exposure to companies that have high ratings for sustainable practices and reduces or eliminates exposure to companies with low ratings. Generally, there are four practices that are considered in a company’s sustainability rating:

Reducing resource consumption: sustainable companies are efficient in their use of natural resources—especially non-renewable resources and energy that contribute to global climate change.

Reducing emissions of toxics and pollutants: companies that emit harmful chemicals, break environmental laws, or disregard local environments are not performing sustainably.

Implementing proactive environmental management systems and initiatives: embedding environmental thinking into the business structure maximizes sustainability thinking at every point in the company.

Helping customers achieve sustainability: thinking beyond the walls of the company to design products that reduce the environmental impacts during product use is a key aspect of sustainability.

But Does It Make Good Investment Sense?

Many people believe that they need to make a choice between sustainable investing and earning a good investment return. The truth is that several academic studies have shown that the investment results of an SRI portfolio are comparable to a those earned by a traditional portfolio.  For example, Craig Israelson, a professor at BYU, studied the returns of SRI funds from 2005 to 2010. He concluded:

“SRI is important to some people and a non-issue to others. Those who care will be glad to learn that SRI funds are leaving behind a reputation for under-performing. In the last five years, SRI funds have performed about as well as their non-SRI counterparts, with a lower turnover ratio and a better tax cost ratio.”

You don’t need to choose between doing well from an investment standpoint and doing good for the planet.

Next Time: The challenges of sustainable investing

The second largest pension fund in the U.S. is considering a move to an all-passive portfolio. The California Public Employees Retirement System (CalPERS) has $225 billion in assets and already half of that is invested passively. CalPERS is engaged in a study to review its investment activities with a focus on its active managers according to the industry publication Pensions and Investments.

This is another indication of a trend gathering momentum. Ten years ago, 84% of  mutual funds and ETFs were in active strategies; as of the end of February 2013, that number is 72%. Costs and under-performance of active investment management play a big part in this shift. The average actively managed mutual fund has a 1.34%  expense ratio; the average U.S. stock ETF average expense ratio is .40%. According to Morningstar, just 18% of actively managed large cap mutual funds outperformed the S&P 500 Index in the last year. Over 10 years, only 38% of large cap actively managed mutual funds have beaten the S&P 500 Index.

Let me ask you a question. If CalPERS, which can afford to hire the best active investment managers because it has billions of dollars to invest, already has half of its money passively invested and is considering making all of its investments passive, shouldn’t you be following a passive investment approach?

Recently, I’ve noticed that clients and prospects are asking some different questions. Since the Great Recession ended four years ago, most investors wanted protection for their investments. The fear was that we would experience another harsh dose of market declines and most investors did not want that painful experience to repeat.

Now most investors are asking me how they can get better returns. One client asked me, “Why the heck do we have all these bonds?” Another client whose portfolio earned a 9% return last year asked me how he can earn more than the 2% he’s earning on the cash he’s keeping in his portfolio.

The concerns in the last few years and now the change in the nature of questions show what behavioral finance people call “recency.” This is the human tendency to believe that whatever has happened most recently will continue to happen. For example, during the late 1990’s, investors assumed that stock market returns in the double digits would continue forever. People who bought houses in 2006 “knew” that house prices would continue to grow at double digits. And so on. Of course, neither assumption was correct.

The point is this: investment markets go up and markets go down. Assuming both condition will persist and acting as if they will is foolish and a mistake. Better to create a good investment plan based on your time horizon and risk tolerance for the long-term and rebalance to that plan regularly. Then, whenever the investment markets turn – and they will, we just don’t when – you are not left wondering what happened to your portfolio.

In this post on the personal financial lessons from the popular PBS series “Downton Abbey,” I want to remind you of the seven  SmartMoney Rules™ because they all apply to the characters of “Downton Abbey” and their predicaments.

1. Have an abundant money mindset.

2. Protect yourself first.

3. Have a plan tied to your values.

4. Use cash and debt smartly.

5. Know how much is enough for retirement.

6. Invest smartly.

7. Review and adjust when necessary.

If the characters of “Downton Abbey” would just follow these seven SmartMoney Rules™ their lives would be so much better. But then we wouldn’t have drama, intrigue, entertainment or a season four starting next January. I hope you tune in. I know my wife Nancy and I will!