The definition of insanity.

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BondGuy's picture
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One of the perks of this business is the ability to live in a nice neighborhood. One of the downsides of living in a nice house surrounded by other nice houses is that the solicitations from financial advisors and consultants never ends. Many on this board who live in these types of places can relate.
This week i received not one but two solicitations from MSSB. One from their local in town office and another from an office located in Capital City about 10 miles away.
 
First, the good news- Hats off to these advisors for their prospecting effort. At least that I respect.
 
Next, the messege to us advisors - If you aren't contacting your clients rest assured someone else is.
 
Finally, the bad news -
 
Mailing number one comes from a three advisor group. The group consists of the typical two senior veeps and a junior FA. They have invited me and my guest to a dinner at one of the area's top restaurants. We will be entertained by Blackrock Investments. Opening for Blackrock that evening, Roosevelt Investments will do its act.  The entertainment should be interesting.
 
The invitation is entitled: A Consultative Approach to Investing
 
It says and I quote: In today's complex world, investors need to develope a sound investment process that addresses asset allocation, developing an investment strategy, evaluating investment managers, and measuring performance.
 
OK folks, what's wrong with that statement?
 
If you answered, nothing listed in the invitation stopped investors from losing money throughout the past decade give yourself a gold star. Nothing in the invitation talks about protecting assets from decline. There's a reason for that.
 
It doesn't work, it's failed strategy within a broken process.
 
Yet "they" continue to push it.
 
If it doesn't benefit the investor, who does it benefit?
 
 
On to mailing number two:
 
This one comes from an advisor without the Veep title, so I'm guessing rookie. The letter is four paragraphs long and totally fails by any standard to grab my attention.
 
The letter focuses on retirement asks: How much should you save for retirement? What level of risk can you live with? How much do you need to live on?
 
These are all good questions that we as profesionals ask as a standard course of business.
 
The letter goes on:
 
I believe that MSSB's comprehensive approach to retirement planning sets a new standard in the industry. We begin with your vision for retirement and try to estimate what that may  cost to fund. (and here's the part i really love) We'll also look at risk factors-longevity,health care costs and others-that could threaten the lifestyle you envision. Then we'll develope a long-range investment plan that details where your income will come from in retirement.
 
OK, I'll give trying to estimate retirement funding a pass. You either can estimate it or you can't.
 
My question is this: When looking at the risk factors that could threaten my retirement lifestyle who proctects me from this Advisor and MSSB? 
 
Ya gotta love rookies. This kid obviously drank the Kool Aid because he believes that MSSB sets a new standard in retirement planning. Did i miss something here? Did MSSB  protect it's clients in 2008? Did thier clients have a positive return in 2008? Are they back to even this year? How have MSSB clients done over the past decade? Were they immune to the tech bubble popping and decade opening 45% sell off?
 
We all know the answers to those questions.
 
The point: On main street people have gotten screwed by this process. Retirees and pre-retirees have little to show for the past decade of investing. Many have had their retirement plans scuttled. This firm, my firm , all our firms, did nothing to protect these people. Yet the beat goes on. The fees are racked up and the cash register rings. Whether you call it a Consultative Approach to Investing or Comprehensive Retirement Planning any program that puts investors money at risk without the safeguards in place to protect those assets is a failed process. A well stuffed mattress has outperformed most if not all of the cookie cutter fee based programs on Wall Street over the past decade.
 
What do you call that when you continue to do the same thing and expect a different result?
 
In this case, it should be called criminal.
 
 

Squash1's picture
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You have been on this for a week now... What is with the anger?

Moraen's picture
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BondGuy's picture
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Squash, rant of the week huh? Actually, I've been at this for a decade. Not anger, frustration.
 
Rather than focusing on me, the messenger, think about the messege.
 
You need to be able to answer this question at your next client/prospect meeting:
 
The market's been down over 40% twice in the last ten years, what will you do to protect me the next time?
 
In your practice you need to develope a way, a process, that pulls your clients who have entrusted their life's saving to you off the tracks.
 
You, me, us, need to think long and hard about what we are doing. Looking at a screen, collecting a fee, and hoping for the best doesn't cut it!
 
 

bspears's picture
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Spot on Bond Guy

B24's picture
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BG,
 
I agree with you on this.  My firm peddles the same lame asset allocation / buy and hold through anything philosophy like every other firm.  They have absolutely NO response to what to do if the market tanks.  Actually, their response is, "you can't time the market".  They constantly come up with new and exciting twists on the "missing the 10 best days in the market" B.S., the "you can't predict" B.S., etc. 
All of it rests on the fact that all the firms want to hang their hats on the same CYA strategy backed up the FPA, et al.  That way, nobody stand out from the crowd and they can't be "wrong".  Personally, I don't think large brokerage firms do anything from a strategic standpoint to help FA's.  I think it is up to us to use our heads and focus more on risk management and less on the "optimal" portfolio.  It drives me crazy to see firms like Goldman, Merrill, etc. (the "stars" of Wall Street) making changes like "moving from 12% in Consumer Durables to 14%, and lowering our "guidance" on Health Care stocks to 10% from 12%".....as if that will make ANY difference AT ALL.
Sometimes I feel like my firm is completely ignorant to what goes on around them.  And yes, many portfolios have made back much of their losses.  But what about the ones that haven't?  And what if the market DIDN'T recover???  Then what?  Just keep sitting tight??
 

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B24, BondGuy *in mock horror*!Sacrilege!  The people at the heads of these firms are soooooo much smarter than you.And do you mean to tell me you don't KNOW that asset allocation is 93 (or 4 or 5 or 6 or 7) percent of returns?Look, just because the market has treated people horribly for ten years, does NOT mean it's ok for YOU guys, retail advisors to question the big dogs (in all fairness, BG is a big dog).Seriously folks, if you haven't been listening to BondGuy, now is the time to do it.  That is some good advice.

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BondGuy wrote:Squash, rant of the week huh? Actually, I've been at this for a decade. Not anger, frustration.
 
Rather than focusing on me, the messenger, think about the messege.
 
You need to be able to answer this question at your next client/prospect meeting:
 
The market's been down over 40% twice in the last ten years, what will you do to protect me the next time?
 
In your practice you need to develope a way, a process, that pulls your clients who have entrusted their life's saving to you off the tracks.
 
You, me, us, need to think long and hard about what we are doing. Looking at a screen, collecting a fee, and hoping for the best doesn't cut it!
 
 
I didn't mean of the "week".... Normally you post on a topic and move on... I completely agree with what you are saying(i learned the hard way at EDJ buy and hold) so I decided by reading a lot of books by a lot of people and experimenting in the past... That "smart" clients don't mind only gaining 50% of what the market does, if they don't lose money in the bad years..
 
I do pull money out of the market and for first time clients they have a hard time grasping the idea, but after the last 2-3 years, they understand now...
 

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I understand what you guys are saying and I agree most investors just roll their eyes at all of this crap. My question is, what is the alternative ? If you pushed bonds the last 10 years you look like a hero and your clients love you, referrals are probably flooding in, but what happens if the next 10 years the market does 10% annually or better ? Those same people will be pissed and rush to someone else. What exactly should someone fairly new to the business and still just trying to gather assets be selling as their value ?

etj4588's picture
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Where's BioFreeze??

Wet_Blanket's picture
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Yes, finally a relevant topic.

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Ron 14 wrote:I understand what you guys are saying and I agree most investors just roll their eyes at all of this crap. My question is, what is the alternative ? If you pushed bonds the last 10 years you look like a hero and your clients love you, referrals are probably flooding in, but what happens if the next 10 years the market does 10% annually or better ? Those same people will be pissed and rush to someone else. What exactly should someone fairly new to the business and still just trying to gather assets be selling as their value ?
 
Insurance products should be part of everyone's plan.

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Ron 14 wrote:I understand what you guys are saying and I agree most investors just roll their eyes at all of this crap. My question is, what is the alternative ? If you pushed bonds the last 10 years you look like a hero and your clients love you, referrals are probably flooding in, but what happens if the next 10 years the market does 10% annually or better ? Those same people will be pissed and rush to someone else. What exactly should someone fairly new to the business and still just trying to gather assets be selling as their value ?
 
It starts with segmentation of money.  Short term/mid term/long term.  Risk.  Don't risk short term money (0-10 years).  Don't risk a lot of mid-term money (10-15 years) - balance is key here.  LONG term money (15-20 years+)  can eb invested aggressively in assets with a high likelihood of long-term appreciation (i.e. emerging markets, etc.).  BUt since it is for a spending goal 15-20 years+ away, you don't need to allocate a lot to it, so you are minimizing your downside risk.
 
Most average FA"s just take the whole thing and say "10% cash, 30% income, 30% growth and income, 20% growth, 10% aggressive" without any plan for the future.  And if things go bad, just "hold on".
 
This is a start, and there are other ways to do it.  I also believe that a portion of your money could and/or should be gauranteed, especially the short-term bucket.  Whether through annuities, CD's, short-term fixed income, whatever.
 
I also feel like we have to look at the bigger picture.  Should it have made sense to get highly allocated to equities in 1998/1999/2000?  Did all the brokerage firms REALLY think the sky was the limit?  How often does the market trade at 30-35 P/E and then grow from there?  Oh, I forgot, it was the "new paradigm".  Thank God that term was lost.
 
Who knows what's next.  But there is this strange deisre to shoot for the moon in investing, when most clients would be perfectly content with 5-8% per year without big losses.  At least my clients would.

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The alternative is to be the alternative. To have an answer.
To have an answer we need to turn back the clock. For those of you who don't know it here's a news flash: I'm a dinosaur. I'm a dying breed. I come from an era of individualistic brokers who not only raised the money but managed it to. Day by day, we are being replaced by a kool aid army of raise the money fee it up advisors. Most of these advisors are clueless on the investment side. They've never bought a stock or a bond. They've never written an option ticket. Most can't read an options screen. And to most Bloomberg is a guy running a big city and nothing else. All this group knows is fee it up and you get to drive a BMW.
 
Ethically, we need to go back to raising the money and managing it. Or, we need to at least exercise the oversight we claim, to justify the fees we collect.
 
My personal answer is to have my own seminar.  It will be entitled:
 
The Bear Ate My Pie Chart
 
Content will be centered on ways to protect assets. From bonds with maturity dates, to annuities with living benefits to options/hedging strategies to momentum analysis of the major market sectors.
 
The messege: The process is broken. I am the alternative.

chief123's picture
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MPT is a joke... In never takes into account the down years... ever... and assumes 35 year times horizons...
 
MPT applies risk in the wrong way. The founder Markowtiz even said the problems are the lack of ability to figure out semivariance...
 
Investors don't care about upside risk, they care about downside risk.. A prime example of this is the idea of a sharpe ratio... It penalizes return above and below a set amount(such as your 12% equity returns) when in actuallity all investors should care about are those below such stated number.

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PS - "Growth & Income" isn't an asset class.  --, Jones told me it was !!!!

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iceco1d wrote:MPT isn't a joke.  It requires some adjustment to account for the "real world" but the concept isn't a joke.

 
As B24 said, most clients would be more than happy to earn 5,6, 7 or 8% a year, consistently.  Without costs, you could have an expected return of 7% with a 20/80 portfolio.  If you could keep your TRUE costs at 1.5%, you could have an expected return of 7% with a 40/60 portfolio.
 
Now, tell me that your average 50-something wouldn't be OK with a 7% return?  And tell me they wouldn't be OK with 40/60 volatility?
 
Throw in some puts, or some living benefits on the risky assets, and you could increase to a (gasp) 60/40 allocation.
 
PS - "Growth & Income" isn't an asset class.
 
I know that.  That was a sideways shot at Jones.  I never understood their asset allocation theories.  Small cap growth is aggressive.  Small cap value is growth.  WTF?  Basically, it's a misnomer for value and growth...sort of.  I still don't get it. 

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Ron 14 wrote:
PS - "Growth & Income" isn't an asset class.  --, Jones told me it was !!!!

According to my buddy at LPL it is too...

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The problem with MPT isn't MPT.  It is that it was never meant to be an all-encompassing theory.  You can use MPT and even EMH as a starting point.  But advisors don't add value by blindly following theory.  It's application of theory and the exceptions to theory is where advisors become worth their salt.

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Thank you once again, BondGuy. Most will make this thread about the merits of MPT or asset allocation or investment strategy.
However, it's a classic BondGuy prospecting thread for me. You sir, with the definition of insanity just gave me my "opening line" to prospects on how I am different. I told a prospect that has his money at MSSB in an asset allocation fee based account that I didn't believe in the old-school method of asset allocation, and he looked at me like I was insane. His broker tells him to "stay the course." Then, I told him what I had been doing for my clients over the last couple of years, step by step. I will still be transferring his assets in, but I felt like I sounded a bit too much like "my rate is better than his rate."
 
You just helped me how I can tie it all in...

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Piker34 wrote:
Thank you once again, BondGuy. Most will make this thread about the merits of MPT or asset allocation or investment strategy.
However, it's a classic BondGuy prospecting thread for me. You sir, with the definition of insanity just gave me my "opening line" to prospects on how I am different. I told a prospect that has his money at MSSB in an asset allocation fee based account that I didn't believe in the old-school method of asset allocation, and he looked at me like I was insane. His broker tells him to "stay the course." Then, I told him what I had been doing for my clients over the last couple of years, step by step. I will still be transferring his assets in, but I felt like I sounded a bit too much like "my rate is better than his rate."
 
You just helped me how I can tie it all in...
 
But the guy probably bought it because you showed him how you would beat his current portfolio, AFTER THE FACT.

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BondGuy wrote:
The alternative is to be the alternative. To have an answer.
To have an answer we need to turn back the clock. For those of you who don't know it here's a news flash: I'm a dinosaur. I'm a dying breed. I come from an era of individualistic brokers who not only raised the money but managed it to. Day by day, we are being replaced by a kool aid army of raise the money fee it up advisors. Most of these advisors are clueless on the investment side. They've never bought a stock or a bond. They've never written an option ticket. Most can't read an options screen. And to most Bloomberg is a guy running a big city and nothing else. All this group knows is fee it up and you get to drive a BMW.
 
Ethically, we need to go back to raising the money and managing it. Or, we need to at least exercise the oversight we claim, to justify the fees we collect.
 
My personal answer is to have my own seminar.  It will be entitled:
 
The Bear Ate My Pie Chart
 
Content will be centered on ways to protect assets. From bonds with maturity dates, to annuities with living benefits to options/hedging strategies to momentum analysis of the major market sectors.
 
The messege: The process is broken. I am the alternative.

Can I buy your seminar content? 

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BG- What happens to me when you post your ideas is something i can't even post in THIS forum, let alone a forum for normal people. YOU ARE THE MAN
I have to admit that when i first came into the business 10 years ago, i drank the firm produced kool aid, asset allocation, buy and hold, blah blah blah, and i used SMA;s
 
We were doing exactly what we were telling clients and prospects we were doing - no lies - we were bringing institutional style money management to the retail investor. The problem is, that is not appropriate.
You have to know who your audience is. I dont know an individual investor who has a 35 year time horizon. Most of them understand a bad year or two. But what they dont understand, and shouldnt, is paying me a fee to tell them that the managers we have are great managers and it doesnt matter that they are standing in front of a freight train coming at them at 120 mph and refuse to move out of the way.
So in 2005 i started firing the managers and took discretion.
Thats why i rarely lose clients.
I am still searching for the "better way" to manage money. Not sure it exists.
But i dont believe its asset allocation buy and hold. I think thats fine for a portion of the portfolio, but you need to have a big piece that is tactical. And even in the strategic piece, you need to have flexibility.
Otherwise you will 1. not bring any value to the table, and 2. sound like every tom d*** and harry with an FA title.
Which leads me to think I'll start another thread to drill down on something i have been doing.

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Where's your God Damn new thread buddy???

Sportsfreakbob's picture
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Give me a few minutes will ya WetB? I just posted this.
Actually maybe i'll start it tomorrow.

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BioFreeze wrote:
You didn't ejaculate, did you?
 
Nah, that was just a test to see if you were still around. I guess you are, since you posted exactly the response i expected

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I know!

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I think BG's suggestion is that we need to look at other options than what we've been told by "the industry".For example, following the tenets of MPT and subsequently the guidance of your firms may not be the ONLY thing.  Maybe it's a beginning.  Maybe you start to think outside of the box.  Maybe the research you listen to is faulty for one reason or another.BG may be reluctant to reveal what he is doing for clients.  Some of us have methods that we choose to keep to ourselves.  The key is not to always listen to conventional wisdom.  What is interesting about both MPT and EMH is that they have been accepted pretty much without question by the broader economic community (yes there are those who question it, but they are in the minority), much like Climate Change.This is anathema to the scientific method.  You should constantly try to prove where those theories don't work.  In the case of EMH, it is something that is impossible to prove, because there are plenty of cases where it won't work.Be thoughtful is what BG is saying.  Evaluate what you are doing, even if you are getting good results.  Constantly look at your methods.  Things may change, and you may need to adjust.  Add some value for the fee you are collecting.  I think that's all he's trying to suggest.

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Ron 14 wrote:Piker34 wrote:
Thank you once again, BondGuy. Most will make this thread about the merits of MPT or asset allocation or investment strategy.
However, it's a classic BondGuy prospecting thread for me. You sir, with the definition of insanity just gave me my "opening line" to prospects on how I am different. I told a prospect that has his money at MSSB in an asset allocation fee based account that I didn't believe in the old-school method of asset allocation, and he looked at me like I was insane. His broker tells him to "stay the course." Then, I told him what I had been doing for my clients over the last couple of years, step by step. I will still be transferring his assets in, but I felt like I sounded a bit too much like "my rate is better than his rate."
 
You just helped me how I can tie it all in...
 
But the guy probably bought it because you showed him how you would beat his current portfolio, AFTER THE FACT.
 
Pretty naive and cynical comment... But to answer your question, I had no idea what his current portfolio was or what his rate of return was. I shared with him what I did for the majority of my clients last year, and how I manage and create portfolios. I figured he's smart enough to figure out what direction he wanted to go.

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Moraen wrote:I think BG's suggestion is that we need to look at other options than what we've been told by "the industry".For example, following the tenets of MPT and subsequently the guidance of your firms may not be the ONLY thing.  Maybe it's a beginning.  Maybe you start to think outside of the box.  Maybe the research you listen to is faulty for one reason or another.BG may be reluctant to reveal what he is doing for clients.  Some of us have methods that we choose to keep to ourselves.  The key is not to always listen to conventional wisdom.  What is interesting about both MPT and EMH is that they have been accepted pretty much without question by the broader economic community (yes there are those who question it, but they are in the minority), much like Climate Change.This is anathema to the scientific method.  You should constantly try to prove where those theories don't work.  In the case of EMH, it is something that is impossible to prove, because there are plenty of cases where it won't work.Be thoughtful is what BG is saying.  Evaluate what you are doing, even if you are getting good results.  Constantly look at your methods.  Things may change, and you may need to adjust.  Add some value for the fee you are collecting.  I think that's all he's trying to suggest.
 
agreed.

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iceco1d wrote:BG, et al - The problem is not with the concepts themselves (MPT, EMH, etc.), it is with the implementation and interpretation of them.
 
Problem #1 - Clients don't know their own risk tolerance, and neither do most advisors. 
 
Problem #2 - To achieve the expected long term returns that most advisors want to use in their assumptions, requires extra exposure to equities because of the excess costs in the portfolios.
 
Simple math:  1.25% wrap fee (this could be higher).  100 bps average fund expense ratios (again, could be much higher).  50 bps in "hidden" fund expenses due to turnover (not just brokerage costs, but bid/ask spreads, etc.).  Note:  Some studies have shown costs due to turnover can exceed 200 bps per year, depending on the level of turnover.
 
Now in this very fair example... 1.25 + 1.00 + .50 = 2.75%.
 
Stocks, over time, aren't going to average much more than 11 or 12%.  Lets say 12.  Lets pretend bonds average 6%. 
 
Lets not get into an active vs. passive debate here, but even if you are a bad ass active manager, you aren't going to deliver 18% returns on equity, or 12% in bonds, we are talking a few bps worth of difference, if any.  On to the example...
 
50/50 allocation, expected return = (.5 x 6%) + (.5 x 12%) = 9%.  Minus 2.75% in costs, and your expected return here is 6.25%.  Wow, that's exciting.  You're giving away over 30% of your gains in costs!  And remember, there are plenty of 1.5%+ wrap fees.  Plenty of funds with expenses over 1%.  And turnover costs could be much, much higher.
 
How about an 80/20 allocation?  (.8 x 12%) + (.2 x 6%) = 10.8% expected return.  Take away your 2.75%, and your expected return is now a shade over 8%.  Pretty reasonable rate of return, but you had to assume an 80/20 allocation to get it!
Give me a break.  Use ETFs and/or index funds, and your fund expenses ratio drops to 35 bps or less.  Your "turnover" costs get cut in half, if not more.  Charge 1% instead of 1.25%.  Now what type of allocation do you need to achieve a 6, 7, or 8% return?
 
Less costs = take on less risks.
 
MPT didn't fail.  People need to take on more risk to overcome the ridiculous costs.  All because "that's why we select these managers Mr. Client," when the truth is "these managers give kickbacks to the b/d, which is why we select these manager," or "this wholesaler pays for my seminars, which is why we selected those managers."
 
MPT didn't fail.  I run almost all of my qualified money in index funds.  I started in the business at the peak of the market.  The clients that started with me at the peak, are currently even or up slightly (at least, the ones with serious money, and older, so in a 60/40 or 50/50 or less allocation).
 
I wasn't in the business during the tech bubble, but I'm guessing my portfolios would have faired OK during that fiasco too.  People suffered then, because you HAD to have the latest and greatest tech fund or stock.  And "the rules have changed!" 
 
No they didn't.  And the people that thought they did, got burned. 
 
In addition to this stuff...I don't see doing things like put options, or covered calls, as "fancy" or not "buy and hold."  Covered calls, to me, are basically buy & hold. 
 
I'm just starting to cross into the darkside, and exploring running index subaccounts in a VA with a GMAB rider - ONLY for the equity piece of the portfolio.  Pretty vanilla.
 
As for Fannie & Freddie, and buyers of bad mortgage debt?  It's MPTs fault that you ASSUMED that Fannie and Freddie were true government agencies, when they clearly were not?
 
It's MPTs fault that credit default swaps were unregulated?  It's MPTs fault that people were overconcentrated in real estate?  Financials?  30 year bonds?  CDOs? 
 
I think you'd find that a SOUND follower of MPT, wouldn't be overconcentrated in those areas, just like they wouldn't be overconcentrated in tech. 
 
BG - you frequently rail against bond funds for doing things to fit into an asset allocation fund, vs. being for income.  So in asset allocation, you are going to view fixed income as a "necessary evil" to stabilize the portfolio?  WTF are these people doing buying bond funds with average durations in the teens?  Or significant pieces in high yield? 
 
Same concept with insurance...VULs, in addition to being pricey, but you buy insurance to reduce risk...why add risk into the mix with a VUL?  Same concept with bonds.  You are 60/40 to reduce the risk vs 80/20 or 100% equity.  So why are you buying 30 year bonds to reduce risk?  Why buying junk bonds to reduce risk?  Should be more fixed annuities, CDs, MMKT, short duration, high grade corps, govies, GNMA, etc., with maybe a "sprinkling" of high  yield and international.
 
Anyway, sorry for the rant...but I don't view last year as MPT failing, I view it as most advisors failing to implement it properly.
 
Ice, you make many very good points with this post. I agree with parts of what you are saying. Still, I say MPT has failed. So, has buy and hold. Of course now the joke is buy and hope.
 
Regarding MPT, it holds that risk can be controlled. That for every return there is a correlating risk that can be largely or completely offset. As well, MPT assumes efficient markets. Possibly its greatest failing.
 
Accounts utilizing MPT got the full ride down.  It's that simple.
 
Everyone thought Captain Smith was a good Captain until his ship hit the iceberg. He went down with the ship and didn't get a second chance to endanger innocent people. MPT has failed twice in a decade to proctect investors. How many more investors have to have their life savings sunk before we write this turkey off?
 
 
 
 
 
 

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Someone asked if my clients lost money in 2008? Not to be evasive, but define loss?
 
Yes, my clients were down. However, the bulk of my AUM are securities with a maturity date. Those who sold, lost. Those who didn't will get 100% of their investment back at maturity. Until then their investments are giving them exactly what they signed up for.
 
For the clients in equities, not as good an outcome. Some were hedged and some were in annuitys with living benefits. And the market over the past 10 or 11 months has largely bailed us out. But that's not good enough. Not by a long shot! It is my search for answers after buying the bill of goods that leads me to my conclusion that our system is broken.

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MPT makes too many assumptions that don't work in the real world.  Like I said, as a theory, it is a good starting point.But as a financial model it is wholly inadequate. Correlations aren't fixed and are affected by external forces.Also, observed returns do not follow the normal distribution.  MPT at it's core uses the Gaussian function.Actually, there are any number of things wrong MPT as a theory.  The problems ice illustrated will not go away, and thus are another hole in EMH and MPT.  Gamblers take on a ton of risk.  What is interesting, is that we assume that investors are risk-averse.  That makes little sense.The one I think takes the cake is that all investors are looking to maximize profit.  Which, is pretty funny, because if everybody follows MPT, they are not trying to maximize profit, just attain the best return for their given risk.  Like I said, good concept, but flawed.  Needs to be questioned, and has.  Hopefully we can build upon MPT and EMH and create models that will allow us to add more value.

Ron 14's picture
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BondGuy wrote:Someone asked if my clients lost money in 2008? Not to be evasive, but define loss?
 
Yes, my clients were down. However, the bulk of my AUM are securities with a maturity date. Those who sold, lost. Those who didn't will get 100% of their investment back at maturity. Until then their investments are giving them exactly what they signed up for.
 
For the clients in equities, not as good an outcome. Some were hedged and some were in annuitys with living benefits. And the market over the past 10 or 11 months has largely bailed us out. But that's not good enough. Not by a long shot! It is my search for answers after buying the bill of goods that leads me to my conclusion that our system is broken.
 
So let me get this straight.......
 
 
You have been in the business over 10 years.
When you started you bought the bill of goods the industry promoted.
Your ideas and opinions have evolved over time.
You are still searching for answers.
Your wife manages retirement plans that I assume are not actively traded.
Throughout this period of professional doubt you and your wife have continued to pay yourselves handsomely for these services.
 
Are these statements accurate ?

patience's picture
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Hi,Mentally deranged was the term used for many years, as well lunatic.
Insanity today implies the behaviour, not the person and it is used
very wisely in any court of law. It is very, very difficult to prove
anyone insane or mentally incompetent today as one must go before an
entire board, which all must agree upon.

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B24
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Here's part of the problem with MPT/Monte Carlo, etc.  It assumes that being "close" is OK.  So maybe you have a 92% chance of meeting your financial goals in retirement.  What does that mean?  Does that mean you will have 92% of the income you thought?  No.  It means that if you experience the 8%, you could run out of money well-short of "death" and be compeltely broke.  It's like going to the casino.  You could go with $1000 bucks and walk away with $1000 bucks, $500,000 bucks or zero (OR, you could end up going back to the ATM machine for more).  But you don't walk away with a littel more or less than $1000 bucks every time.
This false sense of security tricks people into thinking soemthing like this..."well, maybe if I only get 6% instead of 8% over the next 30 years, I might be OK.  I'll just spend a little less."
No, what happens in REALITY is that you are doing great and then WHAP! you lose 40% in one year and the entire plan gets completely destroyed.  And that same year you have a major medical issue, right after you got back from that 6 week trip to Tahiti that cost you $22,000.
So instead of waking up tomorrow with your $500K nest egg, you wake up and have $265K and don't WTF to do now.  And since it is a no-win situation, your FA doesn't know WTF to do now, either ("uh, spend less, go back to work, sell your house, etc.").
 
Point is, all of the "models" that we use don't account for the "Black Swan" effect.  And in reality, they happen more often than you think.  That's why I am so conservative with my clients.  Very few of my clients have more than 50% in equities.  Yes, I will be unpopular if we go on a 10 year win-streak.  But I would rather be unpopular for getting "modest" returns than losing 30-50% of someone's money.
Unfortunately, most firms don't do this.  For some reason there is such a biased towards equities.  They are SO focused on outpacing inflation that they INSIST that you need large allocations of equities.
 
IMHO, risk management is not a major focus at msot firms.  And ironically, I only hear it talked about with the ultra wealthy.  For some reason, firms find it OK to exploit high-risk portfolios with the very population that can't afford to lose it (HNW folks and below), but focus on principle preservation with folks that CAN afford to lose it.  Persoanlly, I think it is all just scale.  We should treat our clients the same way as someone with $50mm.  DON'T LOSE THEIR MONEY.

BondGuy's picture
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Ron 14 wrote:BondGuy wrote:Someone asked if my clients lost money in 2008? Not to be evasive, but define loss?
 
Yes, my clients were down. However, the bulk of my AUM are securities with a maturity date. Those who sold, lost. Those who didn't will get 100% of their investment back at maturity. Until then their investments are giving them exactly what they signed up for.
 
For the clients in equities, not as good an outcome. Some were hedged and some were in annuitys with living benefits. And the market over the past 10 or 11 months has largely bailed us out. But that's not good enough. Not by a long shot! It is my search for answers after buying the bill of goods that leads me to my conclusion that our system is broken.
 
So let me get this straight.......
 
 
You have been in the business over 10 years.
When you started you bought the bill of goods the industry promoted.
Your ideas and opinions have evolved over time.
You are still searching for answers.
Your wife manages retirement plans that I assume are not actively traded.
Throughout this period of professional doubt you and your wife have continued to pay yourselves handsomely for these services.
 
Are these statements accurate ?
 
Ron, that sounds awfully close to criticism.
 
I started in 1983, well before MPT came on the scene.
 
I tried a lot of different things. Some worked, some didn't.
 
My ideas and opinions have evolved over time. Haven't yours?
 
I'm constantly seaching for answers.
 
I doubt nothing.
 
If something doesn't work, we change it and move on. We stopped using MPT in 2001.
 
That the process is flawed is a long held belief within our practice.
 
Our business experience resulting from the great crash of 2008 is , zero acats, production up 30%.
 
Success speaks for itself.
 
We are paid handsomely!

Ron 14's picture
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Modern Portfolio Theory - A theory on how risk-averse investors can construct portfolios to optimize or maximize expected return based on a given level of market risk, emphasizing that risk is an inherent part of higher reward.
 
Markowitz wrote his book in 1959 so I don't see how you started before MPT came on the scene. Maybe it wasn't as popular or an industry wide philosophy, but it was around.
 
The theory is based on risk. It doesn't say an investor will not see their investments decline in value over a period of time. If an investor is completely risk averse that investor still needs to spread their assets among different classes because, as we all know, long term funds in cash are at risk. A balanced strategy, invested using index funds and/or ETF's, rebalanced annually did 5.9%/yr. What is wrong with that ? With a 1 year low of -21.6%. If people can't handle a bad stretch then they just don't understand investments. Those same people saw their home value go down more in that same year, are they selling it out to the first buyer ?
 
It is about constructing portfolios that will get them to their financial goals and coaching them along the way to stick with the plan. Jumping in and out, changing philosophies, not trusting what has worked for decades, getting spooked every so often because the herd drives the market well below its value ? These practices define insanity.
 
 
I am not trying to be critical. We all develop different thoughts and ideas over time. I do think that changing core beliefs on the run can have negative consequences.

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This is one of the best threads I have read in a long time.  And although I may not have as much experience or training as some on this board regarding investement theory, my belief is that no matter what theory you follow the industry is always going to be biased to the buy side. Which in turn makes reducing risk and protecting our clients from loss a difficult thing to do. And I know A LOT of retail advisors that are converted car salesmen, or appliance salesmen, or pharma salesman, and the one thing they know is "if i sell I get paid".  And their logic is I hire money managers to make sure my clients are taken care of, all the time not really knowing what that manager is doing, or how it really effects the client. And my personal favorite is the advisor that uses the fact that the mutual funds he sold to you (A shares probably) are now down 45% to SELL you a fixed annuity and at the bottom of the interest rate cycle and collecting another 6% commission becuase you told him you were tired of losing money. Oh wow thanks for helping reduce my risk. So in my eyes the sell side bias has more to do with what is wrong than any investment theory. 
 

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MPT has been around for a while, but it wasn't widely used as the basis for financial recommendations  until much, much later.  Also, people are selling out of their homes, or not paying the mortgages.  They are starting to realize that homes are really not investments.  I agree that jumping in and out is bad, but a lot of firms have been using MPT as if it were gospel, when in fact, it is far from it.  Also, in your first sentence you state that MPT is a theory on how risk-averse investors can maximize expected return based on a given level of risk.  In fact, one of the key assumptions of MPT is that investors want to maximize profit regardless of any other considerations.  But if everybody is following MPT, that tenet is untrue.

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Ron 14 wrote:Modern Portfolio Theory - A theory on how risk-averse investors can construct portfolios to optimize or maximize expected return based on a given level of market risk, emphasizing that risk is an inherent part of higher reward.
 
Markowitz wrote his book in 1959 so I don't see how you started before MPT came on the scene. Maybe it wasn't as popular or an industry wide philosophy, but it was around.
 
The theory is based on risk. It doesn't say an investor will not see their investments decline in value over a period of time. If an investor is completely risk averse that investor still needs to spread their assets among different classes because, as we all know, long term funds in cash are at risk. A balanced strategy, invested using index funds and/or ETF's, rebalanced annually did 5.9%/yr. What is wrong with that ? With a 1 year low of -21.6%. If people can't handle a bad stretch then they just don't understand investments. Those same people saw their home value go down more in that same year, are they selling it out to the first buyer ?
 
It is about constructing portfolios that will get them to their financial goals and coaching them along the way to stick with the plan. Jumping in and out, changing philosophies, not trusting what has worked for decades, getting spooked every so often because the herd drives the market well below its value ? These practices define insanity.
 
 
I am not trying to be critical. We all develop different thoughts and ideas over time. I do think that changing core beliefs on the run can have negative consequences.
 
Ron this sounds like what i'd expect to hear at the fee based seminar.
 
Markowitz won the Noble in 1990. So, while it may have been bouncing around out there it didn't gain acceptance until after that point. Wall Street embraced it as justification to fee up clients begining around 1992. Full steam ahead by 1995.
 
5.9%? Really? How about the investors who bought in Oct 2007? Did they get 5.9%? How about those who bought in aug 2008? How did they do? Did they get 5.9%? How many years of chugging along at 5.9% do you need to get back a 25% loss? How about a 40% loss?
 
 
 
 
 
 

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Moraen wrote:MPT has been around for a while, but it wasn't widely used as the basis for financial recommendations  until much, much later.  Also, people are selling out of their homes, or not paying the mortgages.  They are starting to realize that homes are really not investments.  I agree that jumping in and out is bad, but a lot of firms have been using MPT as if it were gospel, when in fact, it is far from it.  Also, in your first sentence you state that MPT is a theory on how risk-averse investors can maximize expected return based on a given level of risk.  In fact, one of the key assumptions of MPT is that investors want to maximize profit regardless of any other considerations.  But if everybody is following MPT, that tenet is untrue.
 
Not from me. A definition search online. Either way I understand what you are saying.

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Ron this sounds like what i'd expect to hear at the fee based seminar.
 
Markowitz won the Noble in 1990. So, while it may have been bouncing around out there it didn't gain acceptance until after that point. Wall Street embraced it as justification to fee up clients begining around 1992. Full steam ahead by 1995.
 
5.9%? Really? How about the investors who bought in Oct 2007? Did they get 5.9%? How about those who bought in aug 2008? How did they do? Did they get 5.9%? How many years of chugging along at 5.9% do you need to get back a 25% loss? How about a 40% loss?
 
 
 
 
 
Well what if you bought in Mar of 09 or Nov 08 ?
 
You can cherry pick time frames all day long. People are saying this was "the lost decade." Yeah, the decade sucked, two big crashes. That doesn't mean the global equity market will cease to produce returns that will get clients to their financial goals moving forward. And even though the decade was a bad one it wasn't a world ender. Investments contain risk. Home ownership contains risk. Bank Cd's contain risk. It all contains risk. Having a systematic plan to manage that risk and to prevent panic and euphoria is our value.

SometimesNowhere's picture
Joined: 2008-12-22

I'm with BG, not just because I honestly believes that he has to get his pants tailored to hold the basketball sized gourds he walks around with, but also because I think that the "asset allocation model" that firms have been pimping for years is overrated, and certainly is not for every investor.
 
The theory has a much more plausible application if you are running a pension or endowment, who have no defined target date for use of funds (or a perpetual one, however you want to look at it). If you are a person who plans on creating a net change to the flows of a portfolio (i.e. go from contributing to withdrawing at some point), owning the amount of risk assets that most firms recommend is dangerous. 2008 should be the lesson for that. The deviation from the mean swings far too wildly in many "allocated" portfolios (at least the ones your typical advisor would use) for it to be a practical fit for someone with such a target date, especially when you consider the return is only marginally better than a well diversified bond portfolio.
 
I know, I know..."but SN, the xyz index has gone up an average of 12% a year for the last 100 years". Right. That's awesome if you are Yoda the Jedi Master or Methuselah, but for most investors who actually have a relatively short horizon when you compare it to a secular market cycle that can be too much to bear. And if you believe that the volatility that was experienced in this decade will be more of the norm, you have to take a long look at more stable returns...
 
...or go buy an EIA from Biofreeze (just kidding )
 
Just .02 from the new guy.

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Ron 14 wrote:Modern Portfolio Theory - A theory on how risk-averse investors can construct portfolios to optimize or maximize expected return based on a given level of market risk, emphasizing that risk is an inherent part of higher reward.
 
Markowitz wrote his book in 1959 so I don't see how you started before MPT came on the scene. Maybe it wasn't as popular or an industry wide philosophy, but it was around.
 
The theory is based on risk. It doesn't say an investor will not see their investments decline in value over a period of time. If an investor is completely risk averse that investor still needs to spread their assets among different classes because, as we all know, long term funds in cash are at risk. A balanced strategy, invested using index funds and/or ETF's, rebalanced annually did 5.9%/yr. What is wrong with that ? With a 1 year low of -21.6%. If people can't handle a bad stretch then they just don't understand investments. Those same people saw their home value go down more in that same year, are they selling it out to the first buyer ?
 
It is about constructing portfolios that will get them to their financial goals and coaching them along the way to stick with the plan. Jumping in and out, changing philosophies, not trusting what has worked for decades, getting spooked every so often because the herd drives the market well below its value ? These practices define insanity.
 
 
I am not trying to be critical. We all develop different thoughts and ideas over time. I do think that changing core beliefs on the run can have negative consequences.
 
You're right Ron.  It worked for decades.  Some decades.  If you were the unlucky sap that retired in 1900-1915ish, 1927-1940's, 1968-1975ish, 1998-2008, then it didn't work so well.
You were real lucky if you retired in the 50's, or 80's or early 90's.
 
Go back and look at the charts.  No, not the deceiving mountain charts put out by the fund companies that show the S&P if you invested $10,000 100 years ago.  The one that shows the level of the S&P for the past 100 years.  And then look at one adjusted for inflation.  Shocking to say the least.  It might changed your mind on "buy and hold and wait it out.
 
Why the huge variability in returns?  It's not earnings and GDP growth.  That has been pretty consistent over the years.  Inflation?  Nope.  Interest rates? Nope.  Black Swans.  Big events that upset the entire apple cart and changed the P/E ratio in the market.  We went from a 44 P/E on the S&P in 2000 to a 13 in 2008.  Did people stop spending?  Did people stop working?  Did companies shut down?  Did people stop brushing their teeth? (an American Funds favorite).  No.  Something disrupted the economic universe.  And your stock that was worth $50 was now worth $25.  Nothing any buy-and-hold strategy could defeat.  Thank goodness the market has come back.  We are only short about 35% from the peak.  If the market had dipped to a P/E that was reflective of prior bear markets  (mid to upper single-digits), we would have been at Dow 4500 or so.  I would much rather have gotton out at Dow 12,000 (from 14,000) than ridden it all the way down.  And so would your clients.  Better yet, out at Dow 12,000 and over half your money protected from the stock market to begin with, and actually MAKING money in 2008.
 
Not saying it's easy.  But there are other ways.

Ron 14's picture
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This always comes back around to the same thing. Ok. Asset Allocation is crap, its just a model to help firms keep people in the market, pile up fees, blah blah blah. Then what is the answer ? What do you do for your clients ? What are the core principles you are building your practice on ?
 
I am not trying to piss anyone off I just want a healthy debate.
 
Give me a break !I am not referring to 100 year mountain charts from American Funds. I am talking specifically about the last 10 years of garbage.

BondGuy's picture
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Ron 14 wrote:
 
 
 
 
 
Well what if you bought in Mar of 09 or Nov 08 ?
 
You can cherry pick time frames all day long. People are saying this was "the lost decade." Yeah, the decade sucked, two big crashes. That doesn't mean the global equity market will cease to produce returns that will get clients to their financial goals moving forward. And even though the decade was a bad one it wasn't a world ender. Investments contain risk. Home ownership contains risk. Bank Cd's contain risk. It all contains risk. Having a systematic plan to manage that risk and to prevent panic and euphoria is our value.
 
Cherry picking? What would you call 5.9%? It's all cherry picking. And much of it is lying with statistics.
 
Of course the global economy will perk along and equities belong in all long term investor accts. That's not in question. The problem is we, as in the street in general not you personally, doesn't have a systematic plan to manage risk. MPT is sold as that plan but clearly, it hasn't protected investors.
 
Another word on cherry picking. Ok, fair enough, i can pick periods that show poor performance and the counter arguement can hand pick good periods. Neither is the point. The point is the 50 something pre-retiree who doesn't have time to rebuild if we fall off the tracks. That person doesn't get to cherry pick. They are operating in real time. They need the growth equities can provide, but can't stand a catastrophic wipeout. How do we protect that investor?
 
It's time for the street to go back to telling investors not only what to buy, but when to buy.
 
Tech analysis anyone? 

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BG - there isn't going to be a systematic plan, because the economy is too dynamic.  The biggest issue is that most advisors are salespeople and are very good at selling.  Financial management is a different craft and one that most of us aren't experts in.  Oh, there is bluster on the boards about such things, but in reality MPT has been a godsend for financial companies, because it allows advisors to work within a certain framework.  How many people will take the time to actually become experts in finance?  Maybe people who have been doing it for so long you naturally learn things.  But advisors are going to become pretty scare if there isn't a framework to follow.  And then you won't have enough advisors for everybody.We apply much of financial and economic theory using social science statistical models, when we should more likely use chaos models (non-linear, asymmetric).  Our business is incredibly complex and further complicated because of human nature.I'm not sure we should be tech analysts, but it is an option, and one that can be explored.  But like anything else, it would need to be tested on a relatively consistent basis to insure that it is working.All strategies need to be tested on a consistent basis.

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It is prospecting.  Toss out the line, see what "develope"s.  They might do better if they learned how to spell develop!  Hahahaha!

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Much of it comes back to timing.  There are times that are just not real good to be invested in equities.
 
Ron, do yourself a favor (I don't mean to sound condescending), read Unexpected Returns by Ed Easterling (Crestmont Research).  It will open your eyes.  I read the first version a few years back.  They have an updated version out.  Basically, it talks about the fact that there are times when you can look at the value of a market and know, with almost certainty, that your future potential returns are doomed.  There is simply no way to make money.  1998-2000 was a perfect example.  It was clear beyond clear (unless you prescribed to the "New Paradgim") that there was simply no way you could make money going forward putting money into a 40+ P/E market.  Conversely, investing heavily in equities when the market P/E was 8 or 9 made sense.  You ALWAYS made money.  The long cycles (secular cycles) ebb and flow.  You need to know where you are in the cycle.  When you DON'T know (like now - are we at the beginning, middle or end??), you need to be in "protection" mode, and seek the least risky assets (which is not always what we consider the "least risky " assets like cash or Treasuries - right now, both of those would be poor choices).  But simply dumping 60% into equities and 30% into bonds, and 10% into cash is making an assumption that a market P/E of 44 is the same as a market P/E of 7.
I think MPT is a perfect starting point, or reference point.  A well-balanced portfolio of stocks, bonds, alternatives, and cash.  But you need to look at the balance among them during given market cycles.  Portfolios cannot just be static representations of a market that is anything BUT static.

Ron 14's picture
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BondGuy wrote:Ron 14 wrote:
 
 
 
 
 
Well what if you bought in Mar of 09 or Nov 08 ?
 
You can cherry pick time frames all day long. People are saying this was "the lost decade." Yeah, the decade sucked, two big crashes. That doesn't mean the global equity market will cease to produce returns that will get clients to their financial goals moving forward. And even though the decade was a bad one it wasn't a world ender. Investments contain risk. Home ownership contains risk. Bank Cd's contain risk. It all contains risk. Having a systematic plan to manage that risk and to prevent panic and euphoria is our value.
 
Cherry picking? What would you call 5.9%? It's all cherry picking. And much of it is lying with statistics.
 
Of course the global economy will perk along and equities belong in all long term investor accts. That's not in question. The problem is we, as in the street in general not you personally, doesn't have a systematic plan to manage risk. MPT is sold as that plan but clearly, it hasn't protected investors.
 
Another word on cherry picking. Ok, fair enough, i can pick periods that show poor performance and the counter arguement can hand pick good periods. Neither is the point. The point is the 50 something pre-retiree who doesn't have time to rebuild if we fall off the tracks. That person doesn't get to cherry pick. They are operating in real time. They need the growth equities can provide, but can't stand a catastrophic wipeout. How do we protect that investor?
 
It's time for the street to go back to telling investors not only what to buy, but when to buy.
 
Tech analysis anyone? 
 
Maybe I missed something, but I thought we were talking about recent history and how you believe MPT failed investors. I chose the last 10 years because it was terrible period in the equity markets to show a balanced portfolio didn't kill anyone. My parents are 55. They have what many would call a balanced portfolio. They lost 23% in 2008. They have more money to invest now than at any period because home is nearly paid off and kids are gone. One of them is likely to live beyond 85. That is a 30 year time frame and they will need 4% withdrawals. Why is a bland, low expense, diversified portfolio, rebalanced annually, with 12 months living expenses in cash a bad thing ?
 
If you can systematically buy and sell stocks for profit by using analysis you should not have any clients. You should trade your own account and keep all the profits.

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