Investors Choose a Perilous Route.

August 14, 2014

Colorado epitomizes the rugged independence that once defined this nation.
Soaring 14-thousand foot mountain peaks. Raging rivers flow through valleys covered in wild flowers. Socially liberal. Fiscally conservative. Colorado offers something for everyone. It is the geographic equivalent of a brilliant, easy going friend. Fun to be around. Engaging. Interesting. Athletic. Yet, willing to drop everything to help a friend.

As meritocratic as any region in the country, Colorado rewards those who are proactive, durable, competent and tough. Accordingly, the state features a potpourri of personalities. Ranchers. Students. Spiritualists. Cowboys. Hippies. Entrepreneurs. Environmentalists. Scientists. And industrialists. A warm brew of confident competence, if ever there was.
Recently, my family returned to Telluride, Colorado, where we took it all in. Both vacation and vocation. Truly inspiring, passing time in an area where some homes lack televisions. Where teenage boys fly fish after dinner. Where young girls on mountain bikes hit speeds of 20 miles an hour descending switchback riddled trails. And most of your neighbors are craftsmen.
Understand that Colorado, and areas like Telluride in particular, are distinct. Presenting a unique blend of the rugged western identity alongside a sophisticated arts, business and recreational sporting portfolio.
On any given day, one may ascend the mountain in a gondola packed with attorneys on their way to a presentation by Supreme Court Justice Antonin Scalia. And later descend beside a boy and his grandfather, preparing to jointly conquer some of the nation's foremost mountain biking trails.
Replete with breathtaking mountain backdrops, rivers, waterfalls and an abundance of physical and intellectual activities, boredom finds no vacancy.
The locals know the region as a Midwesterner might his backyard. Moreover, they are warm and engaging. As enthusiastic about your experiencing their little secret as you are.
Equally engaging is the combination of business, environmental and mechanical competence embodied by so many residents. You will never lack assistance in the repair of gear, domicile or vehicle. As seemingly everyone in the area has achieved a level of technical proficiency that would bring MacGyver to blush.
When I snapped a mountain bike break cable, Brenda -- a 22-year old mechanical wunderkind -- was there to help. No sooner was my bike inverted on a repair rack than I felt the need to ensure that my wife did not wonder in. Not for reasons unseemly. But for the fact that Brenda's mechanical inclination only highlighted my own incompetence.
I marveled at the attention to detail. The appreciation for process. That blend of technical acuity and competence that seems missing throughout much of the country. Especially in my line of work.
When we travel, people ask my profession. Then, they often regale me with their investment experiences. In Colorado, I was struck by how many of those with whom I spoke utilized independent wealth management shops as opposed to Wall Street's mega brokerages. Upon closer scrutiny, however, it made sense.
Most of those with whom we spent time were from two states: Colorado and Texas. Residents of both states tend to be proactive. Entrepreneurial. Forward thinking.
Texans, like Coloradans, take a proactive approach to life and business. They do not suffer fools. Or excuses. Twice, someone explained how this had catalyzed their decisions to sever relationships with the traditional Wall Street firms to whom they'd once entrusted investment capital.
The reason? Lack of technical competence. More succinctly, no real process or methodology.
That, it seems, represents the core deficiency bringing so many to flee the brokerage firms with whom they've long worked. The idea that Wall Street, in its quest to maximize quarterly profits at the expense of Main Street's nest eggs, has completely forgone any technical expertise that does not benefit Wall Street, quarterly earnings and annual bonuses.
Self-sufficient investors have noticed. Those having amassed wealth by their own sweat, labor and toil have shunned the inactive, inefficient buy-and-hold approach utilized by Wall Street's self-serving brokerage firms.
Readers know that we have long highlighted the ineffective practices of most of the salesmen posing as advisors at Merrill Lynch, UBS, Morgan Stanley and Wells Fargo. These individuals, many of whom we consider friends, are not deficient in and of themselves. Most harbor the best of intentions. Wear tony suits. Carry leather Italian bags. Can recite the front page of The Wall Street Journal verbatim.
Ney, the issue lay with their employers. The firms for whom they work, which train these salesman-cum-advisors to gather assets, outsource the actual management to third-party fund and money managers, and then develop relationships through steak dinner seminars, rounds of golf and client-appreciation events. None of which help when the market corrects by 38 percent, and advisors -- lacking any downside protection parameters -- watch as client capital plunges dollar for dollar with the indexes.
In fact, one of the most highly esteemed advisors in our region perfectly captures this idea. Three decades ago, he was in the right place at the right time. Due to the branch's proximity and his position as a manager, hundreds employed by a Fortune 100 company lined up at this door. Today, these clients continue sending friends and colleagues his way. Largely because of confirmation biase. This individual is regularly listed as one of the nation's top advisors. Not because of his process or methodology, but because of the assets he has under management.
In fact, this individual outsources nearly all of his investing to third-party managers and mutual funds. Does very little investing on his own. Talks a mean game, but he's actually doing little beyond choosing the money managers to which he'll allocate capital. And in a decent market, he looks fine. But when then market turns, his clients scratch their heads as he charges the same fees while they hemorrhage capital.
But, that's how Wall Street plays with Main Street. Considering how richly Wall Street has been rewarded, it's little wonder the game never seems to change.
The average brokerage is not trained to "think in essentials." Never realizes that good investing is not about how much you know. But, according to trader Victor Sperandeo, the truth and quality of what you know.
Consider the fact that, week in and week out, the industry disseminates vast quantities of data. Sell-side research reports. Analyst white papers. The Wall Street Journal. Barron's. A myriad of financial and trade periodicals. None of which provide real investors with any real value. As it is more than even Warren Buffett could possibly make sense of.
Long ago, Wall Street forgot that the marginal utility of data has nothing to do with the quantity of information, but the means by which it is utilized.
In every human endeavor, methodology trumps quantity. Information overloads you. Process sets you free.
On order to succeed on the behalf of clients -- those who have entrusted us with their life savings -- all that information must be reduced and related to specific driving principles. Essential, fundamental concepts that define the nature of markets. Allowing professionals to effectively operate within these labyrinthine mazes.
As such, investment professionals must develop a process for relating concrete events to abstract concepts. To be able to execute short-term tactics based upon long-term projections. To understand today's events based upon a thorough analysis of past history. Against a backdrop of human psychology.
But, that is not all. A lack of process can be deadly. But, Wall Street's minions suffer from another training deficiency. One that lay hidden from Main Street's nest eggs like an unsprung trap.
Military historians explain that the most accomplished tacticians were those capable of employing offensive and defensive strategies, depending on the circumstances.
Today, Wall Street's brokerage firms teach only offense. Every day represents another rendition of Charge of the Light Brigade. Only, as opposed to the doomed soldiers in Tennyson's poem, it is Main Street's nest eggs that are led to slaughter.
Wall Street's buy-and-hold obsession provides no room for retreat. Little attempt at capital preservation. Even as the battle reveals one to be outmanned, outgunned and outfoxed. The charge is always forward. Endlessly chanting to clients, "We'll be fine in the long run!"
Even as markets may determine otherwise.
Since the early eighties, information dissemination and program trading have increased the volatility of daily and intermediate market movements. Accordingly, daily, weekly and monthly fluctuations have become more pronounced. Calling into question the viability of the buy-and-hold approach, if not condemning it outright.
In his book, Lessons of a Wall Street Master, Victor Sperandeo explains that it seems foolish to hold long positions through market corrections. Watching as years of gains are whittled down to almost nothing. Many of these gains may come back over a period of months to years. But, if you focus on the intermediate-term trend, the bulk of these losses are avoidable.
Wall Street legend Jesse Livermore, made famous in Edwin Lefevre's book, Reminiscences of a Stock Operator, commented on the folly of buy-and-hold tactics over one-hundred years ago. Livermore, still a legend today, began trading as a teenager in Wall Street's "bucket shops" in the late 1800s. He began with less than twenty dollars and went on to amass a $100 million dollar fortune by the turn of the 20th century.
Livermore's seminal book, How to Trade in Stocks, said the following about buying and forgetting positions:
"How often have you heard an investor say: 'I don't have to worry about fluctuations... I never speculate. When I buy stocks, I buy them for an investment, and if they go down, eventually they will come back... But, unhappily for such investors, many stocks bought at a time when they were deemed good investments have later met with drastically changed conditions. Hence, so-called "investment stocks" frequently become purely speculative. Some go out of existence altogether. The original "investment" evaporates into thin air along with the capital of the investor. This occurrence is due to the failure to realize that so-called "investments" may be called upon in the future to face a new set of conditions that would jeopardize the earning capacity of the stock, originally bought for a permanent investment.
"Before the investor learns of this changed situation, the value of his investment is already greatly depreciated.
"It would be simple to run down the list of hundreds of stocks which... have been considered gilt-edged investments, and which today are worth little or nothing. Thus, great investments tumble, and with them the fortunes of so-called conservative investors... I believe it is a safe statement that the money lost by speculation alone is small compared with the gigantic sums lost by so-called investors who have let their investments ride."
Livermore explains that the intelligent speculator realizes that the fortunes of investments can turn on a dime. Accordingly, investors must utilize methodologies involving exit strategies. Strategies involving clear entry and exit points for every position. The intelligent investor prepares to enter and exit an investment. Knowing that, while the market may rise more than fall, it can drop precipitously. Damaging the unprepared portfolio.
The minions of Wall Street, however, are trained to point to the long-term horizon. Yes, there may storm clouds, dark ravines and difficult landscape along the way. But, they preach, if you stay the course, the horizon always leads to sunnier days.
So, perhaps, has that line of reasoning -- more than any other -- needlessly extended the careers of countless would-be retirees. Investors who bought into a faux methodology. One offering an entry without an exit. One that vehemently derides market timing, yet relies on the timing of purchases by its very nature. Because investments purchased at the top of the market -- regardless of how sound -- can remain underwater for years at a time.
Buy and hold benefits the brokerage firms. As well as the salesmen employed to pitch mutual funds, money managers and countless other products. It is not, however, an investment methodology. Nor does it provide a real chance to outperform the blended benchmarks over time.
Last year, my ten-year old son and I went rock climbing. Our guide, Rob, was one of the more competent men I'd ever met. Bright, personable, and concerned that we had a good time. Most importantly, he was obsessed with our safety.
Rob had completed Wilderness Emergency Medical Specialists training. Could tie 38 types of knots. Dig us out from an avalanche. Pitch a bivouac at high altitude.
I would never have entrusted the safety of my son to anyone claiming that, regardless of how dire things became, we'd be fine if we stayed the course. In fact, Rob's technical competence, concern for our safety and proven methodology for getting us up and down safely were the reasons we chose him. He had a plan that prioritized our best interests in every circumstance.
Likewise, a financial advisor must endeavor to safely deliver clients to that distant summit representing financial independence. Like Rob, the advisor must have completed emergency training. Must be prepared to improvise, depending on the conditions. Most importantly, the advisor's plan should always place first the best interests of the client.
Unfortunately, most investors settle for less. Entrusting their nest eggs to decent individuals employed by the wrong outfitter. Individuals lacking emergency medical training. Lacking technical competence. Trained to do little but search for new clients and climb higher, regardless of conditions.
Accordingly, too many investors overpay for a financial expedition with little chance of success. One that never veers more than a few degrees from peril. Never realizing as much until the storm begins.

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