What's Your Advisor's Investment Quotient? by E D Phillips
Rated "G" by the Author.
Last
edited: Wednesday, June 29, 2016
Posted: Wednesday, June 29, 2016
I have had a lifelong interest in the investment markets: I worked as a writer in the business, as a research consultant to a $25 billion dollar investment portfolio; as the “hands on” portfolio manager of $500 million in private investment accounts; and I was the owner of an investment advisory company. After listening to a lot of irrelevant talk on TV during the past few days, it is clear the participants like to engage only in idle chatter about trading. And that is virtually worthless information to anyone who has money at risk in the markets. I therefore feel compelled to offer my free advice about what I believe is the wisest course of action to follow by all those who are interested enough to read and digest information about what is likely to happen in the future where the success or failure of your investment planning will take place.
The current markets are in a state of turmoil, but they are still falling. If you did not anticipate that this would happen following a Brexit “leave” vote (duh!), it is too late for you to take advantage of any quick profit opportunities that others may tell you about. Don’t even think about trying. Your objective should be in getting your investment holdings in order for the longer term; in eliminating all costs from your holdings that you can; and you seek out securities that offer a high reward to risk ratio; that have a current history of producing returns from sources that lay outside the markets.
Caution: Knowledge of the preceding steps does not constitute the kind of advice that you will hear emanating from any of those TV sources. And that is because these elements require a much deeper analysis of the factors behind good financial analysis. Experience does matter in the world of investing. It should go without saying it that this article has nothing at all to offer Day Traders or to anyone looking for the “hot tip” of the day except for this: Good luck.
Unfortunately, I do not have the time, or the space, or the ability to crunch 50 years of training and experience into a page and a half of incredible enlightenment. So I will do the next best thing. I will outline the relevant questions you should ask your broker, or financial planner, or investment advisor, or wealth consultant today. If he or she goes by a different title, ask nevertheless:
Which investment licenses to you hold?
How much risk is in my investment holdings?
What is the historical CAGR (compound annual growth rate) of all my holdings?
What is the risk/reward ratio of all my holdings?
How much am I paying in commissions? In internal costs? In redemption fees?
Are my holdings optimized for best returns at my risk level?
Do you know how to use the CAPM (capital asset pricing model)?
What is my portfolio’s numerical alpha value?
Do you use Monte Carlo simulation to project the probability of my future returns?
Have you ever developed an econometric forecast? An AI (artificial intelligence) forecast?
There is no grading “on the curve.” If he or she cannot give you forthright and compelling answers on at least 6 of the foregoing questions, you have a lazy incompetent managing your financial future. You are paying him or her essentially for doing nothing for you that a monkey with a computer probably do about as well—or as poorly as the case may be.
Helpful Guidance:
Your advisor should have advanced training in investment management, and preferably hold a Certified Financial Analyst (CFA) certificate, or an investment advisor license.
Your portfolio’s risk is calculable by its price standard deviation (how much it fluctuates).
The CAGR is your portfolio’s annual growth rate.
A portfolio’s risk/reward ratio is its Sharpe Ratio (real returns minus the 90 day T-bill rate divided by its standard deviation).
It’s important to know all your costs because every dollar that goes to costs reduces your returns by the same amount.
Portfolio optimization has been around for about 30 years. If your advisor doesn’t have, or can’t use optimization software, he is way behind the industry.
The CAPM model is taught in most advanced financial programs.
Alpha is a numeric value that tells you if, and by how much, your portfolio is outperforming the market—based on your manager’s contribution. If it is zero or less, he or she is adding no value at all to your holdings that you could not get by throwing darts at the financial pages of your newspaper and investing in those securities that the darts hit. Alpha is calculated by this formula: alpha = port. return – [risk free rate + port. beta * (market return – risk free rate)].
Monte Carlo simulation is also taught in advanced courses. It simulates the future by projecting thousands of possible and potential futures, then by calculating the standard deviation of all those potential future outcomes, and then by finding all those values that are above the 95 percent level of your financial goal. It shows you the best estimate of the degree of risk the future holds for you based on the risk/return attributes of your present holdings.
Econometric and artificial intelligence forecasting skills are bonuses. If your advisor has experience with either, you probably selected a winner.
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