Wouldn’t it be peachy if we lived in a world where all the investment advice you received came from totally objective and rational sources that had only your interest at heart? Yeah, it would be just loverly. But it ain’t gonna happen, my friend!
Fortunately, you don’t have to throw up your hands, dismissing everything you hear and read as “lies, lies, lies.” Let’s find out how you can recognize biased investment advice, protect yourself from it — and perhaps even profit from it.
Investment Advice to Beware 1: The Sales Motive
We might as well begin at the unsavory bottom. People who work in the financial field often feel a powerful tug to tell you a slanted story: They’ve got an investment to sell. Stockbrokers, of course, are the poster kids for this kind of behavior, along with some insurance agents, realtors and coin dealers.
I’m not implying everybody in these businesses is crooked — far from it. In fact, I sent a gift card to my crackerjack insurance lady, who saved me more than $5,000 on my 2011 health coverage.
However, it’s essential to remember that salespeople wrestle with an inherent conflict of interest. To earn their bread, they have to move product. And the stuff they move may, or may not, be what’s best for you.
Whenever a salesperson pitches you on an investment, ask yourself: What costs are built into this thing? Could I buy an equivalent product elsewhere with a smaller sales charge, or with lower ongoing expenses?
I’m especially wary of mutual funds that impose a “load” (sales charge). Loads can put a serious dent in your profits if you decide to exit the investment within the first few years. Say, for example, you buy a fund with a standard 4.5% up-front charge. The fund’s net asset value grows 7% annually for the next two years.
When you redeem, you net a 9.3% return on your money, versus 14.5% for a no-load fund with the same portfolio performance. On a sizable investment, that difference can really bite.
Investment Advice to Beware: Velvet Persuasion
Not all sales pitches come roaring in at 90 miles an hour. There’s also the velvety “free” advice that investment firms hand out to the public. My email box is cluttered, as I’m sure yours is too, with financial advertising disguised as research. Fund families offer to share their latest market insights with you in supposedly exclusive conference calls. Financial planners invite you to bring your portfolio in for a complimentary analysis.
Of course, the intent is always to get you to buy something — a product or service the adviser just happens to peddle. Did you ever read a “white paper” on emerging markets by a fund manager who thought it was a bad idea to invest in emerging markets? Did the financial planner ever conclude you didn’t need any planning?
The same subtle bias, by the way, still percolates through much of the stock research issued by major brokerage firms. True, the outrageous excesses of a decade ago are gone. We don’t have Henry Blodget at Merrill Lynch touting stocks in print that he trashes in private. (Instead, Blodget co-hosts a harmless, perennially bearish video interview site at Yahoo Finance.)
Even so, Wall Street analysts continue to be extremely shy with sell advice. Sells account for only about 5% of brokers’ ratings — a number that has barely increased in the past 10 years, despite regulatory censures and mammoth fines. Clearly, analysts are still afraid of angering their firm’s investment-banking clients.
One limited consolation: Buy ratings have shriveled to less than 30% of the total, from more than 70% in 2000. So a Wall Street buy signal means considerably more than it used to. But don’t expect them to tell you when to bail out. It’s not in the Street’s DNA.