Evans Tax Advisors' Blog

Risk. Investing is risky business. So how did your stock broker or advisor protect you from risk? If I can use a little bit of psychic ability I’m seeing that he or she told you that you needed a “diverse portfolio.” And to create this diverse portfolio he or she said you needed a combination of stocks (i.e., mutual funds) and bonds (i.e., bond funds). How much you should have in stocks and how much you should have in bonds was based on your “risk profile” and your age. And if my psychic abilities are holding up this little exercise in “diversification” was the only tool your broker used to manage your risk. So to channel Dr. Phil, how did that work for you? Bottom line:

Did Your Broker’s Plan Work?

How did your diversified portfolio stand up to a real bear market? The mental picture I’m getting is you had big losses in your “diverse portfolio.” Somehow diversification didn’t prevent catastrophic losses. And now I’m hearing your advisor telling you “Hang in there” “You’ve got to stick to the plan.” I spoke with an advisor at a party the other day who said she was trying to keep her client’s spirits up. Well if the strategy most all advisors implement actually worked, then your broker wouldn’t need to be your psychologist or your cheer leader.

The really tragic stories are those who are in retirement or near retirement that followed their advisor on the diversification and buy and hold strategy and now are paying the price just when they can least afford it. Unbelievably we see many seniors with way too much stock exposure and no risk management tool other than so called “diversification.”

Here’s a quote from Kiplinger’s: “Diversification alone is no longer sufficient to temper risk. In the past year, we saw virtually every asset class hammered. You need something more to manage risk well.” (Kiplinger’s 2009). My only comment is that clearly diversification alone was never sufficient – i.e., the world didn’t change in 2008/2009 making the strategy obsolete the strategy was never adequate to handle large market declines. The market collapse of 2008/2009 just exposed the inherent weakness of the diversification strategy at least as practiced by the typical Wall Street trained broker.

They’re Called Stock Brokers for a Reason

The typical advisor or broker’s world revolves almost solely around stocks and stock mutual funds. There is no ailment that stocks won’t cure. Here is a test. Ask yourself if your broker would ever tell you “now is not the time to be in stocks – you need to sell all your stocks and mutual funds.” Of course not – they are primarily compensated by keeping you in stocks. Of course you have to throw in some bond funds for diversification but it’s really all about stocks. They call them stock brokers for a reason.

But stocks are inherently risky. The giant bull market we had through the 80’s and 90’s lulled the brokers and their clients into a false sense of security. Any losses during the bull market were quickly made up and everyone was happy. But we aren’t in the 90’s any more. Stock markets go through long term bull and long term bear markets. We are in a long term bear market. The old rules don’t apply any more. The diversification model as practiced by most advisors has been empirically shown not to work – check your statement if you don’t believe me.

So don’t believe your broker when he or she says that there is nothing that could have been done to prevent your losses – there were and are many ways to prevent catastrophic losses, he or she just doesn’t know them, or is prevented by the brokerage firm from telling you about them.

Believe It Or Not You Don’t Have To Risk Losing Money

Our clients, following our risk mitigation strategies, didn’t lose a dime during the stock market crash. In fact, there is a whole universe of financial instruments and strategies that are completely free of market risk and can give you after tax returns approximately equal or superior to the market. Of course you won’t hear about these strategies or vehicles from your broker because they are trained and compensated to sell stocks and mutual funds.

We did not come up through the Wall Street indoctrination that almost all brokers and advisors come from so we are able to evaluate all the possible investment choices and strategies without the Wall Street blinders.

Based on our risk mitigation strategies and tools we believe you should not be in the stock market at all right now – even after the recent mild recovery. The risk is too high compared to the possible rewards. The reentry point where the risk reward would be favorable may be several years away. Because we are able to offer independent analysis of the world of investment options we can tell you now is not the time to be in the stock market and we can offer you very attractive and likely superior alternatives to being in the stock market. We can also tell you when it would be prudent to reenter the stock market.