The talking heads on TV spend a majority of their time agonizing over the question of stock market direction. When they aren't talking stock market direction, they're talking economic trends - hoping that will help them predict stock market direction. Less often they will focus on individual stocks and try to predict their near-term direction. It is well understood within the industry that most "marks" (read individual investors) don't have the patience to actually buy a stock for the long-term (three to five years) and instead want their investments to start appreciating right away. Stock brokers get that, which is why they tout growth and momentum strategies, despite the mountain of evidence showing that those strategies under perform over the long run. Brokers know that most investors are all too happy to buy a sexy growth story, rather than buy a company selling for less than its intrinsic value.
Speaking of stock brokers, I want to be very clear what they actually do for a living. Stock brokers are out on point, selling whatever new hot products Wall Street wants sold. Oh, they've taken to calling themselves financial advisors, financial planners and "financial health coaches" (no kidding, I actually had a broker tell me recently that he tells his meal-tickets he's a financial health coach. I guess he's hoping the meal-ticket will view him like a personal trainer instead of as the commissioned based salesman that he actually is). But at the end of the day, stock brokers are exactly what they've always been, Wall Streets hit men, compensated handsomely for pushing product through the pipeline and into the hands of the unsuspecting public. John Bogle, founder of Vanguard, is on record as stating that most of Wall Street's innovations are designed to benefit Wall Street, not investors. Ya think! Legendary value investor Jean-Marie Eveillard told Consuelo Mack recently in an interview that, "When I’m in a good mood, I say Wall Street is a vast promotional machine,” Eveillard said. “When I’m in a bad mood, they are a den of thieves.” Amen! And don't forget that the "financial health coaches" aka stockbrokers, are the den-of-thieves' agents (think Mr. Smith from the Matrix)!
Okay, enough of the broker bashing (for now). Let's get to the retirement planning.
You can't know how to get there if you don't know where you're going. Sounds straight forward enough right? But you'd be surprised how many individuals really haven't sat down to figure out where they are going. For example, most individuals I talk with have actually spent very little time thinking about how big their investment portfolio should be in order to throw off enough cash in retirement to meet their desired lifestyle. One million? Two million? Three million?
How's 4 percent grab you?
William Bengen developed the 4% rule in 1994, arguing that investors could safely withdraw 4% from their balanced stock/bond portfolio in the first year, and then adjust that dollar amount upward for inflation each year. Bengen recommended an allocation as close to 75% stocks as possible, with the remainder in bonds. Subsequent research suggested a mix closer to 60/40 stocks and bonds was better. The consensus now seems to be somewhere in the 40% to 75% stock range. Cooley, Hubbard, and Waltz quantified Bengen's rule in 1998, determining that "safe" represented a 95% success rate with a 50/50 portfolio.
And success is defined as making your retirement portfolio last 30 years without running down to zero. Bengen's original findings were that the 4% rule allowed a retiree to live off his investment portfolio in every 30-year period on record from 1926 through 1994, some periods with only a few bucks to spare and some periods with millions left over. The 4% rule has maintained its success rate since 1994, despite the last eight years of horrible stock market returns.
Investors who are sophisticated enough to correctly gauge market valuations can fine tune the 4% rule based on current market valuations when they retire. It turns out (as common sense would suggest) that investors can increase their withdrawal rate when market valuations are depressed at the start of their retirement. Michael Kitces, publisher of The Kitces Report, showed in a 2008 study that safe withdrawal rates in a balanced portfolio depend on market levels. Withdrawal rates in excess of 4% are possible when valuations are depressed, based on Shiller's P/E (a 10-year trailing average). Conversely, of course, withdrawal rates should be reduced when market levels are high, as they were in 2000 and again in 2007. In fact, the greatest risk to a retiree's portfolio is severe market under performance at the beginning of the retirement period, a risk that many recent retirees are unfortunately experiencing first hand right now. The problem with stock exposure is that severe under performance at the beginning of the retirement period will leave the retiree with a depleted portfolio balance that will result in a smaller annual distribution, at least until the portfolio recovers - which can be a very long time depending on the investing period.
There are some retirement experts who believe that stocks should be avoided entirely, precisely because of the risk of early-year under performance. Robert Huebscher has written (Advisor Perspectives, March 24, 2009) that an all bond portfolio is preferable to a stock/bond portfolio. His main contention is that an all-bond portfolio offers far more certainty of success because cash flows are much more certain and total real return depends only on correctly forecasting inflation rates. He further maintains that "inflation is far more predictable than equity market returns and can be efficiently hedged using TIPS." His last main point is that, "the all-bond portfolio is insulated from the risk of historically unprecedented adverse-market conditions near the beginning of the retirement period." Although he admits that there is a risk to the all-bond portfolio - underestimating inflation.
I think Mr Huebscher makes some interesting points, but his over-all argument for an all-bond portfolio is dependent on not underestimating inflation, and that is, in my humble opinion, exactly where we stand today. I also take issue with his contention that TIPS provide an efficient means of hedging inflation. The U.S. government has a huge vested interest in under reporting inflation, since all of the cost of living adjustments for social security and federal employees and retirees are tied to the CPI. It is extremely naive to believe that our government is accurately reporting inflation. In fact, economist Dr. John Williams, of Shadowstats fame, estimates that inflation is currently running about 8% higher than the official number.
More importantly, we are at the cusp of a long period of rising inflation and rising interest rates, brought on intentionally by a government determined to debase our currency in order to make it easier to meet the $65 trillion in unfunded liabilities it has taken on over the last twenty years of unprecedented spending. Governments everywhere and always have chosen the least politically painful option of currency debasement, once they've recognized their inability to make debt payments. The process has just begun in the United States and is likely to culminate, as in the 70's, in double digit inflation rates and double digit interest rates. Now, I am making no guarantees. It is barely possible that our elected officials will do the right thing, sharply curtail spending, raise short-term rates to encourage savings, and defend the dollar at every turn in an effort to keep it front and center as the world's reserve currency. But I doubt it.
The main point, however, is that an all bond portfolio will leave retirees eating dog food in 10-years or so if my inflation scenario comes to pass (and I give it better than a 50% chance of doing so). A prudent investor would do well to maintain a balanced portfolio of stocks and bonds in order to balance the risk of a near term short fall in stocks at the beginning of retirement against a longer-term risk of loss of purchasing power with an all-bond portfolio. It is exactly the uncertainty surrounding both stock market returns AND inflation rates that demands using both asset classes to increase the likelihood of a successful retirement using the 4% rule. (And no I do not think that stocks are cheap enough yet to raise the withdrawal rate to 5%, but that is for a different blog).
Oh, and the average inflation rate since 1966 has been 4.6%, yet many financial advisors use the 2.5% to 3.0% default rates prevalent in the investment planning software used by many of them when projecting real, long-term portfolio returns for their clients. You might want to ask them why next time you speak with them...
Monday, April 13, 2009
Monday, April 6, 2009
Consumers Beware!
Fidelity Investment long ago made a name for itself in the mutual fund industry by providing a wide range of open-ended mutual funds that, at one time, were consistently ranked in the upper end of the mutual fund universe. Peter Lynch made Fidelity a household name back in the 70's and 80's with his stellar performance as manager of Fidelity Magellan, a fund that has fallen on hard times in recent years.
But what many investors don't know about Fidelity is that the firm is no longer a pure mutual fund company, having strayed from its roots as a producer and passive distributor of product to an active distributor of product back in the 1990s. The company currently runs a hybrid operation that now not only offers mutual funds directly to the public, but also pushes managed-money programs and other proprietary products through a broker network of its own. Now, since we're all educated consumers of financial products, we know that anytime a company is selling its own products to consumers through brokers that we have entered the "Conflict of Interest Zone!!!!!"
Apparently, many of Fidelity's own brokers are acutely aware of the conflict as well, given that dozens recently jumped ship, claiming that they were forced to leave because Fidelity was requiring them to obtain their certified financial planner certification. Now why would that cause a problem for the brokers? After all, obtaining a CFP certificate sounds like a step in the right direction for these sales people. It can't possibly hurt to require a stockbroker to actually get an education in investing before going out and peddling stocks to individuals can it?
Of course not, but the problem (as is usually the case) centered on compensation and disclosure. Apparently Fidelity wanted the brokers to get educated, but was continuing to prohibit them from disclosing to clients and prospects that a substantial portion of their compensation was commissioned based. Unfortunately for Fidelity, a CFP holder or candidate must disclose material conflicts of interest to clients and prospects, including compensation arrangements. So what was Fidelity's response to the dilemma? Did it choose to continue to require its brokers to obtain a CFP certificate in order to better serve clients, and then also begin disclosing compensation arrangements to clients?
Hah! Not a chance. Fidelity has decided to rescind the mandate to get educated and is instead no longer requiring its brokers to obtain the CFP certificate, thus preserving the commissioned based part of their compensation scheme (albeit back in the shadows once again) and allowing brokers to continue to profit handsomely from client transactions.
Caveat Emptor!
But what many investors don't know about Fidelity is that the firm is no longer a pure mutual fund company, having strayed from its roots as a producer and passive distributor of product to an active distributor of product back in the 1990s. The company currently runs a hybrid operation that now not only offers mutual funds directly to the public, but also pushes managed-money programs and other proprietary products through a broker network of its own. Now, since we're all educated consumers of financial products, we know that anytime a company is selling its own products to consumers through brokers that we have entered the "Conflict of Interest Zone!!!!!"
Apparently, many of Fidelity's own brokers are acutely aware of the conflict as well, given that dozens recently jumped ship, claiming that they were forced to leave because Fidelity was requiring them to obtain their certified financial planner certification. Now why would that cause a problem for the brokers? After all, obtaining a CFP certificate sounds like a step in the right direction for these sales people. It can't possibly hurt to require a stockbroker to actually get an education in investing before going out and peddling stocks to individuals can it?
Of course not, but the problem (as is usually the case) centered on compensation and disclosure. Apparently Fidelity wanted the brokers to get educated, but was continuing to prohibit them from disclosing to clients and prospects that a substantial portion of their compensation was commissioned based. Unfortunately for Fidelity, a CFP holder or candidate must disclose material conflicts of interest to clients and prospects, including compensation arrangements. So what was Fidelity's response to the dilemma? Did it choose to continue to require its brokers to obtain a CFP certificate in order to better serve clients, and then also begin disclosing compensation arrangements to clients?
Hah! Not a chance. Fidelity has decided to rescind the mandate to get educated and is instead no longer requiring its brokers to obtain the CFP certificate, thus preserving the commissioned based part of their compensation scheme (albeit back in the shadows once again) and allowing brokers to continue to profit handsomely from client transactions.
Caveat Emptor!
Wednesday, April 1, 2009
The Variable Annuity Con
It makes me both sad and mad to see how many individuals get conned into putting IRA and 401(k) money into a variable annuity. Variable annuities are a tax-deferred investment vehicle that come with an insurance contract, typically designed to protect you from a loss of principal. The earnings inside the annuity are allowed to grow tax-deferred and there are no annual contribution limits as there are with other tax-deferred investment vehicles such as IRAs and 401(k)s.
Wait, back up a moment... did I just write "as there are with other tax-deferred investment vehicles such as IRAs and 401(k)s"? Well, by golly I did didn't I. Well then why in the world would an insurance salesman want you to take your already tax-deferred money and put it into another tax-deferred investment vehicle? Is there some kind of double deferment thing happening here? NO
What's happening is the snake-oil (ahem) I mean variable annuity salesman is looking for a big pay day, anywhere from 5%-10% of the total amount of the money you put into the annuity. It's a bad deal for the investor, make no mistake. You gain nothing in improved tax treatment, yet variable annuities are expensive, running 2.44% per annum in annual expenses versus 1.32% for the average open-ended mutual fund, according to Morningstar. And that 2.44% doesn't take into account the additional commissions that are often paid out as ongoing fees. Oh, and there is the pesky little surrender fee designed to lock you into the variable annuity long enough for the insurance company to pay-off the guy who sold you on the idea in the first place. The typical surrender fee in the first year of a contract is a whopping 6%, dropping to a mere 1% in the seventh year.
And what's the big benefit of using a high-commission, high-expense variable annuity? Well the smooth talking salesman is going to point to the minimum guaranteed return, the so-called death benefit. The death benefit guarantees that your account will maintain a certain minimum value - usually the amount that has been invested. Sometimes the minimum guarantee will be some positive rate of return, but you can rest assure it will be a very low hurdle indeed, one that the profit-seeking insurance company expects to clear with ease. As well, the death benefit usually expires at around age 75, making it no real death benefit at all. In fact, given that stocks have returned approximately 11% annually from 1926 through 2007, it isn't surprising that the death benefit is triggered very rarely, perhaps for less than 2% of all annuities sold - almost sounds like a lottery ticket set up doesn't it?
Bottom line here folks is you gain zilch by putting your IRA and 401(k) money into a variable annuity, but you give up plenty in the form of commissions, extra fees and investing flexibility.
Okay, okay you say, no more putting already tax-deferred money into an expensive, inflexible variable annuity. But surely these things are worthwhile for non-qualified chunks of money right? In most cases no. Why?
Because gains are taxed as ordinary income, which can run as high as 35% versus the current 15% on long-term capital gains. Remember, gains are tax-deferred not tax free, meaning you will eventually pay taxes on the high-commission, high-expense investment vehicle's earnings. And the different tax rate makes a huge difference in your after-tax returns. It may take 15 to 20 years for the benefits of the tax-deferred variable annuity to make up for the more onerous tax treatment. Of course, it will take even longer to come out break even when you factor in the higher expenses.
Still want an annuity for your non-qualified money? Fine, at least cut out the snake-oil salesman and go direct to a low-fee, variable annuity provider. You can buy a low-cost variable annuity from many mutual fund and insurance companies such as Jefferson National, Vanguard or T. Rowe Price. Already own a high cost variable annuity? No problem. Make a tax-free transfer (1035 exchange) to a low-fee annuity (but don't forget to check on your surrender charge first).
Wait, back up a moment... did I just write "as there are with other tax-deferred investment vehicles such as IRAs and 401(k)s"? Well, by golly I did didn't I. Well then why in the world would an insurance salesman want you to take your already tax-deferred money and put it into another tax-deferred investment vehicle? Is there some kind of double deferment thing happening here? NO
What's happening is the snake-oil (ahem) I mean variable annuity salesman is looking for a big pay day, anywhere from 5%-10% of the total amount of the money you put into the annuity. It's a bad deal for the investor, make no mistake. You gain nothing in improved tax treatment, yet variable annuities are expensive, running 2.44% per annum in annual expenses versus 1.32% for the average open-ended mutual fund, according to Morningstar. And that 2.44% doesn't take into account the additional commissions that are often paid out as ongoing fees. Oh, and there is the pesky little surrender fee designed to lock you into the variable annuity long enough for the insurance company to pay-off the guy who sold you on the idea in the first place. The typical surrender fee in the first year of a contract is a whopping 6%, dropping to a mere 1% in the seventh year.
And what's the big benefit of using a high-commission, high-expense variable annuity? Well the smooth talking salesman is going to point to the minimum guaranteed return, the so-called death benefit. The death benefit guarantees that your account will maintain a certain minimum value - usually the amount that has been invested. Sometimes the minimum guarantee will be some positive rate of return, but you can rest assure it will be a very low hurdle indeed, one that the profit-seeking insurance company expects to clear with ease. As well, the death benefit usually expires at around age 75, making it no real death benefit at all. In fact, given that stocks have returned approximately 11% annually from 1926 through 2007, it isn't surprising that the death benefit is triggered very rarely, perhaps for less than 2% of all annuities sold - almost sounds like a lottery ticket set up doesn't it?
Bottom line here folks is you gain zilch by putting your IRA and 401(k) money into a variable annuity, but you give up plenty in the form of commissions, extra fees and investing flexibility.
Okay, okay you say, no more putting already tax-deferred money into an expensive, inflexible variable annuity. But surely these things are worthwhile for non-qualified chunks of money right? In most cases no. Why?
Because gains are taxed as ordinary income, which can run as high as 35% versus the current 15% on long-term capital gains. Remember, gains are tax-deferred not tax free, meaning you will eventually pay taxes on the high-commission, high-expense investment vehicle's earnings. And the different tax rate makes a huge difference in your after-tax returns. It may take 15 to 20 years for the benefits of the tax-deferred variable annuity to make up for the more onerous tax treatment. Of course, it will take even longer to come out break even when you factor in the higher expenses.
Still want an annuity for your non-qualified money? Fine, at least cut out the snake-oil salesman and go direct to a low-fee, variable annuity provider. You can buy a low-cost variable annuity from many mutual fund and insurance companies such as Jefferson National, Vanguard or T. Rowe Price. Already own a high cost variable annuity? No problem. Make a tax-free transfer (1035 exchange) to a low-fee annuity (but don't forget to check on your surrender charge first).
Monday, March 30, 2009
Even Congress "Gets It"
I'm not a big fan of the current Congress. Too many of its members seem far more concerned about political posturing designed to garner votes than they do about doing what is best for our country. Nevertheless, it seems even Congress, or at least one member, "gets it" when it comes to financial service providers who both sell products AND give advice to their clients.
Rep. Robert Andrews, D-N.J. said at a hearing last week that advisors who provide advice on IRAs should be independent of companies that sell investments. "I don't think somebody should be giving advice on your retirement money if they serve two masters, whether it's your 401(k), your IRA or your defined contribution account," said Rep. Andrews.
Now to me this is a "Duuuuhhhh" issue, as in "Well of course!" Why on earth would anyone think that they are getting objective advice from an advisor associated with a mutual fund company, brokerage firm, insurance company or other seller of financial products, especially when that advisor is compensated, often handsomely, for selling those products to their clients.
Now, 20-years ago I would have stated firmly and with profound conviction that legislation just isn't necessary because the absolute superiority of a fee-only, independent advisor model over a commissioned based model was so self evident that it would be only a matter of time before stockbrokers and annuity salesmen went the way of the dodo bird. Investors would just stop using them. Hah! Shows you what I knew back then - not much when it came to human behavior as it turned out.
The reality of the modern financial services business is that it has changed very little over the last 20 years regarding the issue of compensation. Fee-only, independent advisors still make up only a small percentage of the total number of advisors. Why? Likely, because most advisors just can't resist selling lucrative investment products to their clients, and most clients just don't seem to understand or care that the advice they receive is tainted by those juicy commissions.
Rep. Robert Andrews, D-N.J. said at a hearing last week that advisors who provide advice on IRAs should be independent of companies that sell investments. "I don't think somebody should be giving advice on your retirement money if they serve two masters, whether it's your 401(k), your IRA or your defined contribution account," said Rep. Andrews.
Now to me this is a "Duuuuhhhh" issue, as in "Well of course!" Why on earth would anyone think that they are getting objective advice from an advisor associated with a mutual fund company, brokerage firm, insurance company or other seller of financial products, especially when that advisor is compensated, often handsomely, for selling those products to their clients.
Now, 20-years ago I would have stated firmly and with profound conviction that legislation just isn't necessary because the absolute superiority of a fee-only, independent advisor model over a commissioned based model was so self evident that it would be only a matter of time before stockbrokers and annuity salesmen went the way of the dodo bird. Investors would just stop using them. Hah! Shows you what I knew back then - not much when it came to human behavior as it turned out.
The reality of the modern financial services business is that it has changed very little over the last 20 years regarding the issue of compensation. Fee-only, independent advisors still make up only a small percentage of the total number of advisors. Why? Likely, because most advisors just can't resist selling lucrative investment products to their clients, and most clients just don't seem to understand or care that the advice they receive is tainted by those juicy commissions.
Chasing Performance
The average stock fund investor has far underperformed the average stock fund return from 1988 thru 2007, according to Dalbar, Inc., which published "Quantitative Analysis of Investor Behavior" (July 2008). According to Dalbar, the average stock fund has returned 11.6% while the average stock fund investor has only earned 4.5%. Dalbar labels the 7.1% difference the "Investor Behavior" Penalty.
Now the "Investor Behavior" penalty is not a new revelation. Dalbar first pointed it out in the late 1990s (early 2000s?) There are numerious explanations as to why investors underperform the very investment vehicles they use, but most center around peoples' inclination to chase performance. The reality is that past performance is no predictor of future performance in mutual fund land. Given that there are maybe 10,000 mutual funds out there, the task of picking a few long-term outperformers is more or less impossible. Focusing on low-cost, tax-efficient funds with a stable investment discipline is about the best one can do. Indexing fits the bill nicely.
Now the "Investor Behavior" penalty is not a new revelation. Dalbar first pointed it out in the late 1990s (early 2000s?) There are numerious explanations as to why investors underperform the very investment vehicles they use, but most center around peoples' inclination to chase performance. The reality is that past performance is no predictor of future performance in mutual fund land. Given that there are maybe 10,000 mutual funds out there, the task of picking a few long-term outperformers is more or less impossible. Focusing on low-cost, tax-efficient funds with a stable investment discipline is about the best one can do. Indexing fits the bill nicely.
Sunday, March 29, 2009
A Market of Stocks
Thought my newsletter from last fall might help delineate my thoughts on real investing versus the ubiquitus speculating practiced by most of the major players.....
From The Bleachers
By
Christopher Royce Norwood, CFA®
Vol. 1, No. 1 October 17, 2008
A Market of Stocks
Much is made of the stock market these days in the newspaper, on television and in the halls of government. Everyone on the planet surely has heard that the derivatives market has finally blown up (Warren Buffett proved prescient when declaring them “financial weapons of mass destruction” way back in 2003). Mr. Buffett wrote in his annual letter to shareholders that some derivatives contracts appear to have been devised by “madmen”. His warning that derivatives could push a company into a spiral that could lead to a corporate meltdown appear virtually Nostradamus in nature now that AIG, Lehman Brothers, Bear Stearns, Fannie Mae, and Freddie Mac have all run aground on the sharp rocks of the derivatives market. Write downs already tally north of $650 billion and the International Monetary Fund (IMF) is predicting they will total $1.4 trillion (that’s Trillion with a T) before all is said and done. And that august international body’s forecast appears downright cheery next to Nouriel Roubini’s prediction that write-downs will top $3 trillion eventually.
Why should we care what Mr. Roubini has to say on the subject? Perhaps because the Professor of Economics and International Business at the Stern School of Business in New York had the intestinal fortitude to stand in front of an audience of economists at the IMF in September of 2006 and warn that the United States was facing a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence and, ultimately, a deep recession – all have come to pass in the intervening two years except the deep recession, which Roubini sees unfolding right now.
Of course, the stock market is on track for its worst year since the 1930s. A deep, consumer-led recession will make a recovery in the market a back half of 2009 or even a 2010 affair, should it come to pass. Investors will undoubtedly collectively wish they’d found something else to do with their hard earned money like, say, gone to Vegas and bet on black, should we experience anything close to Mr. Roubini’s prediction of the worst recession in forty years prove on the mark. 2009 earnings estimates for the S&P 500 will look laughably high in hindsight – they are currently forecast at around $96, but would likely come in closer to $76 in a deep recession.
Perhaps this is a good time to shift to the topic indicated by the title up above, before readers decide we’re just a bit off the mark with it. Our fervent hope is to both entertain and educate our readers on the art of stock picking for – as the title declares – it is a market of stocks not a stock market in which we invest. To be fair, we are contrarian by nature, and a bit old fashion to boot. We recognize that index funds exist, that exchange traded funds are available with which to place your bets on red, black, or even green, but we prefer to build a portfolio the old fashion way, one well researched stock at a time. We hesitate to declare that we’re looking for an undervalued business in which to invest since we will almost assuredly be (mis)labeled as a value investor. So we will avoid the claim. Rather, we simply recognize that a share of stock means a share of ownership in a corporation, which entitles the stockholder to a share of the profits, should there be any.
Now oddly enough, we have found over the years that companies that make increasing amounts of money are deemed more valuable (eventually) to investors than those who don’t, and the stock price of said company invariably rises over time as a result of the increasing stream of cash finding its way into the shareholders’ pocket, a truly wonderful outcome for those of us who enjoy turning a profit with our investing. It is our belief that we are buying ownership in a business that guides our search. Not for us the pursuit of a stock, simply because it is rising – that game belongs to the many speculators who invest with a six to twelve month time horizon. Speculators they are because they invariably buy a stock in the hope that it will trade higher in the coming quarters, allowing them to sell at a tidy profit and move on to the next piece of paper. The many mutual fund managers, institutional asset managers, and individuals who choose to rent a stock (and we are now fairly describing upward of 90% of the investors out there) are not interested in the value of the underlying business. They care only whether the stock price will rise in the short run, and turn to such devices as earnings revisions, upside surprises, relative strength indicators and insider buying to divine the short term future of a company’s stock price. We, on the other hand, care very much what price we pay for a company. Just as we choose not to overpay for a car, house, vacation, or that big flat panel TV that makes Peyton Manning’s flapping and stomping prior to the snap looking even more like a blue heron dancing in the shallows (Of course we are fans, season ticket holders as a matter of fact).
Don’t misunderstand however. We have owned all manner of stocks in our 20 years of investing. Technology stocks, drug companies (back when big pharma was considered a growth industry), the King of Beers, and the royalty of soda pop (Coke) have all found their way into our portfolios. We will buy anything in any industry if the price is right, and we are very patient in waiting for that happy event to occur. For instance, Coke was the poster child of expensive back in the late 1990’s, peaking in the vicinity of 55 times earnings if we remember correctly. We even used it as a marvelous example of a great company that was no longer a great investment. But we didn’t hesitate to pay some 20 times earnings in 2005, with the stock in the low 40s, nor did we hesitate to sell it some two years later in the high 50s when the price-to-earnings multiple no longer matched the company’s growth prospects. A market of stocks, not a stock market, and stocks as certificates of ownership in an ongoing business – two of the guiding principles of our investment philosophy.
INTC $14.28
Intel closed today at $14.28 per share, but not before touching $13.37 intraday – a new 52-week low. The company is paying a dividend of $0.55 per share for a current yield of 3.85% and is expected to raise its dividend to $0.61 per share in 2009, according to Value Line – should reality meet expectations INTC will yield 4.27% for anyone buying at the current price, or some 40 basis points or so more than the 10-year Treasury. Now, of course, Intel common stock is riskier than holding a 10-year Treasury to maturity (although that premise seems increasingly uncertain given our government’s loose spending habits). On the other hand, we get much more than a debt instrument that pays par upon maturity when we buy part ownership of a company. We also get a growing stream of shareholder cash flow that can be returned to us by management either with increasing dividends, share buy backs or both.
In fact, INTC will pay out around $1.19 per share in 10 years if management raises the dividend 8% per annum during that period – only one quarter the growth rate of the last 5 years. Anyone buying and hold Intel’s stock for the decade will then be earning 8.3% per annum on their original investment. Now compare that juicy 8.3% to the measly 3.85% you can currently earn holding the U.S. 10-year note… and you quickly get it – Intel is a raging buy at the current price as long as the company is around in 10 years and as long as management is able to continue to grow the dividend. And our analysis doesn’t yet include the possibility of additional cash that might be available to oh, say, buy in stock, resulting in the dividend yield rising even faster.
In Intel’s case, a quick check of current year estimates reveals that the company will have approximately $0.55 per share in excess cash after paying its dividend and meeting its capital expenditure requirements. A three-year average is often useful in ascertaining a company’s ability to throw off excess cash consistently. According to Value Line, Intel has generated approximately $5.66 in cash flow from 2006 to 2008, while making $2.76 per share in capital expenditures and paying out $1.41 per share in dividends, leaving approximately $1.49 per share in excess cash available to buy back shares, or $0.50 per share per annum. Adding the $0.50 in excess cash to the current $0.55 dividend gives you a current dividend yield of 7.35% (what the dividend yield would be if INTC management devoted all of its excess cash to the dividend). Unfortunately, Intel, like many management teams often chooses to buy back shares with excess cash. We think it unfortunate, because managers tend to pay top dollar for their own shares rather than waiting to buy in shares after their stock takes a dive. Nevertheless, buying in $0.50 per share per annum retires 3.5% of the outstanding shares at the current stock price (call it 2.0% net of stock option issuance), raising current and future dividends accordingly.
Yet another way to do the math without the distortation of a changing share count: Intel generated $34.2 billion in Cash Flow After Taxes (CFAT) during the three years ending in 2007, against $17 billion in Capital Expenditures (CAPEX), leaving $17.2 billion available to shareholders. The entire company was available for purchase for a mere $154 billion at the beginning of 2008 (you could buy it lock stock and barrel right now for $82.8 billion). Taking the three year average shareholder cash number of $5.7 billion and dividing it into the current fully diluted shares outstanding gets you $0.99 per share in stockholder available cash – a nice current yield of 6.9%, some 3.1% better than the 10-year’s current yield.
A couple ways then of looking at the yield to shareholders currently and a decade into the future in comparison to the 10-year Treasury – all favorable. We just need to make a judgment on whether INTC is likely to be around and prospering a decade from now.
The company is currently the world’s largest semiconductor chipmaker based on revenue, according to its 2007 10K SEC filing. INTC develops advanced integrated digital technology products, primarily integrated circuits, for industries such as computing and communications. Intel also develops platforms, which they define as integrated suites of digital computing technologies that are designed and configured to work together to provide an optimized user computing solution compared to separately. Intel currently controls about 80% of the PC processor market.
For starters, Intel has grown revenues from $30.1 billion in 2003 to an estimated $40.4 billion in 2008, or a little over 34% during the five-year period. Net profit is forecast to hit $7.3 billion in 2008, up from $7.0 billion in 2007 but well off the company’s peak profit logged in 2000 ($10.7 billion). Nevertheless, profit has grown steadily, albeit erratically, since the bottom fell out during the last recession in 2001 (profits bottomed in 2002 at $3.5 billion).
Clearly the company is likely to still be in business and growing earnings given its dominating position in the microprocessor industry and strong balance sheet (almost 13 billion in cash on the balance sheet at the end of 2007). On the other hand, just looking at the increasing variability in earnings leads one to the conclusion that the company is no longer a true growth company and should be bought after business conditions (and the stock price) have weakened and sold when investor enthusiasm carries the share price outside of the realm of reasonable valuation. We believe the current valuation is in the buying zone, given our discussion of dividend and shareholder yields.
AND A STOCK MARKET
You can unglazed your eyes now and refocus on the casino – that is to say the stock market. The truth is that few investors really want to spend the time rooting around in the financial statements of publically traded companies with a view toward discovering an undervalued business worth buying. It takes time and patience and more time. We ourselves have found it a profitable way of spending our time and we’re always fascinated by the inner workings of a business and the question of its true worth. But investing is boring compared to speculating – which over the last 20 years has more or less become the nation’s national pastime in our eyes.
Which brings us full circle in this, our first edition, to the derivatives bomb that has gone off in our faces and the resulting mess in which we currently find ourselves. We’ll give you a quick recap, since most of this is now fairly well known. We hope to save some space to sketch out a roadmap for the market in the coming years as well as for the economy that underlies it.
The root cause of our current pickle is easy money. The Federal Reserve dropped rates in response to the 1987 stock market crash and has been a one trick pony ever since (or at least until very recently). The consumer led recession of 1990-91? No problem, cut rates. Mexican Peso and Asian currency crises of 1994-95? No problem, cut rates. Long Term Capital Management implosion and Russian debt crisis of 1998? No problem, cut rates. Technology stock bubble implodes? No problem, cut rates and leave them at a historically low level for a very long time, ensuring that negative real rates will spike the velocity of money and force a veritable tsunami of liquidity into … housing markets around the world! Credit markets freeze as a mountain of bad mortgages and mortgage derived financial products lose their value once house prices start following? No problem, cut rates AND PROSTITUTE THE FEDERAL RESERVES BALANCE SHEET TO THE POINT THAT HYPERINFLATION IS A VERY REAL POSSIBILITY!
Ahem, we hope we now have your undivided attention because we’d like to throw out some thoughts on what the next 10 years or so holds for stocks, bonds, commodities, and our economy. The Federal Reserve appears to have reached the limits of what a one-trick pony can accomplish and so, under Ben Bernanke’s watch, the Fed has transformed itself into a multi-trick pony, all with the aim of preventing the mountain of debt that underpins our economy from crushing our major financial companies and, in a chain reaction, the companies and consumers that depend on them for credit.
In the process, the Federal Reserves balance sheet has ballooned from around $850 billion to some $1.7 trillion in just a matter of weeks, and is likely to reach $3 trillion by year-end. We will devote the rest of this edition to explaining just why that mammoth increase in the Federal Reserves balance sheet is likely to lead to inflation on a scale not seen since the 1970s (don’t worry, we’ll save a little space for telling you what’s likely to happen in the stock market in the next few months as well).
Ready? Okay, here it is…. inflation results when too much money chases too few goods and services. Double the amount of money in circulation but hold the amount of goods and services produced constant and inflation will result. The Federal Reserve has gone one better by doubling its balance sheet on the way to tripling it from what we’re hearing. What’s more, the dollars they are pushing into the system are now backed increasingly by collateral of dubious quality, to say the least. Boat loans, subprime credit card loans, and fancy triple A rated (and worthless) CDOs now represent a goodly portion of the assets backing the greenback. Not convinced that inflation is coming? How about the Federal Reserve buying debt directly from the Treasury? Here’s how that will work if Bernanke, as is currently rumored, elects to monetize the debt. The U.S. Treasury needs to raise the dough to buy up bad assets and make equity injections into insolvent banks, insurance companies and various other corporate miscreants. No one wants the debt because they already have too much of it so the Federal Reserve simple prints up a few hundred billion more of the good old greenback and uses the newly minted cash to buy the debt from the Treasury, which turns around and hands it over to the Titans of commerce in order to salvage our financial system. Sweet deal for sure, except for the fact that no one, and I mean no one will want to hold the dollar anymore if history is any guide. And all of that new paper will push prices higher and higher and higher. We hope the Federal Reserve doesn’t do it, but then we hoped they wouldn’t give J.P. Morgan $29 billion for a bunch of Bear Stearns assets that are almost certainly worth far less because, as taxpayers, we didn’t really want to take a loss on the overvalued paper…
As for the stock market? Our forecast for almost a year now has been for a substantial low in place sometime this fall with a retest sometime next spring. We see no reason to change it at this point. In fact, here’s what I wrote a buddy just a couple of days ago
Scott,
My forecast since last winter was for a significant low in the fall, a rally into winter and a retest by next spring. My fundamental reasons were that by this fall the horrifying extent of the credit market excesses would finally be laid bare for the masses to see, resulting in a selling climax sufficient to set a bottom that would hold for a few months. My retest was based on the thought that earnings estimates for the back half of 2008 and 2009 were way too high and the institutional weenies would start selling the misses and downward revisions by the winter pressuring the market into the spring. I also felt and still feel that the recession we're in (since about last fall) would be longer than normal, lasting up to a year and a half to two years - call it over by next fall/winter (fall of 2009/winter of 2010) at the latest. Figuring the market tends to lead us out by about six months also pointed to a springtime low/retest.
For the first time in 16 months, I’m excited about doing a little buying of some of the increasingly cheap stocks out there, recognizing that we were probably six to nine months early (but I don't want to get too cute with the spring of 2009 retest thing).
Regards,
Chris
From The Bleachers
By
Christopher Royce Norwood, CFA®
Vol. 1, No. 1 October 17, 2008
A Market of Stocks
Much is made of the stock market these days in the newspaper, on television and in the halls of government. Everyone on the planet surely has heard that the derivatives market has finally blown up (Warren Buffett proved prescient when declaring them “financial weapons of mass destruction” way back in 2003). Mr. Buffett wrote in his annual letter to shareholders that some derivatives contracts appear to have been devised by “madmen”. His warning that derivatives could push a company into a spiral that could lead to a corporate meltdown appear virtually Nostradamus in nature now that AIG, Lehman Brothers, Bear Stearns, Fannie Mae, and Freddie Mac have all run aground on the sharp rocks of the derivatives market. Write downs already tally north of $650 billion and the International Monetary Fund (IMF) is predicting they will total $1.4 trillion (that’s Trillion with a T) before all is said and done. And that august international body’s forecast appears downright cheery next to Nouriel Roubini’s prediction that write-downs will top $3 trillion eventually.
Why should we care what Mr. Roubini has to say on the subject? Perhaps because the Professor of Economics and International Business at the Stern School of Business in New York had the intestinal fortitude to stand in front of an audience of economists at the IMF in September of 2006 and warn that the United States was facing a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence and, ultimately, a deep recession – all have come to pass in the intervening two years except the deep recession, which Roubini sees unfolding right now.
Of course, the stock market is on track for its worst year since the 1930s. A deep, consumer-led recession will make a recovery in the market a back half of 2009 or even a 2010 affair, should it come to pass. Investors will undoubtedly collectively wish they’d found something else to do with their hard earned money like, say, gone to Vegas and bet on black, should we experience anything close to Mr. Roubini’s prediction of the worst recession in forty years prove on the mark. 2009 earnings estimates for the S&P 500 will look laughably high in hindsight – they are currently forecast at around $96, but would likely come in closer to $76 in a deep recession.
Perhaps this is a good time to shift to the topic indicated by the title up above, before readers decide we’re just a bit off the mark with it. Our fervent hope is to both entertain and educate our readers on the art of stock picking for – as the title declares – it is a market of stocks not a stock market in which we invest. To be fair, we are contrarian by nature, and a bit old fashion to boot. We recognize that index funds exist, that exchange traded funds are available with which to place your bets on red, black, or even green, but we prefer to build a portfolio the old fashion way, one well researched stock at a time. We hesitate to declare that we’re looking for an undervalued business in which to invest since we will almost assuredly be (mis)labeled as a value investor. So we will avoid the claim. Rather, we simply recognize that a share of stock means a share of ownership in a corporation, which entitles the stockholder to a share of the profits, should there be any.
Now oddly enough, we have found over the years that companies that make increasing amounts of money are deemed more valuable (eventually) to investors than those who don’t, and the stock price of said company invariably rises over time as a result of the increasing stream of cash finding its way into the shareholders’ pocket, a truly wonderful outcome for those of us who enjoy turning a profit with our investing. It is our belief that we are buying ownership in a business that guides our search. Not for us the pursuit of a stock, simply because it is rising – that game belongs to the many speculators who invest with a six to twelve month time horizon. Speculators they are because they invariably buy a stock in the hope that it will trade higher in the coming quarters, allowing them to sell at a tidy profit and move on to the next piece of paper. The many mutual fund managers, institutional asset managers, and individuals who choose to rent a stock (and we are now fairly describing upward of 90% of the investors out there) are not interested in the value of the underlying business. They care only whether the stock price will rise in the short run, and turn to such devices as earnings revisions, upside surprises, relative strength indicators and insider buying to divine the short term future of a company’s stock price. We, on the other hand, care very much what price we pay for a company. Just as we choose not to overpay for a car, house, vacation, or that big flat panel TV that makes Peyton Manning’s flapping and stomping prior to the snap looking even more like a blue heron dancing in the shallows (Of course we are fans, season ticket holders as a matter of fact).
Don’t misunderstand however. We have owned all manner of stocks in our 20 years of investing. Technology stocks, drug companies (back when big pharma was considered a growth industry), the King of Beers, and the royalty of soda pop (Coke) have all found their way into our portfolios. We will buy anything in any industry if the price is right, and we are very patient in waiting for that happy event to occur. For instance, Coke was the poster child of expensive back in the late 1990’s, peaking in the vicinity of 55 times earnings if we remember correctly. We even used it as a marvelous example of a great company that was no longer a great investment. But we didn’t hesitate to pay some 20 times earnings in 2005, with the stock in the low 40s, nor did we hesitate to sell it some two years later in the high 50s when the price-to-earnings multiple no longer matched the company’s growth prospects. A market of stocks, not a stock market, and stocks as certificates of ownership in an ongoing business – two of the guiding principles of our investment philosophy.
INTC $14.28
Intel closed today at $14.28 per share, but not before touching $13.37 intraday – a new 52-week low. The company is paying a dividend of $0.55 per share for a current yield of 3.85% and is expected to raise its dividend to $0.61 per share in 2009, according to Value Line – should reality meet expectations INTC will yield 4.27% for anyone buying at the current price, or some 40 basis points or so more than the 10-year Treasury. Now, of course, Intel common stock is riskier than holding a 10-year Treasury to maturity (although that premise seems increasingly uncertain given our government’s loose spending habits). On the other hand, we get much more than a debt instrument that pays par upon maturity when we buy part ownership of a company. We also get a growing stream of shareholder cash flow that can be returned to us by management either with increasing dividends, share buy backs or both.
In fact, INTC will pay out around $1.19 per share in 10 years if management raises the dividend 8% per annum during that period – only one quarter the growth rate of the last 5 years. Anyone buying and hold Intel’s stock for the decade will then be earning 8.3% per annum on their original investment. Now compare that juicy 8.3% to the measly 3.85% you can currently earn holding the U.S. 10-year note… and you quickly get it – Intel is a raging buy at the current price as long as the company is around in 10 years and as long as management is able to continue to grow the dividend. And our analysis doesn’t yet include the possibility of additional cash that might be available to oh, say, buy in stock, resulting in the dividend yield rising even faster.
In Intel’s case, a quick check of current year estimates reveals that the company will have approximately $0.55 per share in excess cash after paying its dividend and meeting its capital expenditure requirements. A three-year average is often useful in ascertaining a company’s ability to throw off excess cash consistently. According to Value Line, Intel has generated approximately $5.66 in cash flow from 2006 to 2008, while making $2.76 per share in capital expenditures and paying out $1.41 per share in dividends, leaving approximately $1.49 per share in excess cash available to buy back shares, or $0.50 per share per annum. Adding the $0.50 in excess cash to the current $0.55 dividend gives you a current dividend yield of 7.35% (what the dividend yield would be if INTC management devoted all of its excess cash to the dividend). Unfortunately, Intel, like many management teams often chooses to buy back shares with excess cash. We think it unfortunate, because managers tend to pay top dollar for their own shares rather than waiting to buy in shares after their stock takes a dive. Nevertheless, buying in $0.50 per share per annum retires 3.5% of the outstanding shares at the current stock price (call it 2.0% net of stock option issuance), raising current and future dividends accordingly.
Yet another way to do the math without the distortation of a changing share count: Intel generated $34.2 billion in Cash Flow After Taxes (CFAT) during the three years ending in 2007, against $17 billion in Capital Expenditures (CAPEX), leaving $17.2 billion available to shareholders. The entire company was available for purchase for a mere $154 billion at the beginning of 2008 (you could buy it lock stock and barrel right now for $82.8 billion). Taking the three year average shareholder cash number of $5.7 billion and dividing it into the current fully diluted shares outstanding gets you $0.99 per share in stockholder available cash – a nice current yield of 6.9%, some 3.1% better than the 10-year’s current yield.
A couple ways then of looking at the yield to shareholders currently and a decade into the future in comparison to the 10-year Treasury – all favorable. We just need to make a judgment on whether INTC is likely to be around and prospering a decade from now.
The company is currently the world’s largest semiconductor chipmaker based on revenue, according to its 2007 10K SEC filing. INTC develops advanced integrated digital technology products, primarily integrated circuits, for industries such as computing and communications. Intel also develops platforms, which they define as integrated suites of digital computing technologies that are designed and configured to work together to provide an optimized user computing solution compared to separately. Intel currently controls about 80% of the PC processor market.
For starters, Intel has grown revenues from $30.1 billion in 2003 to an estimated $40.4 billion in 2008, or a little over 34% during the five-year period. Net profit is forecast to hit $7.3 billion in 2008, up from $7.0 billion in 2007 but well off the company’s peak profit logged in 2000 ($10.7 billion). Nevertheless, profit has grown steadily, albeit erratically, since the bottom fell out during the last recession in 2001 (profits bottomed in 2002 at $3.5 billion).
Clearly the company is likely to still be in business and growing earnings given its dominating position in the microprocessor industry and strong balance sheet (almost 13 billion in cash on the balance sheet at the end of 2007). On the other hand, just looking at the increasing variability in earnings leads one to the conclusion that the company is no longer a true growth company and should be bought after business conditions (and the stock price) have weakened and sold when investor enthusiasm carries the share price outside of the realm of reasonable valuation. We believe the current valuation is in the buying zone, given our discussion of dividend and shareholder yields.
AND A STOCK MARKET
You can unglazed your eyes now and refocus on the casino – that is to say the stock market. The truth is that few investors really want to spend the time rooting around in the financial statements of publically traded companies with a view toward discovering an undervalued business worth buying. It takes time and patience and more time. We ourselves have found it a profitable way of spending our time and we’re always fascinated by the inner workings of a business and the question of its true worth. But investing is boring compared to speculating – which over the last 20 years has more or less become the nation’s national pastime in our eyes.
Which brings us full circle in this, our first edition, to the derivatives bomb that has gone off in our faces and the resulting mess in which we currently find ourselves. We’ll give you a quick recap, since most of this is now fairly well known. We hope to save some space to sketch out a roadmap for the market in the coming years as well as for the economy that underlies it.
The root cause of our current pickle is easy money. The Federal Reserve dropped rates in response to the 1987 stock market crash and has been a one trick pony ever since (or at least until very recently). The consumer led recession of 1990-91? No problem, cut rates. Mexican Peso and Asian currency crises of 1994-95? No problem, cut rates. Long Term Capital Management implosion and Russian debt crisis of 1998? No problem, cut rates. Technology stock bubble implodes? No problem, cut rates and leave them at a historically low level for a very long time, ensuring that negative real rates will spike the velocity of money and force a veritable tsunami of liquidity into … housing markets around the world! Credit markets freeze as a mountain of bad mortgages and mortgage derived financial products lose their value once house prices start following? No problem, cut rates AND PROSTITUTE THE FEDERAL RESERVES BALANCE SHEET TO THE POINT THAT HYPERINFLATION IS A VERY REAL POSSIBILITY!
Ahem, we hope we now have your undivided attention because we’d like to throw out some thoughts on what the next 10 years or so holds for stocks, bonds, commodities, and our economy. The Federal Reserve appears to have reached the limits of what a one-trick pony can accomplish and so, under Ben Bernanke’s watch, the Fed has transformed itself into a multi-trick pony, all with the aim of preventing the mountain of debt that underpins our economy from crushing our major financial companies and, in a chain reaction, the companies and consumers that depend on them for credit.
In the process, the Federal Reserves balance sheet has ballooned from around $850 billion to some $1.7 trillion in just a matter of weeks, and is likely to reach $3 trillion by year-end. We will devote the rest of this edition to explaining just why that mammoth increase in the Federal Reserves balance sheet is likely to lead to inflation on a scale not seen since the 1970s (don’t worry, we’ll save a little space for telling you what’s likely to happen in the stock market in the next few months as well).
Ready? Okay, here it is…. inflation results when too much money chases too few goods and services. Double the amount of money in circulation but hold the amount of goods and services produced constant and inflation will result. The Federal Reserve has gone one better by doubling its balance sheet on the way to tripling it from what we’re hearing. What’s more, the dollars they are pushing into the system are now backed increasingly by collateral of dubious quality, to say the least. Boat loans, subprime credit card loans, and fancy triple A rated (and worthless) CDOs now represent a goodly portion of the assets backing the greenback. Not convinced that inflation is coming? How about the Federal Reserve buying debt directly from the Treasury? Here’s how that will work if Bernanke, as is currently rumored, elects to monetize the debt. The U.S. Treasury needs to raise the dough to buy up bad assets and make equity injections into insolvent banks, insurance companies and various other corporate miscreants. No one wants the debt because they already have too much of it so the Federal Reserve simple prints up a few hundred billion more of the good old greenback and uses the newly minted cash to buy the debt from the Treasury, which turns around and hands it over to the Titans of commerce in order to salvage our financial system. Sweet deal for sure, except for the fact that no one, and I mean no one will want to hold the dollar anymore if history is any guide. And all of that new paper will push prices higher and higher and higher. We hope the Federal Reserve doesn’t do it, but then we hoped they wouldn’t give J.P. Morgan $29 billion for a bunch of Bear Stearns assets that are almost certainly worth far less because, as taxpayers, we didn’t really want to take a loss on the overvalued paper…
As for the stock market? Our forecast for almost a year now has been for a substantial low in place sometime this fall with a retest sometime next spring. We see no reason to change it at this point. In fact, here’s what I wrote a buddy just a couple of days ago
Scott,
My forecast since last winter was for a significant low in the fall, a rally into winter and a retest by next spring. My fundamental reasons were that by this fall the horrifying extent of the credit market excesses would finally be laid bare for the masses to see, resulting in a selling climax sufficient to set a bottom that would hold for a few months. My retest was based on the thought that earnings estimates for the back half of 2008 and 2009 were way too high and the institutional weenies would start selling the misses and downward revisions by the winter pressuring the market into the spring. I also felt and still feel that the recession we're in (since about last fall) would be longer than normal, lasting up to a year and a half to two years - call it over by next fall/winter (fall of 2009/winter of 2010) at the latest. Figuring the market tends to lead us out by about six months also pointed to a springtime low/retest.
For the first time in 16 months, I’m excited about doing a little buying of some of the increasingly cheap stocks out there, recognizing that we were probably six to nine months early (but I don't want to get too cute with the spring of 2009 retest thing).
Regards,
Chris
Conflicting Interests
There are three main types of compensation received by financial advisors, brokers, financial planners and the like. The most lucrative by far is the commission based compensation scheme. Stockbrokers, insurance salesman, and some financial advisors and planners receive a commission when they sell you a product.
Fee-based compensation is a mix of fee for service and commission based. Some financial planners and advisors run a fee-based model, which allows them to charge a set fee for services while also receiving commissions for selling you a product or for referring you to someone who wants to sell you a product.
Fee-only advisors work for you rather than selling products to you. Fee-only financial advisors are still less common than the other two types of financial service providers, likely because they aren't compensated quite so handsomely. A major distinction between a fee-only provider and the other two types is that the fee-only provider is paid only by you, the client.
Fee-based compensation is a mix of fee for service and commission based. Some financial planners and advisors run a fee-based model, which allows them to charge a set fee for services while also receiving commissions for selling you a product or for referring you to someone who wants to sell you a product.
Fee-only advisors work for you rather than selling products to you. Fee-only financial advisors are still less common than the other two types of financial service providers, likely because they aren't compensated quite so handsomely. A major distinction between a fee-only provider and the other two types is that the fee-only provider is paid only by you, the client.
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