I wish that someone would have given me a list of money manager “red flags” when I first got into the business 13 years ago, but it is through various experiences that I have learned a few things to walk away from. If you are working with a top notch financial advisor, they should be giving you access to top notch money managers to manage pieces of your portfolio. Here are a few common things to be wary of:
1. Back Testing– Typically a money manager will provide historical investment returns, which I believe is a very important part of the selection process. Make sure that these are true historical returns and not “back tested” returns (the return that hypothetically would have happened if they had managed the portfolio in the same way in the past). Look out for phrases such as “This is how the portfolio would have performed if it would have been around since 1995”. Many advisors fall into this trap early in their career. Make sure that your money manager has true historical returns. Historical returns do not guarantee future results, but it is a good indication of the quality of the money manager that you are working with.
2. The Latest and Greatest– Investing in the newest, latest, greatest strategy is another pitfall to be aware of. We have different product wholesalers that walk into our office at least twice a week that can’t wait to tell us about the newest, latest, greatest, most unique, never been done before, sure to be victorious (you get the point) strategy. You hear words such as dynamic hedging, momentum, algorithm, and derivatives. It all sounds intriguing, it’s exciting, and the truth is that it may be a good strategy. If it is a good strategy today, it should still be a good strategy 3 years, 5 years, and 10 years from now, so let the strategy withstand the test of time before you let your advisor invest your money into it. Let someone else take that fall in the first few years while they work the kinks out.
3. Over Exposure to Any One Sector- A great example of this is the Oil and Gas Sector three years ago. We were in the middle of an “Energy Revolution” in the U.S. and the price of oil was well over $100/barrel. It was the hot sector to invest in at the time. Very few people thought that the price of oil would go down to $27 a barrel within the year. These things happen and being invested in a hot sector is not necessarily a bad thing, just be careful not to overexpose yourself to a sector. Another great example is healthcare over this past year. Healthcare stocks were on a five year run before falling almost 20% last year. Be sure that you are diversified enough that if one sector performs poorly, it is not going to take down your entire portfolio.
Investing involves risk including loss of principal. No strategy assures success or protects against loss.