(How To Select A Financial Advisor Series – Ed Mahaffy) Request Copy of eBook In Its Entirety With Charts

SECTION 5 INDEX FUNDS

Chapter 12: Index Funds

An index fund is a bundle of stocks. The stocks that the fund holds are the same stocks, with the same weightings (percentages) as the stocks represented in a particular index, such as the S&P 500 index. You cannot own an index. You can own the same stocks as the index—an index fund.

The only time a stock in an index fund is bought or sold is when the publisher of the index makes a change in its lineup. For instance, if the S&P 500 expels ABC Company and replaces it with XYZ Company, then any index fund tracking the S&P 500 will do the same thing. This is mutual fund investing in its simplest form.
Index funds are said to be “passively-managed” because there is really not much to manage, which is why the costs are so low. As it turns out, more intense managing does not equate to more money for mutual fund shareholders, only more money for Wall Street.
Index funds do not buy or sell stocks often because changes to the underlying index do not often occur. This keeps capital gains tax liability low. The index fund avoids the expense associated with a lot of buying and selling—such as high-priced analysts, costly research, and the expense of conducting numerous transactions. The savings enable these funds to compete very effectively with mutual funds that are trying to beat the market.

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Ask Ed Financial Planning Q&A

Once I read Ed Mahaffy’s book titled “How To Select A Financial Advisor: The Least You Should Know”, interviewed him, reviewed his video library, I knew we had the right person for this special financial planning series. On Fridays, TaxConnections presents questions often asked of a Financial Planner.

Dear Ask Ed:  Special Financial Questions For Women

Question: Are you participating in the financial planning process?

Answer: You need a financial plan. If you are married, become an active participant in all aspects of the family finances. Be aware of how to access all accounts and other assets in the event of divorce or death of a spouse.

Question: Do you understand your situation, how it relates to your goals and what consistent steps  on your part, such as saving and investing an adequate  amount each month, are required to maximize the probability of reaching your goals?

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How To Select A Financial Advisor: The Least You Should Know (Part 12 In eBook Series)

Chapter 11:The Importance of Proper Asset Allocation

The way in which you allocate your assets among asset classes, such as stocks, bonds, and cash will have the greatest impact on your investment results. Studies show that up to 88 percent of the variation in returns is explained by one’s asset allocation, not by individual security selection, fund selection or market timing.

What Is Asset Allocation?

Asset allocation is the process of combining asset classes such as stocks, bonds, and cash in a portfolio in order to meet your goals.

A financial advisor, whether a retail broker or independent investment advisor, can add value by helping you make the important decision about how to allocate your investment assets. Essentially, asset allocation is the concept of proper diversification—not putting too many eggs in too few baskets, and of seeking the most efficient balance of the perceived risk and expected return.

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Dear Ed: Financial Planning Questions & Answers

Once I read Ed Mahaffy’s book titled “How To Select A Financial Advisor: The Least You Should Know”, interviewed him, reviewed his video library, I knew we had the right person for this special financial planning series. On Fridays, TaxConnections presents questions often asked of a Financial Planner.

Ask Ed: Financial Planning Questions 

Question: How are you compensated-by commissions, fees or both?

Answer: Many advisors charge a percentage of the value of the assets they manage-typically 1.0% to 2.0%. Most advisors are licensed to sell products and earn commissions as well.

It’s critical to identify all sources of advisor compensation and determine which compensation model makes the most sense for you. Be advised that many financial products have commissions that can be difficult to identify.  Require the advisor to disclose, in writing, any revenue sharing or commission arrangement they may have.

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How To Select A Financial Advisor: The Least You Should Know (Part 11 In eBook Series)

Chapter 10: Active Management vs. Passive Management

If a financial advisor’s value proposition is founded on their (or their firm’s) ability to consistently pick winning stocks, mutual funds or investment managers, or to time the market swings, it is highly unlikely that they will agree with what you will learn in this chapter. However, facts are facts.

Active management: Attempting to beat the risk-based returns of the broad market or a particular asset class, either through individual security selection or market timing. Any mutual fund, annuity, or separate account manager attempting to beat the market subscribes to active management. The term “active” does not necessarily mean that the manager is executing frequent buys and sells, although this is often the case.

Passive management: Attempting to match the risk-based returns of the broad market or a particular asset class by broad ownership of many or all stocks in the broad market or asset class. An example of a security relying upon passive management would be a no-load S&P 500 index fund.

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How To Select A Financial Advisor: The Least You Should Know (Part 10 In eBook Series)

Chapter 9: Know Thyself

One of the most important things that any investor can do is identify their risk tolerance. You should understand how recent market activity may influence the way you feel toward the market, and consequently, your risk tolerance at any given time.
I have followed Jason Zweig for many years and have always found him to be a voice of reason. Your Money and Your Brain by Jason Zweig, Simon & Shuster, should be required reading for all investors. The following article appeared in the Wall Street Journal in February 2012. If you do not read Jason’s book, at least read this article.

The Intelligent Investor: This Is Your Brain on a Hot Streak by Jason Zweig

Past returns are no guarantee of future success. Just like smokers ignoring the Surgeon General’s warning on the side of cigarette packs, investors over-look the most obvious caution about the stock market at their peril.

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How To Select A Financial Advisor: The Least You Should Know (Part 9 In eBook Series)

Chapter 8: Hidden Ongoing Commissions

When I was growing up, I spent summers working on the family farm, which grew cotton, soybeans and rice. There were many snakes in the rice fields. I learned quickly that the snake you can see is not the one that bites you. It is the same way with hidden commissions, also known as 12(b)-1 fees. If you own a mutual fund or variable annuity, you are most likely paying a 12(b)-1 fee, whether you realize it or not. A 12(b)-1 fee is an ongoing commission often amounting to 1.0 percent of the value of your investment annually.

Named after the 1980 legislation that created them, 12(b)-1 fees were intended as one-year relief for struggling mutual funds. Today, over 70 percent of mutual funds and many variable annuities charge these onerous fees, which cost investors well over $10 billion each year. They are collected by the mutual fund directly from fund assets, and paid to the brokerage firm that holds the fund. Also known as trailing commissions or “trails,” these fees can be charged for many years for mutual funds, variable annuities, or other products that impose them.

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Ed Mahaffy: How To Select A Financial Advisor

Chapter 6: FEES MATTER
Too often, what makes big bucks for Wall Street makes
little sense for investors.

The miracle of compounding returns has been overwhelmed by the tyranny of compounding costs. ~ John C. Boyle, Founder, Vanguard

How long will it take for your money to double? The “Rule of 72” provides the answer: simply divide 72 by your compounded annual rate of return.

For example, if your investment return is 10 percent, it will take 7.2 years to double your money: 72/10. With an 8.0 percent return, it takes 9 years to double your money: 72/8 = 9.

Let’s examine the impact of fees on your returns. It is not uncommon for annual fees to exceed 2.0 percent for many financial products—variable annuities, mutual funds, and separately-managed accounts, for instance. Many products collect fees directly from the fund’s assets, so shareholders never see an invoice (Wall Street’s true genius) for charges such as management fees, administrative fees, and ongoing asset-based commissions known as 12(b)-1 fees. A 2.0 percent expense ratio (annual expenses/total assets) is a huge burden to overcome. Consider the illustration on the following page.

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How To Select A Financial Advisor: The Least You Should Know (Part 7 In eBook Series)

Chapter 5: Your Financial Advisor’s Business Model Matters

Despite the many job titles and professional designations that exist in the financial advisory profession today, there are three basic business models for financial advisors: a retail broker employed by a brokerage firm, an independent broker, or an independent investment advisor. Although you will find exceptional financial advisors working under each of these business models, the following discussion identifies the strengths and weaknesses of each business model from the client’s perspective. Let’s compare them.

The Retail Broker

The retail broker is employed by a brokerage firm and is otherwise known as a stockbroker or registered representative. Retail brokers offer brokerage accounts. As noted in Chapter 4, brokerage accounts provide no fiduciary legal obligation to act in your best interest.

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How To Select A Financial Advisor: The Least You Should Know (Part 6 In eBook Series)
Chapter 4:
The Type of Account You Maintain Matters

The type of investment account that you maintain will determine the extent to which you receive the protections offered by the fiduciary standard. Your account type also can affect the investment recommendations that you receive. Will your portfolio be comprised of cost-effective, tax-efficient investment vehicles? Or will it include financial products characterized by high annual expenses, surrender charges and unnecessary tax liability? Over time, these factors can make a huge difference in your account balance.

There are two basic account types: the Brokerage Account and the Advisory Account. What is the difference? Brokerage accounts must only meet the suitability standard, but advisory accounts must meet the fiduciary standard. To repeat from the previous chapter, the suitability standard provides far less protection for investors than does the fiduciary standard.
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Ed Mahaffy: How To Select A Financial Advisor: The Least You Should Know (Part 5 In eBook Series)

Chapter 2

Fiduciary: The “Gold Standard” Of Care

What is a fiduciary or a fiduciary relationship?

A fiduciary is a person or organization that owes to another
the duties of good faith, trust, confidence, and candor.
This special relationship of trust established by law is similar to the relationship one has with an attorney or doctor. When an advisor acts in a fiduciary capacity, that advisor is legally obligated to maintain an allegiance of confidentiality, trust, loyalty, disclosure, obedience and accounting to his or her clients. All NAPFA members must sign and abide by the NAPFA Fiduciary Oath. Source: NAPFA

Chapters 3, 4, and 5 provide an historical perspective of the landscape prior to Regulation Best lnterest (Reg BI), which took effect in 2019. lt requires somewhat better disclosure on the part of broker-dealers. However, Reg BI fails to require brokers to meet the fiduciary standard, or anything close to it. Although chapters 3, 4, and 5 now serve the purpose of providing an historical perspective, the past and the present are not too far afield. Again, Barbara Roper, Director of lnvestor Protection for the nonprofit Consumer Federation of America stated the following regarding Reg BI: “lnstead of strengthening protections for investors, the new standards place them at greater risk—misled into expecting best interest advice that the rules do not require.”

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How To Select A Financial Advisor: The Least You Should Know (Part 4 In eBook Series)

Chapter 2:
The Least You Should Expect

What are the basic credentials, skills, and policies that you should expect from your financial advisor?

1. A clean disciplinary background. Ask the advisor which organization regulates his conduct: the Securities and Exchange Commission or the Financial Industry Regulatory Authority. Then, go to the appropriate website (www.sec.gov or www.finra.org), and see if the advisor has faced any disciplinary proceedings.

2.A full-time fiduciary obligation to always act in your best interests. A fiduciary is a person with a legal requirement to always act in your best interests.

3. Use of transparent investment vehicles that clearly identify the costs of ownership.

4. A reputation for honesty, integrity, accessibility, accountability, and confidentiality that is confirmed by several long-standing clients.

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