LFM&P
Linnard
Financial Management & Planning, Inc.
Registered
Investment Advisor, Wealth Management & Financial Planning
July 1, 2006
Outlook & Trends
This
issue of Outlook and Trends discusses the different kinds of financial advisors
and the concept of a financial fiduciary, in addition to reviewing the current
condition of the economy and markets as we always do. The fiduciary issue is
important to consider as you retain and work with a financial advisor to build
and execute your financial plans. You want to make sure your advisor’s
allegiance is 100% to you. Also, you will find our business card included. I
hope you will tuck it away in safe place for when you need it, or give it to a
friend who might need financial planning or management assistance today.
Economy
The Federal Reserve has seamlessly changed from a policy of raising rates to remove monetary accommodation to raising rates to ward off potential inflation. Every month or so the pundits attempt to psychoanalyze the Fed’s Open Market Committee and wind up predicting a stopping point that is ¼ percent higher than the prior month’s forecast. Rather than try to predict the end of the rising rates, it makes more sense to take the Fed at its word. They will stop the rate increases when economic data show that inflation is under control.
The
level of rates is, of course, of great importance. The higher the rates become,
the greater the chance of a more significant slowdown. Bond values and the real
estate market are already directly experiencing the effect of rate increases.
Other businesses and stocks will be affected eventually if rates continue to
rise. For now, however, economic conditions are very good. The economy grew
fairly fast at a real annual rate of 5.6% in the first quarter, up from 1.7%
during the last quarter of 2005. Employment is high. Corporate profits have
grown rapidly (28.5% over the last 12 months), but salaries have not kept up,
rising at about a 3.5% rate. Consumers are a bit more pessimistic than normal.
The stock market hit its post-bear-market peak in May, and prices have been falling fairly continuously ever since, led by the smaller stocks and commodity sectors that had been posting the big gains before. Likewise, bond prices have been falling as yields have risen as a result of the Federal Reserve’s interest policy. We have mentioned more than several times since the market bottom in 2003 that stocks have been undervalued in relation to bonds. This is still true, although not as much as before. The implication remains that in order to restore parity, stocks must rise or bonds must fall, or both. This adjustment process has been occurring slowly since we first mentioned it, and as yet there is no distinct sign of it ending, although the rate of gain in stock prices may be slowing down.
There is no law that says that
markets must follow historical averages, but they often do. Unfortunately the
third quarter of the year tends to be the weakest. Not only that, but the second
year of the four-year presidential term tends to be the weakest year. So here we
are, in the third quarter of the second year. This is not a prediction by any
means, but we thought you might like to know.
Before
1999, roles within the financial industry were clear. That changed when the
Financial Services Modernization Act was passed and insurance companies started
selling mutual funds, stockbrokers started selling insurance, and banks began
selling both. After these changes, insurance agents, stockbrokers and bankers
all began to call themselves “financial advisors”. Identifying their real
role has been more difficult ever since.
One
of the important distinctions to make is whether or not your advisor has a
“fiduciary” relationship with you, meaning that your advisor must place your
interests before their own self-interest. Doctors, lawyers and trustees
are all fiduciaries. This distinction is basic and obviously important. If your
advisor’s relationship is not clear to you, you are not alone. A study* by TD
Ameritrade found that only 26% of investors knew that Registered Investment
Advisors (RIA) must be fiduciaries, while stockbrokers are not. Insurance
agents, real estate agents, and mortgage brokers also are not required to be
fiduciaries. In fact, it is difficult to see how any commissioned sales
relationship could be a fiduciary relationship, because of the inherent
potential for monetary conflict of interest.
The
US Securities and Exchange Commission recently issued Rule 202 that exempts
stockbrokers from the Investment Advisors Act of 1940, which requires investment
advisors to act as a fiduciary. In an attempt to clarify the difference between
the brokerage function (including fee-based accounts) and that of a Registered
Investment Advisor, the rule requires brokers to disclose, “Your
account is a brokerage account and not an advisory account. Our interests may
not always be the same as yours...” Furthermore,
the rule says that stockbrokers may only provide investment advice that is “solely
incident to the brokerage services provided”, i.e. brokers may only advise
you about the products they are selling to you. They may not say they are a
financial planner, deliver a financial plan to you, or say that the advice
provided is part of a financial plan.
Making
it even harder for you to distinguish, a company that provides brokerage
services might also have set up an advisory subsidiary to provide you with
planning advice under a separate agreement for an additional fee. They are then
permitted to “wear two hats”, but the planning services must be provided as
a Registered Investment Advisor. This means that the advisor must accept the
additional responsibility of being a fiduciary to you. Since it may not be clear
which type of relationship you have, you may want to ask your representative
whether they are a fiduciary.
How
can you tell if your financial advisor is a fiduciary or a sales agent?
·
If
commissions or mutual fund loads are involved, it is most likely a sales, not a
fiduciary relationship.
·
In
determining whether an advisor is a fiduciary or not, generally ignore
designations like CLU, ChFC, CFP®, Series 7 etc., which are
certifications or licenses that are earned through education and experience.
Fiduciary status is related to function or position, such as Registered
Investment Advisor, Trustee, or Qualified Retirement Plan Officer. Other
fiduciaries, such as NAPFA-Registered Advisors, agree to act as a fiduciary as a
condition of membership in an organization.
·
Ask who
licenses the advisor or regulates your business with them.
o
If it is
the National Association of Securities Dealers (NASD), Real Estate Board, or
State Division of Insurance, your representative is not a fiduciary.
o
If the
regulator is your state’s Securities Division or the US Securities and
Exchange Commission, your advisor is an RIA and a fiduciary.
To learn more about LFM&P
financial planning and investment management services, our client goal-centered
financial philosophy, and to better understand the value we can bring to your
financial life, we encourage you to contact us or look at our website, www.linnardfinancial.com.
David C. Linnard, MBA, CFP® Barbara V. Linnard
President Vice President
*www.amtd.com/governance/advocacy.cfm
, “TD Ameritrade Investor Perception Study”