For best results, focus on allocation on your investments

South Florida Sun-Sentinel
Humberto Cruz

Q: I am astounded, turned off and shocked by your statement: "I choose not to invest in individual stocks because I prefer the diversification of mutual funds and because I do not feel qualified to select individual securities." How can you write a column as a financial adviser if you are not qualified in individual securities selection?

Mutual funds have become a fashionable cop-out. Many have been found fraught with corruption, insider crime and excess fees (except for Vanguard). Finally, the Securities and Exchange Commission and attorney general of New York have caught up with them.

The alternative is to construct your own "mutual fund" with as much diversification (a stock from every sector and size) or as little as you wish (say oil and gas stocks, which I have pursued quite successfully).

A: Let me say it again: I am not a financial adviser. I am a columnist. I write about personal finance issues, including the pros and cons of investment strategies, but I do not recommend specific investments.

Investing is only one of many factors in personal finance. Before you invest, you need to follow a budget and save, handle credit wisely and have adequate insurance. When you invest, you need to consider tax and estate planning implications. Questions on investment planning per se account for just 19 percent of the score in the examination for the certified financial planner designation, the credential of choice in the financial advice industry.

Investing, of course, is important. I've been writing about problems with mutual funds since long before New York Attorney General Eliot Spitzer fired his first shot in September 2003 by charging that some funds allowed a favored hedge fund client to engage in improper late trading and market timing that hurt long-term shareholders.

These charges, and subsequent civil and criminal actions by Spitzer and the SEC, have underscored the overriding ill afflicting much of the industry: a focus not on what's best for investors but on maximizing profits for the fund management companies.

The results, even when laws are not broken, have been rising fees and expenses; a myopic focus on short-term performance that leads to escalating portfolio turnover, higher transaction costs and unwanted taxable distributions; and the creation and heavy marketing of risky funds designed to suck in investors chasing after the latest "hot" sector.

So, why not construct your own "fund" by picking individual stocks?

That's fine for investors with enough know-how and money to build a diversified portfolio. Two nonprofit investor education groups I often mention, the American Association of Individual Investors and National Association of Investors Corp., are built on the premise that people who take the time to study and learn can select winning stocks.

Both organizations, however, also teach investors how to select mutual funds. I believe that, for most investors, low-cost, broadly diversified stock mutual funds (they do exist, and not just from Vanguard) offer the most practical and cost-effective way to invest in the stock market.

Diversified funds, including passively managed index funds, allow investors to focus on the fundamental decision of asset allocation, or how much of the portfolio should be in stocks and how much in fixed-income or other type of investments. Although there is far from full agreement on the specifics, numerous studies have shown investment returns depend more on the overall asset allocation than on what stocks you buy.

So, if you want to pick your own stocks, go ahead. But remember that everybody cannot beat the market because investors as a group are the market.

"For every winner, there is a loser," said Harold Evensky, a certified financial planner in Coral Gables who is widely considered by his peers to be among the best in the country. "For your reader or anyone to be qualified to select individual stocks, they must have some reasonable, not naïve, expectation that they will, over time and net of expenses, consistently outperform institutional competitors ... And I have serious doubts regarding most professionals' ability" to beat market indexes themselves.

"If it's of any consolation," Evensky said, "I've been in this business almost 30 years. I've served as a vice president of investments at Bache [now Prudential] and Drexel Burnham Lambert [now Smith Barney], and owned my own broker-dealer and registered investment advisory firm for almost 20 years. I do not feel qualified to select individual stocks. I do, however, feel eminently qualified to advise my clients regarding portfolio design and implementation, including the selection of appropriate investment strategies, money managers and investment vehicles."





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