September 2010

Researching a Financial Advisor: Form ADV Part II

One thing I’d suggest doing before enlisting the services of a financial advisor is getting a copy of the advisor’s Form ADV.

Form ADV is a document that Registered Investment Advisers (RIAs) are required to file with either their state or with the SEC. It’s broken down into two parts.

ADV Part I includes:

  • Identifying information about the firm,
  • How many clients they have,
  • Total amount of assets they manage,
  • Whether or not they’re a broker-dealer or a registered representative of a broker-dealer (That is, are they paid commission to recommend certain investments?), and
  • A whole list of other (less interesting) tidbits.

ADV Part II includes (among other things):

  • What type of services they offer,
  • How they charge their clients (hourly fees, percentage of assets under management, fixed fees, commissions, etc.),
  • What type of analysis they perform when selecting securities for a client, and
  • The RIA’s education and career background.

Finding an Advisor’s Form ADV

There are two ways to get a copy of an RIA’s Form ADV:

If you look it up online, you can search by name of the firm or by name of the advisor. Unfortunately, RIAs aren’t currently required to submit Part II electronically, so you’ll have to ask the RIA for it.

Note: If a financial advisor doesn’t have a Form ADV, that means that he or she is not a Registered Investment Adviser. It’s likely that this person is either a commission-paid stockbroker or insurance agent, in which case my suggestion would be to look elsewhere for advice.

How About an Example?

It would surely be useful, but I don’t have the heart to make an example of an RIA whose Form ADV sets off all kinds of red flags. Instead, let’s take a look at an RIA whose ADV shows pretty much everything I’d look for.

Dylan Ross is an RIA and CFP who regularly reads and comments on this blog. His ADV Part II is publicly available on his website. From it, we can see that:

  • He charges hourly or fixed fees rather than commissions or AUM fees (and if you scroll through to Schedule F, you can see the specific fees for each service),
  • He counsels clients on long-term investing rather than short-term trading,
  • He provides advice in the areas of cash flow, debt management, risk management, college funding, retirement planning, estate planning, tax planning, asset allocation and investment selection.

And we can see the following about his investment selection process:

“Adviser believes that the appropriate allocation of assets across diverse investment categories (e.g. stock vs. bond, foreign vs. domestic) is the primary determinant of portfolio returns and critical in the long-term success of one’s financial objectives; therefore, Adviser advocates the use of passive, low-cost, broad-market index investments.”

Why Not Just Ask?

Wouldn’t an RIA would be willing to share any of the above pieces of information if you asked? Yes, almost certainly. Still, I’d suggest getting the official documentation for two reasons:

  1. It may call your attention to a potential red flag that you would not have thought to ask about, and
  2. It doesn’t allow for any wiggle room. Rather than getting a carefully-worded answer that conceals an unpleasant piece of information, you get a check in a box: “yes” or “no.”

September 29, 2010 4 comments

Stocks Aren’t a Ponzi Scheme

In the last two years, one assertion I’ve heard over and over is that the stock market a giant Ponzi scheme — it only works if everybody continues to feed it money, and it collapses when people take their money out.

A similar assertion is that the stock market is just a “greater fool game,” in which stocks’ only value lies in the hope that you can sell them at a higher price to a greater fool at some point in the future.

Both claims are nonsense.

Stocks Have Inherent Value

If the public at large decided that they wanted nothing to do with stocks, and they all pulled out (and this is, to a lesser extent, what goes on in severe bear markets), stocks wouldn’t become worthless. Yes, they’d be worth less, but not worthless.

For the value of a stock to go to zero, the company itself has to be worthless. As long as a company has intrinsic earning potential, a share of ownership in that company has value as well.

A Worthless, Profitable Company?

For example, imagine if the price of Verizon’s stock declined all the way to $0.01 and that this decline was caused purely by investor panic. That is, it had nothing to do with any fundamental change in the profitability of the company. With a share price of $0.01, the company’s dividend yield (based on its most recent dividend) would be 4750%! Even if the price never went back above $0.01, you could get an obscenely high return from buying at such a low price.

Of course, such a scenario would never occur. The price of a company doesn’t ever go that low unless there’s a fundamental decline in the company’s profitability. At some point, investors would step in to snatch up the high dividend yield, thereby keeping the price from falling further.

Owning, Not Just Selling

Yes, companies’ earning potential can decline, or even go to zero. But it’s not caused by people getting scared.

Unlike a Ponzi scheme or a “greater fool” game, stocks have an inherent value. And they have that value even if there’s no “greater fool” to sell to, and even without investors continually pumping  money into the system.

Now, to be fair, stocks do have a ponzi-ish aspect to them, in that their market value does go down when other people pull their money out. But to assert that stocks’ only value lies in their ability to be sold is simply not true. You can receive value by owning stocks, not just by selling them.

September 27, 2010 5 comments

Investing Blog Roundup: Looking for a Technical Editor

I know that lots of CPAs, CFPs, EAs, and other knowledgeable folk read this blog. So I have a request for you.

I’m currently looking for a technical editor for my upcoming book — somebody who can read over my draft(s) to help make sure that I don’t put my proverbial foot in my mouth by misstating any tax law or anything of that nature. (I try to be careful, of course, but I’m human and make mistakes.)

If that sounds like something you’d be interested in helping with, please let me know, and hopefully we can work out a fair rate of compensation for your time.

Thanks!

Update: Wow, thank you, everybody, for all the emails! Looks like we’ll have a great team lined up. :)

Investing Articles

Other Money-Related Articles

Blog Carnivals

Thanks as always for reading. :)

September 24, 2010 1 comment

Deducting an IRA Loss (Roth or Traditional)

From time to time I get emails asking whether it’s possible to claim a deduction for a loss in an IRA.

Yes, it’s possible. But the rules for deducting an IRA loss are so restrictive that it’s a non-option for most investors. Specifically, there are three reasons why most taxpayers won’t be able to gain any tax benefit from a loss in their IRA.

You Can’t Claim a Loss on a Per-Investment Basis

In a taxable account, you can sell an investment that’s currently worth less than your cost basis (which, in most cases, is what you paid for the investment) and claim a loss. In an IRA, you can’t claim a loss on a per-investment basis. The whole IRA needs to be worth less than your basis in the IRA.

  • For a Roth, your basis is equal to the sum of your Roth contributions.
  • For a traditional IRA, your basis is equal to the sum of your nondeductible traditional IRA contributions. (Note: This means that for many investors, their basis in their traditional IRA is zero, and, therefore, they cannot claim a loss no matter how low the value of their IRA goes.)

Also, for purposes of deducting a loss in an IRA, all your Roth IRAs are considered to be one Roth IRA, and all your traditional IRAs are considered to be one traditional IRA.

Example: In 2009, Jerry opened his first Roth IRA with a $5,000 contribution. In 2010, he opened another Roth IRA (at a different brokerage firm) with a $5,000 contribution. At the end of 2010, one IRA is worth $4,000, and the other is worth $7,000. Even though one IRA is worth less than his initial contribution, Jerry cannot claim a loss because the combined value of his Roth IRAs is greater than his basis ($10,000).

You Must Distribute the Entire IRA

The second reason many investors can’t benefit from the ability to deduct IRA losses is that, in order to claim the loss, you have to have all the money in the account distributed to you. That is, you have to withdraw every dollar from the IRA. (Or, more specifically, you have to withdraw every dollar from all your IRAs of that type, because, as we just discussed, they’re all considered to be one IRA.)

The reason this can be a problem is that taking IRA distributions to claim a loss does not exempt you from the 10% penalty if you’re under 59½. As such, unless you meet one of the other exceptions to the penalty, the extra 10% tax will almost surely negate the benefit of being able to deduct your IRA loss.

Note: In the case of a Roth, this is a non-issue, as you can take Roth IRA withdrawals up to the amount of your contributions without paying tax or penalty. (And your contributions are obviously greater than the IRA’s current value, otherwise there would be no loss for you to consider deducting.)

It’s a Miscellaneous Itemized Deduction

The final reason that most investors can’t benefit from claiming an IRA loss is that the deduction you get is a miscellaneous itemized deduction. You can only deduct the loss the extent that it (plus your other miscellaneous itemized deductions) exceeds 2% of your Adjusted Gross Income.

And even then, you only receive a benefit from the deduction if it (plus your other itemized deductions) exceeds your standard deduction for the year.

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September 22, 2010 0 comments

Merrill Lynch Debit Card Review

This is a guest post by Michael from Credit Card Forum

If you want the best cash back credit card, check out Mike’s recent post about the Fidelity Retirement Rewards American Express, which offers rewards worth 2%. But if you prefer debit cards over credit cards, you may want to consider the Merrill Lynch Signature Rewards debit card.

What makes it special?

As we all know, it’s rare to find a debit card that offers rewards. There are a few on the market, but the fine print often includes traps or tricks. For example, Chase recently started offering a debit card with “up to” 3% cash back, but it’s not nearly as good as it sounds — there’s an annual fee, cash back is only given on a few categories of spending, and you have to spend over $1,000 per month to qualify for the maximum rebate.

The Merrill Lynch debit card is different from the rest. For starters, it offers a flat 1% back on spending — for a credit card that may be average, but for a debit card that is almost unheard of. It also offers a wide array of benefits that, to the best of my knowledge, aren’t offered on any other debit card at the moment. There is an annual fee, but you won’t necessarily have to pay it (which I will discuss further in a moment).

A closer look at the rewards…

You earn 1 “Merrill Point” per dollar spent, and for most redemption options, each point equals a penny (so 1% rewards). Here’s what you can cash them out for:

  • IRA Account: You can convert the points to cash which will be deposited into your Merrill Lynch IRA.
  • 529 Account: Your points can also be converted to cash for your Merrill Lynch 529 account (college savings account).
  • Fees & Commissions: If you don’t have a Merrill IRA or 529 account, you can still redeem your points to pay for fees and/or commissions posted to most other Merrill Lynch accounts during the current calendar year.
  • Travel: They say you can “travel anytime, anywhere, any airline with no blackout dates starting at 25,000 Merrill Points”
  • Miscellaneous: There are other options for merchandise, gift cards, etc.

A closer look at the benefits…

This debit card is a Visa Signature, which is something normally only found on credit cards. It comes with benefits for travel purchases made on the card, such as lost luggage reimbursement, trip cancellation insurance, medical evacuation coverage, common carrier travel accident insurance, and more. One benefit in particular I like (because I do not believe AmEx offers it) is the Hotel/Motel Burglary Coverage –- in the U.S. and Canada, you’re eligible for up to $1,000 in coverage if personal property is stolen from your room.

They also throw in phone concierge service and “Purchase Security” which covers eligible purchases made with the card for up to 90 days against theft, some types of accidental damage, etc.

What’s the catch?

For starters, you must have a Merrill Beyond Banking or Cash Management account. Your card will be linked to it and purchases will automatically be debited from its balance. Last but not least, there is a $95 annual fee which you may or may not have to pay. I know at least one accountholder who has the fee waived. Whether or not they will be willing to waive it likely depends on your balance and relationship with Merrill Lynch.

Verdict?

If you use Merrill Lynch for your brokerage account, their Signature Rewards debit card can be a great way to offset fees and commissions. Alternately, the card can be an easy way to add to your 529 college savings or IRA. That being said, if they’re not willing to waive the annual fee for you, it might not be worthwhile.

Michael runs CreditCardForum, which is a message board and blog for the discussion of credit cards and debit cards. Topics range from cash back credit cards to credit card customer service. On a personal note, traditionally Michael has invested in individual stocks based on intrinsic value, but due to time constraints, during the last few years he has been sticking with index funds.

September 20, 2010 4 comments

Investing Blog Roundup: Hedge Funds and ETFs

I’m not sure what happened differently, but when it came time to prepare this week’s roundup, I noticed that I’d tagged a lot of posts for inclusion. As such, they’re broken down into more categories than normal to make it easier to pick out the ones you want to read.

Enjoy!

Investing

Frugality

Credit

Other Interesting Articles

Blog Carnivals

Thanks for reading, everybody. I hope you enjoy your respective weekends. :)

September 17, 2010 2 comments

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