Wednesday, July 14, 2010

Skeptical Investing

John Lawrence Reynolds pulls no punches in his book The Skeptical Investor: How to Grow and Protect Your Retirement Savings. He rips through the investment industry, fraudsters, and poor investment vehicles. Overall, the book is useful for novice investors, but they may find themselves cowering under a bed before reaching the last page.

The main focus of the book is what investors should not do. Less focus is placed on what investors should do, but this makes some sense. There is only one best path and many bad paths. Reynolds explains what is wrong with the bad paths in easy to understand compelling terms.

About mutual funds he says “Canadian mutual fund expenses charged to those who entrust the fund with their money are outrageously and indefensibly high.” Reynolds thinks that a fee-based approach where investors pay a fixed percentage of their assets rather than paying commissions and MERs makes more sense.

“Nearly 5% of Canadians have been victims of investment fraud at some point in their lives.” This surprised me greatly. Could this really be true of over a million people? Reynolds devotes an entire chapter to an interesting discussion of different types of investing fraud.

A common theme in the book is that investors must be protected from huge drops in stock prices like what happened in 2008 and 2009. Many times Reynolds tears apart financial advisors for not protecting their clients from stock market crashes. At first I thought he meant that advisors should have seen the crash coming, but he never explicitly says what the advisors should have done to protect their clients.

The book goes through various methods of protecting principal, but finds them all lacking. Principal-protected notes, segregated mutual, and lifecycle funds have high fees built in. The risk of default with high-yield bonds is too high. Put options are too complicated for most investors to understand. Good financial advisors who can protect their clients are available only to those with 7-figure portfolios. Asset allocation does not prevent losses.

Wolves await the small-guy investor behind every door. What does the author suggest we do? In the end he advises a fairly conservative asset allocation where your percentage in fixed-income matches your age up until about age 80 when you should buy an annuity. This is a little too conservative for me, but most investors will make worse choices than this.

Overall this book is useful for explaining the many pitfalls awaiting the unwary investor. The criticisms of the investment industry are mostly deserved. The exception is the implication that financial advisors can somehow protect clients from losses. Of course, investors who view financial advertising can be forgiven if they believe that they were promised protection from losses.

4 comments:

  1. You have to be a skeptical as an investor. Securities regulation can't be counted on -- look at the recent proposal to create a national securties regulator without a head office.

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  2. @Larry: I agree that you have to be skeptical. Many people and organizations survive by persuading others to hand over their money. This is easier than trying to make money by doing something useful.

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  3. I think that investing in general requires a lot of skepticism (probably more than I can handle). However, knowing what warning signs to look for is helpful for those of us cowering in our beds after reading such a book.

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  4. @Jenna: I agree that knowing the warning signs is important. The author had a flair for dramatizing risks, but the information provided is mostly solid.

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