Despite all the choices available today, successful investing is more difficult and challenging than ever. In this article, Paul Merriman discusses the important decisions investors must make as they come to two fundamental forks in the road.

When I entered the investment business 40 years ago as a broker-in-training in New York, I was told the biggest decision my clients would face was how much to put in stocks and how much to put in bonds.

Life seemed easy and simple, with limited choices. Investing in stocks meant picking 15 to 20 surefire rockets out of the “Nifty 50.” There was no schooling on what types of bonds were best. In fact, most portfolios contained a healthy dose of low-paying municipal bonds. These were used to shelter income from the 70% maximum tax rates on ordinary income. There were no IRAs, 401(k)s or Roths.

Most investors followed the advice of brokers. The commissions brokers charged clients for trades were regulated and so expensive that no one entertained the thought of day trading. The front-end loads on mutual funds were 8.5 percent. A small number of no-load mutual funds were available, but they attracted only a trickle of money compared with the flood going into load funds.

It was a paternalistic era, when people could expect somebody else to take care of them. Investment decisions for retirement planning were made by corporate employers. The company set the necessary funds aside, made the long-term investment choices and shouldered the risk if those choices should turn out to be bad ones.

If you worked for a stable company, you could count on your employer for health care and a retirement plan to supplement Social Security, which lived up to its name with unquestioned security.

IN TODAY’S WORLD

Today’s young investors face a different landscape. Most will never have a defined benefit plan from an employer. Future Social Security benefits are less certain than ever before. Health care costs are on the rise while coverage is shrinking.

(Talk about insecurity: As I was putting the final touches on this article in August, I read that Radio Shack fired about 400 people, effective immediately, via email.)

In today’s do-it-yourself world, you are in charge of securing your own future.

Unfortunately, millions of people still behave as if the old reality were in place, incurring too much debt, practicing poor financial habits and not saving enough money. According to a recent survey by the Employee Benefit Research Institute, about 68 percent of workers have household retirement savings of less than $50,000.

Looking out for your financial health and planning for your future isn’t so simple. You have literally thousands of choices of providers, products and services.

In addition to bankers and brokers, there are investment advisors, wealth managers, investment consultants, financial advisors, financial consultants, financial planners, Certified Financial Planners, Chartered Financial Analysts, retirement planners, portfolio managers, mutual fund salespeople and insurance company salespeople in the investment game – all vying for your attention and your money.

No individual could possibly wade through all the available investment information, which seems to be growing exponentially. Hundreds of TV and radio channels, newsletters, websites and other venues offer 24/7 access to business news, hot tips, profiles of mutual funds, stocks, industries and global business news coverage.

Even the investment experts can’t master it all. And so at the end of the day, baffled, buffeted and exhausted, investors come to two forks in the road.

THE FIRST FORK IN THE ROAD

“Who Do You Trust?” was an early TV game show hosted by Johnny Carson. It’s off the air, but the question in its title defines a major fork in the road for today’s investors: Where will you go for information you’re willing to rely on?

Your two main options are Wall Street and the academic community of experts who have studied Wall Street. The choice you make will be critical to your future financial health.

Wall Street’s information is easy to come by. It’s always friendly and usually doesn’t demand much from you. Academic information is something you must look for, and it usually requires some critical thinking.

The differences are very real:

•    Wall Street (I’m referring to much of the financial industry and much of the popular financial media that depend on that industry) seeks to entice and exploit. Academic experts seek to inform and elucidate.
•    Wall Street profits from you. Academic experts don’t.
•    Wall Street has a major financial interest in keeping your attention and belief. Academic experts don’t.
•    Wall Street is interested primarily in only one question: what sells?
•     Academics are interested primarily in only one question: what works?

The currency on Wall Street is made of hyperbole and sales pitches. The currency in the academic world is made of knowledge and facts.

Wall Street’s siren song is enticing. That's for sure. But should you trust this industry to understand you, to take care of you, to tell you the truth and to give you the information you really need?

After you read all the hot tips, the up-to-the-minute insights, the advertisements and the round-the-clock national and global business news, your job will be to see if you can filter all the information into smart decisions that let you sleep. Good luck.

You’ll need to be able to recognize ambiguity. Investment advertisements must by law be factually accurate, but “the whole truth” is something else. Remember this gem from Benjamin Franklin: Half a truth is often a great lie. If you rely on Wall Street, your job will be to figure out what important things the ads and the sales pitches aren’t telling you.

Academic research, on the other hand, is virtually unknown to the majority of individual investors today. Academics don’t run glitzy advertising campaigns. They don’t write articles for mass-market consumer magazines and they aren’t household names.

But you probably know the names of some very smart people who have sought out this new source of unbiased information - Warren Buffet, Peter Lynch, John Bogle, Charles Schwab and Suzie Orman to name a few. Each one has publicly applauded the academic research community.

Academics are neutral, third-party sources of a tremendous amount of research on stocks, bonds, indexes and mutual funds. Some are Nobel Laureates.

They have gained great credibility with savvy investors precisely because they have nothing to gain from the results of their research. In fact, there exists a wonderful check and balance system within the academic community. It’s called peer review. Every academic study that comes out is subject to the “scrutiny of peers” in which other academics get points for finding flaws.

Hundreds of academic studies show that:

•    Lower expenses lead to higher returns.
•    Active management leads to higher expenses, thus lower returns, and higher taxes.
•    Certain asset classes have a high statistical probability of producing long-term returns greater than those of the S&P 500 Index.
•    One of the most effective tools for successful investing is smart diversification: asset allocation using non-correlated assets.
•    High returns don’t come from great talent or magic by managers; they come from asset classes.

Academics favor low cost, tax-efficient index fund investing. This isn’t an exciting investment strategy that will hold your companions riveted at a cocktail party. It can’t sell magazines nor hold viewers’ attention long enough to sell endless investment company commercials.

Owning index funds is more like watching paint dry. But more and more smart people are realizing that this is all the excitement you need in your long term investment strategy.

Some of the top minds in the investment business have read the research and are encouraging investors away from actively managed funds.

•    Warren Buffet: “The best way to own common stocks is through an index fund.”

•    Peter Lynch: “All the time and effort people devote to picking the right fund, the hot hand, the great manager have, in most cases, led to no advantage.”

•    Charles Schwab: “Most of the mutual fund investments I have are index funds, approximately 75 percent.”

WALL STREET WANTS YOU

But Wall Street wants your investment dollars and the money that can be made from the higher fees associated with active management. The financial media finds active managers much more interesting than index fund managers. Collectively, “The Street” spends a tremendous amount of money to engage our attention and get us to think that:

•    In order to make money we should trade; whatever it is that we own, it’s no longer the best thing.
•    Experts can tell us where the market is going and help us pick tomorrow’s winners.
•    Wall Street is there to help.

That’s the hype. Here’s the reality:
 
•    Wrap programs that charge annual fees up to 3 percent.
•    Mutual fund companies that cleverly disguise sales loads so they look like something else.
•    After- hours trading scandals and insider-information scandals that ruined some careers and damaged many portfolios.
•    “Independent” auditors who weren’t the public watchdogs they were supposed to be.
•    Investment bankers and analysts who operate with blatant conflicts of interest, supposedly giving objective advice while their real agenda is to avoid ruffling corporate feathers.
•    “Buy” recommendations are rampant. “Hold” is code for “sell.” “Sell,” a rating given to only about 3 percent of stocks, loosely translates into “Anybody with any brains has already run for the hills.” (Here’s something that puzzles me: If 97 percent of the securities are worthy of buying and holding, how is Wall Street picking the winners?)

Only you can decide what information you are going to stake your future on: Wall Street’s or academia’s.

THE SECOND FORK IN THE ROAD

The second major decision is who you choose to trust for help and advice. All the many professionals eager to help you can be divided into two groups, fiduciaries and non-fiduciaries. This is a very important legal distinction that savvy investors pay attention to.

A fiduciary is someone with a legal responsibility to do what is in your best interest and to disclose all real or potential conflicts of interest. Investment advisory and trust companies, for example have this responsibility. 

On the other hand, professionals without a fiduciary duty are not clearly obligated to act in your best interest and are not obligated to disclose any conflicts of interest. They are essentially salespeople.

A broker, for example, is typically not a fiduciary. Brokers are held to different legal standards, and the law presumes you understand this. A broker’s job is to sell you a product or service. Today that can be anything from an individual security to a mutual fund to an expensive wrap program in which investment managers assume discretionary authority and make decisions on your behalf.

The scandals on Wall Street have taught investors an expensive lesson: look for disclosure on conflicts of interest. Pay attention to the fine print. Unfortunately, most investors ignore disclosure, and Wall Street knows it.

It’s not always easy to know who is a fiduciary and who is not. The best way to find out is to ask for a statement in writing of fiduciary responsibility.

GETTING IT RIGHT

Gradually, the news from the academic research community is beginning to filter through the noise of Wall Street.

The news reached institutional investors first. Individual investors are starting to catch on to the value of high-quality information, high-quality advice, reduced costs, reasonable fees and the lower risks that can result from wide diversification.

The latest information I have indicates that one out of every five new dollars invested in mutual funds is going into index funds – and that number is growing.

You aren’t likely to read about this in a mass-market consumer magazine. No multi-million dollar advertising campaign is heralding this change. The profits are so low in index funds that there is no huge advertising budget for them. But if you don’t know about the merits of index funds, you are likely leaving some of your money on the table.

Here’s what you can and should do about all of this. First, have a plan. Second, have the core of your investments in index funds. Third, don’t allow emotions to dictate your investment decisions. Fourth, use smart diversification. Fifth, find and use a good advisor who has a fiduciary duty to you.

Here’s why you may want to hire an advisor:
•    An advisor will help you put together a road map for your financial future. If you don’t have a formal investment plan, it becomes easy to get off track.
•    An advisor will meet with you regularly to review changes in your financial life. This could save you from making a serious financial mistake. It could help you recognize and take advantage of financial opportunities.
•    In many marriages there is one spouse who enjoys the investment process while the other has little interest in financial matters. Many investors simply want a relationship with a professional advisor who would help a surviving spouse in case the one with the investment savvy were to die first.
•    An advisor can relieve you of the everyday concerns and chores of investing.
Forty years ago you may have been able to do this on your own. Now, more than ever, you need an advisor to guide you through this new landscape.

Remember this quote from Yogi Berra: "If you don't know where you are going, you will wind up somewhere else.”