Choose an Ethical Investment Company, Consider ETF's over Mutual Funds, and Keep Enough Money in the Bank: A Few Timely Lessons from a Great Financial Advisor

Jill Schlesinger, CFP®, is the Executive Vice President and CIO of StrategicPoint Investment Advisors, a federally registered investment advisor. Jill also has a weekly radio show during which she answers investor questions, so if this interview prompts further interest, you can catch her on the Making Money Show on WHJJ Talk Radio 920-AM on Saturdays from 9 am to 12 pm.

Several years ago, when I was fresh out of social work graduate school and commensurately in debt, I approached Jill for some financial advice. Jill was very kind and helpfully pointed out that the first thing I needed to do was make enough money to pay off my loans and save up something to invest, no small task when joining one of the lowest paid graduate-level professions in the country. Nevertheless, by scrimping and saving and buying everything on clearance, I have achieved a measure of financial success. Now it's time for some more guidance.

Kiersten Marek: In your online column series Strategic Point of View, you provide some concise data about the recent spate of corporate fraud scandals. In one column called Benny in the Hood you mention various scandals including the Worldcom collapse. This collapse has concerned me, and I researched it a bit and found out how much money companies named in the settlement are responsible for paying the government. Companies like UBS Financial are on the hook for $80 million in fines for their involvement (which, of course, they neither confirm or deny) in the Worldcom mess. When choosing a company to go with for financial services, should investors steer clear of these companies who will be forfeiting large sums of money to the government, for fear this will impact their ability to provide services and realize a profit for their clients?

Jill Schlesinger: While it may seem obscene to say, $80 million in fines for a company the size of UBS is a drop in the bucket. In fact, the financial institutions involved in the $1.4 billion analyst settlement are among those that have been the most profitable in the two years since the settlement date. Therefore, in terms of their financial stability, I would have to say that these companies are unlikely to imperil their investors or their clients.

However, there is a fundamental issue that investors should address and that is, is this the kind of company that I really want to do business with? In the case of the recent mutual fund scandals, we have recommended that investors choose to work with those companies not implicated or charged in the scandals. The reason is not that Putnam or Alliance is going out of business, rather these are institutions that allowed the improprieties to occur because they lost sight of their ultimate responsibility to their shareholders.

Earlier this year, Money Magazine described Putnam Investments (a division of Marsh & McClennan) as "The Greed Machine…the problem at Putnam is not just fund managers actively trading their own funds. It's that the firm and others like it put profits first and investors last."

We would avoid any company that has created a culture where investors come last.

Kiersten Marek: That's refreshing to hear. UBS is of particular concern not only because of the Worldcom settlement, but also because they are now facing a new class action lawsuit for their involvement with HealthSouth and its estimated 4.6 billion in fraud. But they are a huge company and so their stability is probably not in jeopardy, and if your money is already with a company, it is hard to take the initiative to move it just because of an outbreak of scandal and fraud. I find this to be the case for me and the company with whom my retirement funds are invested, for example.

On a related topic, I recently received an "Urgent Investing Bulletin" from The Motley Fool entitled "The Case Against Mutual Funds." In this bulletin, David and Tom Gardner argue that mutual funds 1) force you to own bad stocks; 2) expose you to more risk than you know; 3) are shamefully costly; 4) kill you with taxes; and 5) limit your upside potential. Reading through this bulletin, I was a bit flummoxed. Like a lot of people, I have been burned by some mutual funds (my all-time biggest loser was Firsthand Funds Telecomm - I caught the proverbial falling knife on that one) but at the same time, a great deal of my retirement savings is invested in mutual funds. I thought I was well diversified by owning several different funds, but now I am starting to wonder. Should people like me think about taking some of their money out of mutual funds?

Jill Schlesinger: About two years ago we started to talk about alternatives to the mutual fund industry. Our motivation had nothing to do with the current trading scandals, rather we were focused on the fund industry's complete abandonment of investor interests.

In yet another instance of an industry forgetting that the small public investor created its success, mutual funds grew fat and happy. Notice I did not say dumb, because mutual funds did not grow from about $1 trillion in assets in 1990 to $7 trillion today by being dumb. Nope, funds have been incredibly savvy by playing to investors' worst habits-advertising short term returns, keeping escalating fees in fine print and creating the illusion that actively managed accounts could beat the indexes.

Given the enormous changes in the investment world, it is time for the eighty year old mutual fund industry to evolve too. Unless mutual funds transform themselves from bloated and expensive options for the average investor, they will become the dinosaurs of the investment world. For despite the hype, investors have typically received results that lag the indices for fees that have only increased. Average investors are not stupid. They will demand more from an industry that has grown rich off their backs.

The good news is that this process has already started. Many have extolled the virtues of index funds for years, and now investors are discovering a superb alternative to mutual funds in exchange traded funds. An exchange-traded fund (ETF) is an investment company that provides the pluses of mutual funds, like broad diversification, without the big fees or potential trading conflicts. Investors can buy and sell ETFs intra-day, versus the mutual fund world where purchases and sales are based on the closing price on the day of the transaction. Although they do not yet have the same mass market appeal of mutual funds, ETF's are likely to become commonplace, as they provide investors with an efficient, cost effective way of acquiring securities.

Investor action can ultimately force change in the fat fund industry-just like voting with your pocketbook, all that you need to do is withdraw your money from the managed funds that you own and redirect it into index funds or ETFs. If you are a retirement plan participant, rally the troops and demand index funds within your plan, not costly funds whose only asset is their recognizable name. Yes, Wall Street has been dominated by insiders for years, but as part of the group that accounts for $7 trillion of the market, you are now officially an insider who can effect change.

Kiersten Marek: Yes, ETFs seem to be the investment vehicle of choice right now. I noticed that my discount broker has added a new "ETF Center."

Although some say that bull markets generally run for at least a year, the current one, which started in March 2003, seems to be petering out. Without reassuring new employment data, it seems like we might be headed into a longish correction or possibly another bear market. What is your current market outlook, and what factors do you think will have the greatest influence on the market in the coming year?

Jill Schlesinger: This question is certainly timely after last week's tumble in the stock market. I wrote the following SPOV (posted on Monday, March 15) on my train ride down to New York on Friday afternoon.

Speed Bump or Jersey Barrier?

In a week that saw the four year anniversary of the NASDAQ top and the one year anniversary of the start of the most recent rally, investors want to know if the first significant pull-back in the stock market in a year is a mere speed bump or a collision into a Jersey barrier?

The three indexes had a rotten week, with two of the three turning negative on the year. After losing 3.4% on the week, the Dow Jones Industrial Average closed at 10,240, now DOWN 2% this year, while the NASDAQ Composite and the S&P 500 each lost 3.1% for the week, leaving the tech-heavy index down 0.93% on the year, while the S&P has managed to eke out a gain of 0.78% thus far in 2004.

At its worst last week, the Dow was down more than 465 points, which was the biggest four-day drop in fifteen months, and 600 points below the high set in February. The NASDAQ, which in January reached just under 2200, dropped to 1943 (a 9.7% decline from this year's peak) on Thursday before recovering to 1984 by the end of the week-a 7.8% decline from the top.

While many are pointing to the terrorist attacks in Spain, the lousy employment report and eroding consumer confidence, we are solidly in the camp of those who were waiting for a correction in the broad stock market for all of the seen and unforeseen events that could occur. After a whole year, the rally was simply running out of steam.

As incurable investor optimism continued to rise with its corresponding inevitable gloss of greed, we have been wary. Investors have flooded back into stocks because there are no other compelling alternatives and that risky investor behavior comes courtesy of Greenspan & Co's low interest rate environment. However, it is important to note that while stocks have been a major beneficiary of the Fed's' easy money policies, prices have also increased due to an impressive rebound in corporate profits. Top-line growth has improved in the past year, as margins continue to benefit from tight control over costs and a declining dollar.

So was last week was the start of the big melt-down or just a rest along the way? There is no way to know yet, but we believe that the current low interest rate environment will likely create a scenario where economic growth will bump along at about 4%, companies will make money and correspondingly, their stock prices should appreciate, although maybe only slightly, for the remainder of the year. But stay tuned…traffic conditions can change quickly.

Kiersten Marek: And finally, having a certain amount of savings is an important part of financial security. What percentage of an individual's net worth do you generally recommend they keep in secure fixed-interest savings?

Jill Schlesinger: This is an easier question to answer. We generally recommend that individuals maintain an emergency reserve fund of 3-6 months of living expenses. However, if for example the person were self-employed with variable income, we might suggest 6-12 months of reserve funds. It is imperative that these funds be held in low risk instruments, like savings, checking, money market accounts or in short-term Certificates of Deposit.

For more information about StrategicPoint Investment Advisors, you may visit their website at StrategicPoint.com.