The canvass of investment planning has been subject to a variety of hues absent from the traditional 24 color Crayola box. Industries evolve, rules of thumb lose their grip on what’s considered suitable and unannounced complexities require a different brand of expertise from those providing advice.
As a consequence, most financial advisers have successfully expanded their body of knowledge to include the sharp edges on new pieces of a familiar puzzle. Investors would be wise to verify this transition with a few quick questions.
1. How will you mitigate the risks posed by Europe?
The subprime market peaked at $1.5 trillion, but the outstanding debt of peripheral European nations is valued at $4.6 trillion. Moreover,€519 billionof French, Italian and German obligations come due in the first half of 2012, a year in which European banks must refinance a trillion Euros and will compete for capital.
European banks not only have tremendous exposure to distressed sovereign debt, but have sold €178 billionin credit default swaps to investors who are intent on hedging their holdings. And while these same banks have purchased a corresponding amount of insurance on said exposure, counterparty risk would likely create inefficiencies during the midst of a crisis and invalidate their protection. Your adviser should understand these dynamics and have a reasonable game plan to protect your assets in the event of a disorderly default.
2. What long-term impact might the central banks have on the financial markets?
The expressed purpose of a central bank is to monitor the supply of money, curtail inflation and reduce fluctuations in the business cycle. During the last several years, however, they have become the lender of last resort and now find themselves intimately involved in preventing the financial markets from further shocks. The side effects of loose monetary policy can be profound and basic knowledge of central banking activity is now a required skill set for financial service professionals.
3. Have you amended your asset allocation strategy over the last ten years, and if so, why?
There was a time when traditional asset classes were non-correlated and shielded investors from risk during periods of extreme volatility. Unfortunately, they are now ill-suited for risk management, moving in the same direction regardless of market conditions. Few workers could perform their job function without email, a cell phone and the internet - why would investors accept an asset allocation that hasn’t changed in 20 years?
4. How will inflation affect my quality of life?
If the CPI was calculated today in the same manner as it was 30 years ago, inflation would be almost 10 percent. Furthermore, bonds may be referred to as fixed income, but expenses are hardly static. In addition, should artificially low interest rates begin to rise in response to depreciated currency values, bond prices will decline accordingly. Stocks have historically been effective at preserving purchasing power, but as we’ve seen over the previous decade, that script is dire need of your adviser’s editing abilities.
5. What are the last three books you’ve read?
Financial advisers cannot possibly navigate the cavernous gallery of derivatives, correlations, central banking activity and government policy in between client meetings, administrative requirements, return phone calls and other professional demands. Internal research departments can offer support, although now might be a bad time for your adviser to completely outsource his/her ability to reason.
Long held investment strategies are suddenly in question, as the foundation of the global economy shifts like sand. Financial advisers don’t need a PhD in economics, although the majority have an educated opinion based on empirical evidence and a firm grasp of macroeconomic principles. Make sure yours is amongst them.
Expensive suits and a smooth sales pitch are awfully impressive, and it sure is nice to have a local office at your disposal, it's just that great presentations don't always ensure competence. The person you’ve chosen to manage your money has in all likelihood mastered their craft. Nevertheless, an updated version of due diligence is probably in order.
Ivory Johnson, CFP, ChFC, is the director of financial planning at Scarborough Capital Management, Inc. and has over 20 years of investment experience. Mr. Johnson attended Penn State University, where he received a Bachelor of Science degree in finance. He can be followed on www.IvoryJohnson.com.