Whether a simple language blunder or insight into the psychology of the rich and powerful, Svanberg’s comments touch on a belief held by many – that in this world there are rules for the privileged and then rules for the rest of us little people, conjuring up memories of the late Leona Helmsley’s famous statement that, “only the little people pay taxes”.

Wall Street is founded on the little people premise. One manifestation is seen in the ubiquitous conversation by wealth managers about AUM or Assets Under Management. AUM is the measuring rod of their success and compensation -a topic of their urbane, cocktail-party banter. Every wealth manager or investment adviser is aware of his AUM as well as that of their friends and competitors because it indicates how much one earns.

Wealth managers trim 1% to 1.5% in fees off of “their” AUM every year. The bigger your retirement account, the more you add to your manager’s AUM and you become a “bigger person” in his eyes. If your account is under $500K, you are likely a little person. Some top managers won’t even answer you’re call if you can’t add $5 million to their AUM.

While AUM is the accepted business model, we have a huge problem with it. What value does a wealth manager add that gives him the right to extract a fixed percent every year off the spoils of your life’s work?

We deliver our advice to all for the same low cost regardless of a portfolio’s size. We treat every investor as a big person. There are no special investors who are on the inside track with access to special insights or favors.

At MarketRiders, we’ve begun measuring our success, in part, by AOM, or Assets Out of Management. We track the amount of draining fees from the AUM game that we’ve helped you escape. This week, we celebrate reaching $500 million of AOM and you — our thousands of investors that are now saving millions in fees. Here’s to no little people!

Sadly, it was no surprise to learn the Goldman Sachs threw their clients “under the bus” by deceitfully selling them mortgage securities while at the same time making a killing on shorting the housing market.  Their slogan, “Helping clients build and preserve their financial wealth” needs a minor adjustment. “Helping clients build and preserve OUR financial wealth.” This is a paragon of the Wall Street ethic – make money (hmmm – a lot of money) even if you must trample your client under foot. When you manage your own diversified portfolio of ETFs through a MarketRiders account, you truly get Wall Street out of your pocketbook by removing the intermediaries.

The Wall Street gurus seem to have a closet full of tricks to help investors outperform the market. Unfortunately, most of this advice is unproven and ineffective. In this MoneyWatch article, James Picerno points out one of the ONLY scientifically proven secrets to boost portfolio returns year-upon-year – disciplined rebalancing. Mr. Picerno underscores that rebalancing can deliver a 0.5 to 1.0 percentage point annual bonus compared to what you’d earn on the same portfolio that’s left alone. Our research shows that by using MarketRiders’ advanced rebalancing algorithms rather than a simple calendar based approach, investors add up to 2% additional growth in some portfolios and market conditions. We have more on this topic here: “How Often Do I Need to Rebalance?”.

When it comes to retirement investing, remember that you don’t have as many friends in the financial services industry as you think. By taking the time to learn the virtues of low cost indexing, global diversification and disciplined rebalancing, you will truly build and preserve YOUR wealth.

To draw a parallel, we assembled a few articles that describe how random investment success really is.  For example, if you own actively managed mutual funds, you’ll retire with a lot less money than if you’d just bought, held and rebalanced the boring ETFs others and we recommend.  This is a non-debatable fact that’s been proven over and over again.

But why do so many want to believe something that just isn’t true? Ivy League MBAs who are smart, motivated and work hard must be able to beat a dumb computer managing an ETF or an index, right?  Wrong for two reasons.  First, investment pros charge fees that are an impossible handicap to overcome.  And second, unlike other professions like a surgeon, litigator, race car driver or a pilot where success can be accounted for by how well one manages risk, most professional investors who beat the market one year, are just plain lucky.  They win for short periods of time because of random events, not skill or intelligence. Just luck.  We all became acutely aware of this in 2008 when all the gurus somehow didn’t see it coming.

Consider it likely that the great professional investors may really be no better than the 4 finalists in the 8th round of a 1000 monkey coin-flipping contest.  Yes, there will always be a winner. But why did the winner win?  Did someone know something?

This point is made in an article in The New Yorker:  “Blowing Up” by Malcolm Gladwell author of “The Tipping Point” and “Blink.”  Gladwell interviewed Nassim Taleb, a professional options trader.  Taleb’s book “The Black Swan” describes about how random events in the financial markets are common and unpredictable – essentially dismissing 90% of the value of professional investing.

“Wall Street was dedicated to the principle that skill and insight mattered in investing just as they did in surgery and golf and flying fighter jets….  For Taleb then, the question of why someone was a success in the financial marketplace was vexing.  Taleb could do the arithmetic in his head…”

In another article in Fast Company, called “The Myth of Mutual Funds,”  Chip and Dan Heath the authors of “Made To Stick,” explore why we don’t always want to believe the truth about investing.  “Let’s pull off the Band-Aid quickly. You’ve come to believe that mutual funds are a smart place to put your money. They’re not. That’s the assessment of the smartest minds in finance, supported by a mountain of historical data. So two questions: How can this possibly be true? And why, in gleeful defiance of the data, do more people keep buying mutual funds every year?”

Last, read Moneywatch’s  “Hedge Funds – Case Against, part 2” if you’re considering investing in one. Allan Roth writes some compelling pros and cons for doing so.  He addresses the question:  Are these fund managers lucky or smart?   “If I had a dime for every time I’ve heard that hedge funds provide above market returns with lower risk, I’d be a very rich man. Every time I hear this claim, however, I ask for any evidence that supports it. I have had no takers to date, though maybe this column will change that.  Unless you happen to have a few billion to invest (and give me a ring if you do), I’d steer clear of hedge funds as they provide too much risk with too little return.”

Think of the conversations that occur behind closed doors at the White House, corporate boardrooms or U.S. Central Command. We all understand that there are elements of those conversations that are deemed, for whatever reason, unsuitable for public consumption. They are tucked into the classified file, sworn to secrecy and solemn oaths. But every now and again, some of the untold story leaks out – finds its way to the common person. Sometimes the information is so unbelievable, that it is marginalized as ridiculous. Other times it is corroborated with such credibility that all we are left with slack jaws and nodding heads.

Below are three brief but shocking behind-closed-doors accounts about Wall Street and investing that left me stunned.

CEO of a Top Publically Traded Tech Company: Having participated in the Silicon Valley for years and sat on the board of Baidu, I come into contact with a broad network of technology leaders and professionals. Recently, I became part of a stunning conversation with one of the top executives in The Valley.  This individual, while surprising humble, is also profoundly wealthy. For years he used the “top” wealth managers who have access to elite money managers who in turn “outperform” the market to justify their fees. After years of high cost and poor performance and tens of millions lost, this executive was seriously underwhelmed. He pulled his money out, embraced a simple indexing strategy and global diversifications. It takes him only a few hours a year to manage the money himself. He save hundreds of thousands if annual fees and achieves a much better result. Why don’t we ever see that ad during Wimbledon?

Former Banking Firm Top 500 Producer: Imagine being an investment advisor who has built a dream business – over $1B in assets under management (AUM) and a coveted Chairman’s Club member. Making just over 1% a year on AUM, this wealth manager was grossing over $10MM annually in fees. Unfortunately, he had a huge problem – he still had a conscious. The more he study active money management, the more he learned that it not only failed to add value to his customers, but was in fact deleterious.  When he approached management about this problem and sought an indexing approach, he was run out of town. After a legal battle and negotiations, the firm and the manager struck a settlement. He left his customers in the hands of the banking firm and he had to move on. I guess someone is now making money “the old fashion way – earning it.”

$750 An Hour Tax Attorney to the Uber-Wealthy: I was once invited into a private conversation with the uber-wealthy about tax management. The strategy was architected by top legal minds in the country. Profoundly expensive to set-up and maintain, this apparently legal and sophisticated offshore strategy would result in profound tax reduction. Imagine most of your wealth free to compound without tax consequence. These uber-wealthy could invest in the most sophisticated and elite products. When I asked the attorney what the majority of his clients were investing in, he just snickered. Over 60% of their dollars were dedicated to simple and diversified indexing strategies. There was no Wall Street, no active managers, or Jim Cramers – just hundreds of millions, even billions, going into a simple, proven approach used by those in the know.

I hope you are doing the same.

For all you ‘Home Depot’ types in the investing world – the ‘do-it-yourselfers’- an investing strategy worth considering is using an on-line portfolio management tool to help you determine an appropriate asset allocation given your investment needs.  For the more passive investor,  index fund and ETF portfolios are preferred as you are able to get diversification at a low cost. Not only do these services make it easy for anyone to set up a portfolio but also the management tools account for rebalancing, a necessary component for any passively managed portfolio.

As Mamundi states, “While it has been established that most actively managed mutual funds lag behind their indexes over time, [this] study further twists the knife: Active management suffers even more by comparison on a risk-adjusted basis. The study found that in many cases where an actively managed fund beats its index on an absolute basis, the additional risk it took didn’t justify the returns earned. Not only should that be a warning sign for investors — because greater risk means greater volatility — but it also suggests that fund managers aren’t living up to what is expected of them.”

As Mamundi points out, it is typically thought that a riskier fund should reward investors with higher returns, but contrary to this popular thinking, over the past three years higher risk has equaled lower returns. Travis Pascavis, director of equity indexes at Morningstar, further explains that, “The key to thinking of risk in terms of returns versus an index is that, in theory, if investors wanted to take on more risk for greater returns, they could simply buy an index fund and lever up their exposure. That would also increase returns while adding risk — and do so at a cheaper cost than most actively managed funds. It is against this standard that actively managed funds should be judged.”

Although we at MarketRiders do not encourage adding risk to a globally diversified portfolio of ETFs via leverage or any other means, it is interesting to note that highly paid money managers once again seem to be the only ones benefiting from their higher-risk game.

As stated by Dolan, “just under 6% of fund managers invest $1 million or more of their own money in their funds. Also, of the 4,383 funds tracked for manager ownership levels over the past five years, a paltry 51% of fund managers owned no stake at all. Having a stake in a mutual fund means that managers have their interests truly aligned with shareholders. The best managers that we’ve followed and respect a lot tout the fact that they’re investing alongside investors. They find their funds the most attractive place to invest their own money.”

Ms. Dolan has uncovered the stark reality that mutual fund managers, on the average, do not invest in their funds. They are quite happy, however, to sell their products to you, and for a handsome profit to their firm and their retail investment adviser partners. When it comes to mutual funds, the lesson seems to be the same – watch out! ETFs offer a much lower cost and more tax efficient option for long-term retirement investors.

–Settle on an allocation between stocks, bonds and cash: Decide how much stock you wish to have in your portfolio over the next decade, assuming that you won’t be able to sell for the duration, and assuming that you’re likely to lose one-half the value at any given time during the decade. Keep enough cash to cover between six months and one year of living expenses.

–Diversify your holdings: Use various asset classes including US equities, developed foreign equities, emerging market equities, real estate (REITSs) investment-grade bonds and Treasury inflation protected securities.

–Choose low-cost, no-load mutual funds: Index funds and select exchange-traded funds (ETFs) are an ideal way to represent asset classes because they track the performance of markets very closely, less a small annual fee.

–Rebalance occasionally: Regular portfolio maintenance keeps risk in line with your target from Step 1. You can rebalance annually or as needed. For example, assuming a 50% stock target, you could rebalance when stocks hit 55% or 45%.

–Minimize taxes: Place tax efficient investments in taxable accounts and place less tax efficient investments in retirement accounts

So, when you sit down to work on your investment portfolio, think asset allocation, diversification and rebalancing.

In 2008 it turns out that asset allocation decisions have everything to do with a portfolio performance.

On MarketRiders, we use our own ETF portfolio builder to track some “Celebrity Portfolios” including the “Lazy Portfolios” (published by Paul B. Farrell at Marketwatch). These portfolios mimic allocations based upon Yale University’s David Swensen, Dr. William Bernstein, Ted Aronson, and Bill Schulthesis who wrote “The Coffeehouse Investor.” Community members also have posted many interesting portfolios with unique asset allocations that have held up well in the last few months.

These portfolios use ETFs without active management and we track weighted average portfolio fees. The component ETF fees range from .08% to .50% and the weighted average portfolio fees are between .12% and .21%.

Comparing and contrasting portfolios with similar asset allocations, shows a lot about how to build solid “all weather” allocations that have held up even in 2008. While some of the variance is surely explained by the allocation in non-equities (Bonds, Treasury Inflation Protected Bonds and Cash), a lot of it is explained by the level of diversification amongst the other asset classes.

There’s quite a variance between some of the portfolios – even when their equity exposures are similar. Two portfolios each with 60% equity exposure have dramatically different results.

For example, Bill Schulthesis, a ex-Salomon Smith Barney broker who wrote The Coffeehouse Investor, designed a portfolio with 40% in an intermediate bond index (BND) and 10% in each of 6 stock funds (Vanguad REIT ETF (VNQ), SPDR S&P 500 ETF (SPY), Vanguard Small-Cap ETF (VB), Vanguard Small-Cap Value ETF (VBR), Vanguard Value ETF (VTV), Vanguard FTSE All World ex-US ETF (VEU)). Dr. William Bernstein wrote the “Intelligent Asset Allocator” and “The Four Pillars of Investing” and proposed the same basic allocation. But high exposure to small cap value US stocks and REITs allowed Coffeehouse’s returns to trump Bernstein by over 2 times.

Here are the results as of last night’s close.  These portfolios and the ETFs in them are posted on MarketRiders.

The Best and the Worst Returns

To better understand where the variances lie, we drill down into each asset class to see where returns (or lack thereof) are coming from. Aronson’s portfolio, is the worst so far, down (16.65%) with 80% equity exposure. Unfortunately, Aronson had no REIT exposure and heavy exposure to Emerging Market (VWO) and Foreign Markets (European (VGK) and Pacific (VPL)) which have both been crushed this year. Aronson’s portfolio has performed very well for 5 years on the backs of these asset classes, but 2008 has been his come-uppance.

The MarketRiders “Low Risk” portfolio is doing the best so far this year – down only (1.83%) – but with 25% exposure to equity and Real Estate (RWR). A strong US allocation (iShares S&P SmallCap 600 Index  (IJR) and SPY) over Foreign Developed and Emerging Markets (VEU) helped dampen the losses.

It’s Time to Rebalance!

Today, we’re rebalancing a few of these portfolios where actual allocations now vary greater than 20% off our targets. The most out of balance portfolio is the one built by John Spense and Rick Ferri on MarketWatch. Emerging Markets, Foreign Markets, TIPs and Small Cap US stocks are all out of whack so this portfolio and others will be brought back to their targets.

Stay tuned.  At the end of the year, we’ll report back and show you how these portfolios did.

But many people just want investment advice. Most people will spend more time shopping for a car on the weekend to save $1000, than to understand the true cost of the investment advice they are receiving on the nest egg that they’re spending their entire working lives building. If you must, here are some tips that I think will help you minimize the damage and give you a shot at having a successful relationship with your stock broker, financial adviser or investment manager.

1. Show Me The Fees. If your financial adviser is charging a fee to oversee your investments, he is probably investing your money in mutual funds that also have fees. Ask for a comprehensive list of all the fees you are paying each year including each fund, its fees, and his fees. Try to get these aggregate fees below 2% per year. My friend has a $6 million account with one of the largest four brokers and to make my
point, I calculated his mutual fund fees, loads, and fees to his advisor. Last year he paid about $138,000! He is considering switching to index funds and where he would pay $18,000 per year.

2. Get Invoiced. Most financial advisors “debit” your account either in advance of the quarter or month. Ask them to send you an invoice and write them a check. That way you’ll stay aware of the cost for these services.

3. Show Me The Commissions. Ask your adviser to disclose the exact amount of commissions, credits
or any form of compensation he or she is paid as an incentive for having you invest in a certain financial product like a mutual fund, annuity, or life insurance product. Also ask for the cost of an index fund alternative so that you can understand exactly what it is costing you to be “sold” a particular product and so that you can justify its price in the future.

4. What’s The Tax? The average turnover for a mutual fund is 70% a year. That means nearly all stocks in a portfolio are sold each year and traded for other stocks. Turnover can create taxable income at year end. Each February, after these taxes are known, give your financial advisor your federal and state tax rates and ask him to calculate the taxes generated turnover from your funds. Then sell down these accounts in the amount you need to pay the taxes so you will be able to know the true after tax returns. After all, that’s what you keep.

5. Benchmarking — Compared to What? Many investors are happy when they make money in a fund. But that’s how amateurs think. Endowments and elite institutions manage their money managers against a benchmark who, net of fees, should outperform a comparable index fund which charges almost no fees. Have your financial advisor pick a benchmark for each fund and measure your adviser’s fund picking skills against how well that fund did against the benchmark. For example, the largest diversified emerging market funds have been up between 25.3% – 35.06% over the last five years. Vanguard’s Emerging Markets Stock Index (VEIEX) was up 29.24% including fees of .35%. So if you are happy that you’ve compounded for 5 years at 25.3% with American Funds New World (NEWFX), you shouldn’t be because you lost 4% paying someone trying to beat the market including the 1% you paid in fees.

If your stock broker fashions himself as a stock picker, ask him for a benchmark by which to judge his performance. For example, if he or she is picking large cap US stocks, then buy a token amount of the S&P 500 Index Fund (NYSE:SPY) in the account and measure his yearly returns against the yearly returns of this index.

If the requests I’m suggesting that you make of your adviser or stock broker make you uncomfortable, that’s no reason not to make them anyway. These are reasonable ways to hold your advisers accountable. Just think of the discomfort you’ll feel if in 15 years, a good chunk of your retirement nest egg has been siphoned away in fees!