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The March 19th headline in the Financial Times was "Alarm was raised on Lehman " The front page article then goes on to say that officials at both the Securities and Exchange Commission (SEC) and Federal Reserve were warned by Merill Lynch officials that Lehman was incorrectly calculating a key measure of its financial health. This story follows last week's Valukas report revelation that Lehman used questionable financing tools to flatter its balance sheet. Also incriminated in the report was the accounting giant Ernst & Young, Lehman's auditors. If these headlines were unique or rare we could stomach them. The problem is headlines like these occur far too frequently with disturbing predictability. A simply search of Google using "financial scandals" will enlighten those want a complete picture. What all this means is that the ordinary people who are just trying to earn living and save for retirement have a problem. The very people and institutions with the moral and legal responsibility to help us are the same ones who continually violate our trust. Sadly, if history is any indicator the problem will continue.
Even though the system is broken for us there is some hope. We believe it is still possible to prepare for retirement and avoid the majority of crooks, shysters, liars and thieves. It's not easy and you must be willing to do a minimum of work yourself. If you simply trust another to act in your best interest while you do nothing you're naive. You also probably lost 25% or more of your retirement value during the 2007-2009 crisis. You didn't have to do that.
When confronted with these issues we devised an investment strategy that avoids the majority of risk arising from corruption and greed. And, our strategy is simple enough that most anyone can do the same as we are doing with our own money. Here's our strategy to minimize these risks.
- Diversify - This is certainly not new advice but few take the advice as far as they should. For us diversification means investing in an index of a broad market of major economies. It does not mean investing in a broad selection of stocks, mutual funds or market sectors. It means investing in virtually the entire market.
- Use Index Exchange Traded Funds - The reason for using Index ETFs is two fold. First, the index that determines what stocks are used is determined by a group different from the group managing the ETF. Second, Index ETFs are managed by computers based on maintaining the index's weighting of the individual stocks, not a human fund manager. No human is deciding how much of which stock to buy.
- Use Investment Companies with Demonstrated Integrity - Granted these are few and far between but some still exist. Look for companies that have a long and consistent history of actually doing what is right, not just saying that they do what's right. Don't believe what companies say about themselves. Don't believe positive reports from their friends or auditors. Read what third parties say. Use the information available on the Internet but understand that many there are biased.
- Use Members of SIPC and FINRA - To invest in ETFs you will need an online broker. If they are not members of SIPC and FINRA find another. These organizations help protect you from bankrupt brokers.
- Only Buy ETFs of Major Markets - The reason is that large markets reflect the underlying economies and are less easily manipulated and less susceptible to irrational reactions. What do we mean by Major Markets? Essentially we mean any market that represents a significant economic portion of the world. For example, the markets of North America, Europe, South America, Pacific Rim, or collections of these like BRIC (Brazil, India, Russia, & China).
- Trade Funds based on Long Term Market Trends - OK, we know this seems to state the obvious but few investors actually do it! Most investors trade based on emotion or what they believe to be unique information. We suggest you do neither. All major markets go through long term up-down trends. These trends have names like "bull" & "bear" or "expansion" & "recession." These long term trends are slow enough that they can be identified in time to be advantageous. For example, in the last 17 years there have only been four (4) long term trend changes for the broad US market. However, acting on only these four changes would have increased a retirement fund 493 percent over a traditional Buy&Hold strategy.
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