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NEWSLETTERS & ALERTS
Investments - Unsuitable
Taking the Doctor to the Cleaners
[Photo / HealthyDebate.ca]
by Howard Haykin
WHAT WENT WRONG. During the summer of 2013, a broker with PHX Financial, Inc., cold-called the doctor and convinced him to become his customer. Had the doctor looked into the broker’s credentials, he might have had second thoughts about working with this broker. Besides having a recent string of civil and tax liens, the broker was now working for his 16th firm in 20 years - a guy who couldn't hold down a job. [Mistake #1: Trusting the Untrustworthy]
The customer’s New Account paperwork indicated he was a 45-year old doctor working in St. Croix, and …
- had no experience trading equities, bonds, or options;
- had no experience with active short-term trading;
- expressed a "balanced growth" investment objective with and a "moderate" risk tolerance;
- had a net worth, less his home, of $300,000;
- had a liquid net worth of $285,000; and,
- had an annual income of $400,000 to $499,999.
Shortly after the account was opened, the broker convinced his customer to engage in options trading. The broker, who was also PHX’s Registered Options Principal (ROP), authorized the customer’s account for “Level 3” options trading – a grade that’s only assigned to customers with extensive experience in buying puts and calls and with writing puts. [Mistake #2: Choosing a Wrong Asset Allocation]
From there, the fun began. Over the next 21 months, the broker excessively traded his customer’s account. With an opening account balance of $200,000, the broker recommended 208 equity and options transactions trade te customer, an OB/GYN working in a medical clinic in St. Croix, deposited a little over $200,000 in his account at PHX. Over the next year and half, the broker recommended approximately 208 equity and options transactions worth a principal value of over $3 million. The trades generated over $135,000 in commissions and caused the customer’s account to incur losses of nearly $72,000. These commissions made up 95% of the broker’s total commission income for the period. [Mistake #3: Confusing Speculating with Investing]
[For further details, click on … FINRA Case #2016048921102.]
Let's flush out the mistakes cited in this case - as presented by Wealthydoc.org.
Mistake #1 - TRUSTING THE UNTRUSTWORTHY. Some have a “money guy.” They met them at a “free” dinner at a steakhouse. They can’t tell you what their credentials or track record are. Yet they trust them to do a great job and look out for all their financial interests. Don’t be naive!
There are no specific legal requirements to call oneself a “financial planner.” We assume every professional has rigorous training and a high ethical standard. Many financial planners have minimal formal education in investments or finance. Some are brokers or insurance salespeople.
Most financial planners are good people trying to make an honest living. Their company-sponsored training convinced them their product will benefit you. They are also trying to provide for their own family in the process. There are conflicts of interest galore and their advice may turn out to benefit them more than you.
You don’t have to be a do-it-yourselfer like me. Not everyone enjoys finance the way I do. I get it. But no one will care about your money as much as you do. Understand what your advisor is doing and how they get paid. You can delegate. Oversee and understand the process. Abdicating your financial responsibilities can end in financial disaster.
Mistake #2 - CHOOSING A WRONG ASSET ALLOCATION. Some are afraid of losing money. They play it safe. They won’t consider buying companies or real estate. Those could go down. So they stick to CDs, short-term bonds, and money markets.
Others are too aggressive. With 100% growth stocks, start-up small companies, market timing, and stock picking.
The asset allocation decision is one of the most important decision you will make. Your savings rate and your asset allocation determine your financial future. Spend time thinking about these two factors.
Even following a simple guideline would be better than no thought to the issue. Options are setting your bond percentage equal to your age (e.g. a 40-year-old would have 40% bonds). Adjust it every five years or so.
Or pick a target retirement fund. Or a balanced fund with a 40%, 50%, or 60% stocks and the rest in bonds. Set it and forget it and you will do fine. You will capture generous returns over the long-run but with little volatility.
Mistake #3 - CONFUSING SPECULATING WITH INVESTING. I know doctors who claim to have picked the “next Microsoft.” Then they tell me about the company and it boggles my mind. Companies to ship air to China in little soda cans. Or to make all food become “organic” by a chemical process. Maybe to make a movie, build a satellite, or fund a trip to Mars. Wow.
And they think these are “investments!’ These are super-smart doctors mind you. They know a lot. Not how to assess the intrinsic value of a company. Or even the difference between an investment and speculation.
For those still wondering what the difference is, I refer to Benjamin Graham. He is the “founding father” of value investing. He also taught Warren Buffett who went on to be the most successful investor of all time.
Graham noted that something is an investment only if it is safe from loss. And that isn’t from guessing, but a reasoned financial analysis. One should expect only a modest return. If safety is not assured and high but unlikely returns are being sought, then that is speculation.