Five Tips to Avoid Potential Investment Fraud

I recently wrote about avoiding investment fraud (How to Avoid Being Madoff’ed) but the subject keeps coming up.  In the most recent news from Wall Street, securities fraud has affected individual investors, pensions and charitable organizations.  At the risk of being a bit repetitive, here are five key safety tips that may help you prevent this from happening to you:

1. Know your advisor.

Most advisors (like me) are registered with government organizations. You can research registrations and review any past complaints with the Securities and Exchange Commission (, or with the respective state regulatory agency.  If a firm is a Broker-Dealer, you can research it with the Financial Industry Regulatory Authority (  You should also be aware of what you have authorized your advisor to do.  For example, if you have granted your advisor discretion over your investments, then you have given her permission to buy and sell investments to meet your stated objectives without your approval for each individual trade.  The authority you have granted your advisor should be stated in your client services agreement (you do have one, right?)

2. Know your investments.

Consider stocks, bonds, exchange traded funds (ETFs), and mutual funds that are publicly traded and listed on major exchanges like the New York Stock Exchange.   They are valued independently at least daily, if not minute by minute, when the exchange is open.  You can check their reported returns against your own portfolio.  If you can’t look up the prices and performance of what you own in the newspaper or on the Internet-that’s a red flag, so ask more questions.  If you choose to invest in complex securities like private placements, then you have much more additional homework to do.

3. Use an independent custodian.

By utilizing an independent custodian, there is objective, unbiased pricing of underlying securities.  Investment performance can look better if the prices reported to clients are manipulated, showing winning performance year after year despite the ups and downs of the market.  For example, our custodian, TD Ameritrade, receives security prices through well-known third-party pricing vendors or directly from issuers.  In many cases, prices are provided on a real-time basis for most securities.  We have no input on asset pricing or valuation.  Clients get statements directly from TD Ameritrade.  In addition, your advisor’s independent custodian should have a business continuity plan and a privacy policy to provide access to your investments in the event of a disaster and to protect your personal information.

4. Check on protection.

Your advisor’s custodian MUST be a member of the Securities Investor Protection Corporation (SIPC); if not, find one that is.  If it is, the securities in your account are protected up to $500,000, of which $100,000 may be applied to cash.  For additional information, please visit and see the Account Protection Sheet.  Our custodian, TD Ameritrade, also provides additional coverage through London insurers of up to $149.5 million per customer of which $900,000 may be applied to cash (and an aggregate of $250 million for all customers).  Please see the Evidence of Excess SIPC Coverage for additional details.  SIPC protection and Excess SIPC insurance protect against losses from brokerage failure, not from market value decline.

For additional information, please see TD Ameritrade’s FAQ for Investors on Protection against Market Fraud.

5. If it Sounds Too Good…

One final thought: If it sounds too good to be true, it probably is.  Beware of consistent annual returns that are out of line with established benchmarks.  Remember, there is no return without risk, so never believe anyone who says that they can get you a high return with little or no risk.  There’s always a “gotcha” hiding somewhere (e.g., excessive fees, commissions, early termination penalties) when they tell you this, so you should be very suspicious.

If you or someone you know has been affected  by investment fraud, or if you have any questions, please comment below.

How Does the Stimulus Plan Affect You?

The biggest benefit from the $787.2 billion federal stimulus package will hopefully be a noticeable improvement in the nation’s economy.  But on an individual level, it’s wise to check if you might be eligible for benefits in health care, education, various tax credits, and housing.

A visit with a tax expert or a financial adviser such as a Certified Financial PlannerTM professional can help you determine the best ways to use the following provisions that may affect you.  It’s also a good idea to get a financial checkup in an uncertain economy such as we are experiencing for the following reasons:

  • As much as it might hurt to look at the performance of your current retirement accounts and other investments, the economy will recover.  When an upturn comes, it’s wise to position your holdings to take full advantage of the recovery.
  • Your future plans with regard to spending for your home, your family and your education come into sharp focus under the stimulus plan, and making these provisions work for you in the short-term should be part of a long-term plan.
  • If you fear that your job might be in danger in the coming months, or if you might be facing pay or benefit cuts, it’s good to talk through your personal finances before your employer makes a move.  The best time to prepare for a job loss is while you’re still making a salary.  Not only is it a good opportunity to build an emergency fund, but it’s generally easier to look for new opportunities while you still have your current one.  Your emergency fund should be at least 3-9 months of salary, with a minimum of $1,000.

Here’s a quick summary of the stimulus plan provisions that may affect your finances:

Educational provisions:

College student aid: The package awards $15.6 billion to increase maximum individual student Pell grants by $500.

American Opportunity Tax Credit: This credit temporarily provides taxpayers with a new tax credit of up to $2,500 of the cost of tuition and related expenses, though it phases out for taxpayers with adjusted gross income in excess of $80,000 ($160,000 for married couples filing jointly).  Forty percent of the available credit is refundable, which means that you could receive a refund even if you have no tax liability.

529 Plans: The scope of allowable education expenses expands to now include computers and computer technology.

Tax credit provisions:

One more cap for the Alternative Minimum Tax (AMT): Lawmakers put one more patch on the AMT to protect a wider number of people from getting hit.  This latest break for potential AMT targets increases the exemption amounts to $46,700 ($70,950 for married couples).  The bill would also exclude interest on all private activity bonds issued in 2009 and 2010 from the AMT.  Normally, interest on private activity bonds is added back as an AMT “preference item,” thereby increasing the AMT .

“Making Work Pay” Tax Credits:  This is the refundable tax credit of up to $400 for individuals and $800 for families for 2009 and 2010 that phases out for taxpayers with adjusted gross income in excess of $75,000 ($150,000 for married couples).  This isn’t a lump sum payment, but instead is reflected in reduced payroll taxes starting in April or May of this year.

Car Buyers Tax Credit: This allows a deduction for state and local sales and excise taxes paid on the purchase of a new vehicle through 2009.  This deduction is phased out for taxpayers with adjusted gross income in excess of $125,000 ($250,000 in the case of a joint return).

Expanded Child Credit: This increases the eligibility for the refundable child tax credit in 2009 and 2010 by reducing the minimum income for eligibility to $3,000.

Earned Income Tax Credit: This provision will create a temporary tax credit increase for working families with three or more children.

Housing provisions:

Refundable First-Time Home Buyer Credit: First-time home buyers (generally, someone who hasn’t owned a home in the last three years) can claim a credit worth $8,000 – or 10 percent of the home’s value, whichever is less – on their 2008 or 2009 taxes.  The added bonus is that the credit is refundable, which means that filers will see a refund of the full $8,000 even if their total tax bill is less than that amount.  Note that the term “first-time home buyer” has several conditions, so you may be qualified even if you have actually owned a home in the past.

If you’ve already filed your 2008 income tax return, and you’ve completed a qualified purchase in 2009, then you can amend your 2008 return or claim the credit on your 2009 return.  Alternatively, if you are contemplating a home purchase by October 15, then you may want to request an automatic extension by filing form 4868 with the IRS by April 15.

Married couples do not qualify for the first-time home buyer credit if either spouse has owned a home in the last three years.

Unemployment and Healthcare-Related Benefits:

Extension of Unemployment Benefits: The package provides 33 weeks of extended benefits through Dec. 31, 2009.

Unemployment Compensation: The first $2,400 a person receives in unemployment compensation benefits in 2009 won’t be taxed.

Short-Term COBRA Subsidy for Involuntarily Terminated Workers: This provides a 65 percent subsidy for COBRA premiums for up to 9 months, which will put a dent in the considerable cost of COBRA health benefits for the unemployed.  The subsidy phases out for high income individuals.

Sam H. Fawaz CFP®, CPA is president of YDream Financial Services, Inc.,a registered investment advisory firm.  All material presented herein is believed to be reliable, but we cannot attest to its accuracy.  Investment recommendations may change and readers are urged to check with their investment advisors before making any investment decisions. Opinions expressed in this writing may change without prior notice.

This column is based on content provided by the Financial Planning Association, the membership organization for the financial planning community, and is provided by YDream Financial Services, Inc., a local member of FPA.

Are Mutual Funds Becoming Obsolete?

The markets that we’ve seen during the past several months are unlike any others I’ve seen in my lifetime.  In fact, they’re probably unlike the markets most of us have ever seen.   This market upheaval has caused me to re-examine everything that I thought was “sacred” about investing and the markets. This in turn has led me to begin questioning many basic premises about how financial planners think about investing, proper diversification, and trading.  Specifically in this article, I’m looking at the future of saving and investing in mutual funds.

I’m by no means an expert in this area.  But I have taken to reading and researching as much as I can about what works and what doesn’t work while saving and investing for the long and short term.  Between listening to tons of podcasts, attending numerous webinars and conferences, reading books, newsletters, magazines and newspapers, I’ve become intimately familiar with the arguments advanced by “buy and hold” crowd and their counterparts, the “market timers.”  I’ve learned that both approaches have their merits, and each has its time and place in the right types of markets.  This article is not about those merits or which method is superior.

While re-examining and researching mutual funds in client and prospect portfolios, and seeing how much some of them suffered in this awful bear market, I keep asking myself if there is a better way to invest their money.  Even though most mutual funds were down 35-50% over the past twelve months, I shook my head in disbelief that many of the same funds, even as late as January 2009, were still ranked as four and five star funds by the investment rating firm Morningstar.  Really?  Four and five stars were given to funds ranked in the bottom 35% of their category?  Funds that had double-digit negative annualized returns for 1, 3, and 5 years still earned three or four stars?

Just to be clear, as an advisor, I don’t rely on Morningstar “Star” rankings to rate and choose funds for my clients and prospects.  I dig much deeper into the details and third party information for comparison, research and evaluation purposes.  But I know that many consumers do rely on star rankings.  And I have to wonder how much of a favor Morningstar is doing for consumers when managers who are paid handsomely to manage mutual funds missed the whole financial crisis and didn’t steer their funds away from the financial or the big oil stocks in the second half of 2008.

In a secular bear market like the one we’ve been in, buying and holding mutual funds (or any investment for that matter) can be a money losing proposition.  But mutual funds have a few characteristics that make them even riskier, if not downright inappropriate for certain market conditions.

One characteristic that makes mutual funds riskier is the once-a-day, end-of-day pricing; you can’t get intra-day pricing on a mutual fund like you can on a stock.  If the market is trending down, there’s no way to cut your losses when the writing’s on the wall and the market’s headed for a big daily loss.  Wouldn’t it have been nice, on an 8% down day, to cut your losses in half?  Well, sorry, you can’t; you have to ride it all the way down.  Of course, on an up day, you may benefit from the extra upside.  Exchange traded funds (ETFs), which trade just like stocks, don’t suffer from this disadvantage and can be bought and sold at intra-day prices.

Another risky characteristic of mutual funds in bear markets, closely related to the above characteristic, is the inability to put a stop-loss order on a mutual fund.  If the market is crashing, and you’re unable to monitor your investments every minute that the markets are open, you could lose big or give up a good chunk of your gains.  Stocks and ETFs don’t have this disadvantage; you can have a standing stop-loss order on them with your broker for up to 6 months.  As soon as the stock or ETF drops to the sell-stop price, a sell is triggered and voila, you’re in cash, protected from further downside.  This gives you time to assess market conditions and decide on your next investment.

The inability of most mutual funds to deviate from their stated investment objectives prevented many mutual funds from cashing out on money losing stocks (almost all of them in 2008) and being able to sit on the sidelines with significant amounts of cash.  Funds with more flexibility in their cash positions, and those with the ability to take inverse (e.g., short) positions fared better than most in this bear market.  To be fair, many ETFs are index-based and have the same problem.

Mutual funds also suffer from a lack of timely disclosure of their investment holdings.  While they all publish their stock and bond holdings, most holding lists are usually at least three months old.  Mutual fund managers don’t like to publish their holdings more frequently so they don’t have to tip their hand to the competition.  It’s important to know what investments your funds are holding so you don’t duplicate or overlap your holdings with funds carrying the same stocks or bonds.  And if your fund was still holding, say Washington Mutual when it was sold for pennies on the dollar to JP Morgan Chase, maybe you would have known better to avoid the fund.  ETFs are much more transparent and publish their holdings on a daily basis.

Many will argue that ETFs have commissions that must be paid to buy and sell them, thereby making them a more costly option than mutual funds. To that I say three things: 1) commissions at most big brokers are about $19.95 or less; 2) the potential higher-gain or lower-loss on an ETF may pay for the commission in multiples; and 3) many desirable mutual funds have transaction fees much higher than ETF commissions at many brokers.

So will the mutual fund industry eventually die? I don’t think so.  Mutual funds are so ingrained in institutional settings and retirement plans that they likely have a long future ahead of them.  But I have a feeling that the mutual fund industry is already trying to reinvent itself.  Many of the big mutual fund companies have gotten into the ETF business because of the net (negative) out-flows from mutual funds and the net (positive) in-flows to ETFs.  Perhaps mutual funds will get some of the nice advantages that ETFs have like intra-day pricing, sell-stops and timelier holdings disclosures.

What I also hope for is that more 401(k) and self-directed retirement plans embrace ETFs and give employees the option to invest in them.  That way, they’re not sitting ducks when the markets come crashing down.

Do you think that mutual funds are headed for extinction? Do you think that employees should have more choices (e.g., ETFs) when it comes to their 401(k) investment choices? Please let me know what you think.