A cruel September? pg. 7

Benefits of the fee-based modelpg. 3

The perils of predictions pg. 4

RICH RALSTON’S

pg. 8

WATERSHEDMOMENT

September 4, 2014 | Volume 3 | Issue 10

First magazine focused on active investment management

opportunity to take advantage of po-tential market returns in a more con-trolled and disciplined fashion.

There are two other benefits to this combined approach. First, employ-ing highly qualified third-party active managers frees me up to focus on client needs and prospecting. It also allows me to conduct unbiased client reviews. If something is not working the way it should or if the client’s circumstanc-es have changed, I do not hesitate to make alterations. Clients have come to understand that I am managing their assets for the long haul and this has led to a high degree of satisfaction and retention.”

have made several changes to my advisory practice over the

years. The two biggest were moving almost exclusively to a fee-based model and using active investment management for my clients’ portfolios.

The fee-based model allows me to build a transparent and totally objec-tive relationship with clients. I develop a financial strategy that clients know is not influenced by the motivation of selling a product. And because my fees are largely paid via a percentage of assets under management, I do not charge a fee to review an exist-ing financial plan. I will handle some commission-based products, but that comes within the framework of what is in the clients’ best interests in their total financial strategy construct.

The move to active management has had many benefits. It fits in with my desire to employ a high level of risk management for clients after the experiences of the two market crash-es of the 2000s. I do this by utilizing third-party managers that are highly proficient at developing risk-mitigat-ing strategies.

Active management helps clients feel confident that they will have the

Why fee-based active management works

Jim MardockPortland, OR

Transamerica Financial Advisors, Inc.

I“

Jim Mardock is a Registered Representative and an Investment Advisor Representative with Transamerica Financial Advisors, Inc.

Securities and Investment Advisory Services offered through Transamerica Financial Advisors, Inc. (TFA), Transamerica Financial Group Division—Member FINRA, SIPC, and Registered Investment Advisor. Non-securities products and services are not offered through TFA. TFG004351-08/14

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TIPS & TOOLSPOLLS

PREDICTIONSPERILSThe

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proactiveadvisormagazine.com | September 4, 20144

n early July of 2014, Citigroup issued a thoughtful and nuanced market perspec-tive to its clients. The chief U.S. invest-

ment strategist at Citi, Tobias Levkovich, is a well-respected and oft-quoted figure on Wall Street, and market participants take notice of his outlook. In this particular case, the note was obtained by the press and characterized in two very different headlines and leads by two of the most well-read financial news sources.

Bloomberg: “Concern Over ‘Severe’ Pullback Sends U.S. Stocks Lower. ‘Many inves-tors wonder if the ride is over,’ Tobias Levkovich, chief U.S. equity strategist at Citigroup Inc., said in a report today.”

Forbes: “Raging Bull Market Still Has Stamina, Citi Says. The firm’s chief equity strat-egist, who predicted in 2011 that the then-de-veloping bull market would eclipse 2007 peaks, writes in a note Tuesday that the rally still has room to run.”

Neither of these news sources necessarily “got the story wrong,” as Mr. Levkovich was reviewing both sides of market sentiment in his note and presenting a carefully hedged perspec-tive. This case simply illustrates in one succinct example how a confusing and often contradic-tory flow of news and opinion is constantly washing across the investment landscape.

Warren Buffett is fond of saying, “Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important.”

Why might this matter to advisors and their clients? Simply because many of the principles of behavioral psychology—and their relation-ship to investing—have taken on increased importance during the dramatic market cycles of the past fifteen years. Investors have seen two huge market troughs, each followed by raging and record-setting bull markets.

The time-worn fundamental beliefs in passive, buy-and-hold investing have been

challenged, with often disastrous—or at least less-than-ideal—results. Even though markets in each bear market case cycled back up to new market highs, many investors have not reaped the full benefits of the market recovery in their portfolios.

And that is understandable, as panic-strick-en investors in 2008-09 often sold out on the way down and have since been hesitant to wholeheartedly commit to equities—with some even “swearing off” the stock market forever. A recent MarketWatch column declared, “Buy-and-hold investing is impossible,” citing the extreme bias of basic human nature toward wanting to avoid pain—making the very long-term mean reversion tenets of passive investing unrealistic for most.

The most recent run-up in the markets over the past five years has been called the “most unloved bull market of all time” for exactly those reasons. Too many investment profes-sionals, advisors, and individual investors have either been “on the sidelines,” under-allocated

continue on pg. 11

Market predictions generally tend to be worth about what you pay for them.The onslaught of 24/7 financial news, opinion, and market “noise” can often be detrimental to the health of investors’ portfolios. Can active investment management help?

I

to equities, or spooked by market fears into a whipsawed in-and-out lack of commitment.

The blaring headlines of the European debt crisis that reached crescendo levels throughout 2010-12, combined with the threat of a U.S. government budget/debt ceiling crisis in 2012 and 2013, hardly have provided a backdrop fueling investor confidence through much of the current bull market. For example, the 2013 consensus forecast from the top fourteen major Wall Street banks and investment houses for the S&P 500 was in an unusually tight and conservative range. This averaged out to a pre-dictive call for 1540 on the S&P by year-end 2013, for about an 8% annual gain. This fell far short of the index’s actual 30% gain, with the market finishing at 1848.

Importantly, these universally understated forecasts were accompanied by the expected caveats, overviews of market risk factors, and generally less-than-upbeat outlooks—all of which received amplified treatment by the media. It was little wonder that investors en-tered 2013 under a strong cloud of pessimism and doubt—likely reflected in the portfolio actions of self-directed investors and, for those with financial advisors, in their advisor review sessions.

Optimism

Excitement

�rill

EuphoriaAnxiety

Denial

Fear

Depression

Panic

Capitulation

DesperationHope

Relief

Optimism

�e Cycle of Investor Emotions

A confusing and often contradictory flow of news and opinion is constantly washing

across the investment landscape.

September 4, 2014 | proactiveadvisormagazine.com 5

Will September be the cruelest month?

he old adage of “Sell in May …” certainly did not play up to form this year, as the S&P 500 logged

over a 6% gain from the end of April to the end of August. The NASDAQ Composite registered an even more impressive gain of 11% over the same period. The month of August, while living up to its weak historical pattern early in the month, rebounded with gains of 3.8% on the S&P and 3.2% on the Dow, and the NASDAQ continued to lead with nearly a 5% gain.

T

Source: Bespoke Investment Group

Bespoke Research notes that September has “historically been a brutal month, followed by what has traditionally been the best 3-month stretch of the year, October through December.”

According to Bespoke, over the last 100 years, the Dow has averaged a decline of 0.8% in September, with gains just 43% of the time. Over the last 50 years, September has also been the worst month of the year, with the Dow averaging a decline of 0.7% and posting gains just 39% of the time.

Over the last 20 years, the average decline has been a little bit better, but not by much at -0.5%.

A host of factors will be thrown into the mix this September, with the Fed winding down asset purchases, mid-term U.S. elections on the horizon, the ECB contemplating increased stimulus against a backdrop of weak European economic performance, and the increasingly ever-present geopolitical risk from several global hotspots.

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AVERAGE MONTHLY % CHANGE FOR THE DJIA

7September 4, 2014 | proactiveadvisormagazine.com

TOPPING THE CHARTS

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BY DAVID WISMERPHOTOGRAPHY BY TODD DOUGLAS

On the heels of the 2003 dot-com crash, Rich Ralston learned about active investment management. As his advisory practice began utilizing third-party managers for dynamic, risk-managed strategies, he made sure his clients received the education they needed to appreciate an active management approach.

RICH RALSTON’S

WATERSHEDMOMENT

8 proactiveadvisormagazine.com | September 4, 2014

Proactive Advisor Magazine: Rich, can you tell me about your client base?

Rich Ralston: We are based in Pensacola,

Florida, and have over 400 clients, made up of all age groups from all walks of life. But this area has more than its fair share of people ap-proaching retirement or already retired, so we see many people like that.

Describe your “ideal” client.

I personally like to work with clients who are fundamentally responsible with their finances. I want to see if someone, single or married, has low levels of debt, emergency reserve funds in place, and has been contributing throughout their work life to a savings or retirement plan, whether employer-sponsored or not.

I also like to work with people who are open to financial education, willing to consider new alternatives, and open-minded. We pride ourselves on not doing things in any predeter-mined fashion and everything is dependent on a needs analysis and risk profile for each client. We employ sophisticated, modern strategies for investment and risk management that a lot of people may not be familiar with. So they need to be open to looking at things in a new light.

What are your clients or prospects most concerned about today?

It really depends on their life circumstances and financial health, but I continue to hear about their fears on the equity markets. What happened in 2008 has had a lasting impact on people and made them more risk-averse than ever, even now, five years later.

Preservation of capital is the number-one concern, closely followed by how are they going to make those assets grow and last throughout retirement.

How do you address those issues?

That is really right in our wheelhouse. Starting around 2003, not long after the dot-com crash, I was introduced to active invest-ment management and it was really a watershed moment for our practice.

Fortunately, we had been able to weather

that crash fairly well as I had been pruning the equity side of client portfolios and moving a fair amount of money into fixed income.

But that was really more of a “seat-of-the-pants” decision-making process and I thought there had to be a better way. So I started ex-ploring third-party asset managers who were all about tactical money management. This is exactly what I was looking for and what my clients were calling for, though they had very little idea then what it was all about.

Active management is a totally different ball game than traditional buy-and-hold strategies. As I explain now to clients, their money is being managed by experts who are constantly watch-ing the markets and making portfolio adjust-ments as needed. There is very little guesswork or opinion involved, as most of these managers have very strict rules-based methodologies and use a quantitative decision-making approach.

The bottom line is that the vast majority of my clients who are very concerned with capital preservation can now employ a systematic and disciplined approach for long-term asset growth. They know someone is watching over their money every minute of every day, which is very reassuring to them. They know they are using strategies that usually have long track records and are based heavily on research.

What are the challenges to this approach?

Let’s go back to my point on having clients who are open to education.

Active management is a totally new concept

for many people who have been brought up on the buy-and-hold approach their entire lives. When they hear the phrase “active manage-ment” for the first time, some are concerned about it being riskier than buy-and-hold, when in fact it is built to be just the opposite. So I use this as an educational process with a lot of charts and illustrations to communicate what it is all about and how it is designed to work.

There is also the matter of fees, which can be somewhat of a concern initially. But the per-centage, frankly, is very low and I demonstrate how that can be offset in a meaningful way when we come upon the next inevitable market

displacement. The numbers do then make sense for most people.

Finally, there is the matter of how active management might perform in strong bull markets. But, it is built around risk manage-ment, and that can sometimes lead to under-performing the market. There will always be clients who, if the S&P 500 is up 30%, want to see a return of 32%. The challenge is edu-cating clients that this is an approach for the long term, across market cycles, and the key is risk-adjusted returns.

This makes sense to most people, but to some it is a hard concept to grasp. Then I have clients, like a very smart former engineer, who say, “It’s about time investment methods moved into the 21st century. It’s about time strategies were monitored in real-time.” I think most of my clients eventually come to that point of view. And it does not have to be a total and abrupt change. For some, I introduce active strategies very slowly.

continue on pg. 10

September 4, 2014 | proactiveadvisormagazine.com 9

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over lengthy time periods. Helping clients to succeed with their goals over the long-term is what it is all about for me.

Talk a little more about returns and how that fits into the overall active management discussion with clients.

I approach it from two different perspec-tives. First, I will review the returns of actively managed strategies—let’s say on a 10-year basis—versus traditional buy-and-hold strate-gies. They can see with their own eyes how the strategies have performed and what the risk levels, or drawdowns, have been. This is usu-ally a very eye-opening comparison. Of course, there is no guarantee of future similar returns.

I am also quick to show that over the last four years or so, most active strategies have underperformed the S&P, and show those numbers as well. The message here is really that the benchmark for most people should not be the S&P 500. Who really wants to see 50%+ drawdowns in their portfolios? And who wants to try and count on 30% annual gains?

This should not be the objective over the long haul. For me, the perfect analogy is the race between the tortoise and the hare, and I am most interested in who is going to win that race in the final analysis. I love to communicate the storyline about how the “slow and steady” approach—and avoiding excessive volatility—can make a big difference when looking out

continued from pg. 9

Richard L. Ralston is a Registered Representative and Investment Advisor Representative of and offers secu-rities and advisory services through WRP Investments, Inc., Member FINRA & SIPC.  Securities and advisory activities supervised from 4407 Belmont Ave., Youngstown, OH  44505 (330) 759-2023.  Parkway Financial Group is not affiliated with WRP Investments, Inc.

10 proactiveadvisormagazine.com | September 4, 2014

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In another example, Bloomberg notes that in the beginning of this year, all 72 economists in their ongoing survey predicted higher in-terest rates and falling bond prices for 2014. At the time of their follow-up reporting in mid-July, Treasuries had rallied about 10% in 2014 as yields fell. Little wonder this particular article was titled, “Pro Forecasters Stink, but Individuals Are Worse.”

All of these factors play into those destructive behavioral traits that seem to doom many investors to chronic underperformance: chasing returns, entering at market tops, sell-ing at market bottoms, acting on emotion, or overreacting to the latest headline. Behavioral psychology has many interrelated terms for these and other such actions, including:

Confirmation Bias (reaching conclusions first and finding supportive evidence for that point of view)Loss Aversion (while greed and fear of loss usually compete, studies indicate loss aversion can be over two times stronger and can lead to those panic decisions or, conversely, a fear of making any decision)Herding (following the crowd, or what appears in the media to be the crowd’s public opinion)Recency Bias (extrapolating recent events or market performance into the future)Disposition Effect (the tendency to sell winners too early and hold on to losers too long)Noise Trading Effect (overreaction to both good and bad news in the market)

Financial advisors have a difficult task in many ways, but perhaps nothing is more diffi-cult than dealing with the psychological hurdles their clients often face. What if advisors had at

continued from pg. 5

Perhaps nothing is more difficult than dealing with the

psychological hurdles that clients often face.

their disposal a holistic and systematic invest-ment approach that removed emotion from the decision-making process, paid little attention to market noise, and employed strong measures of risk management?

Active investment management is making huge strides among the advisor community, not only for its less volatile and risk-managed performance over full market cycles, but for its very real benefits of helping to manage client satisfaction and expectations. This disciplined investment approach can provide competitive returns, while avoiding biased reaction to short-term market fluctuations.

Active management’s objective of removing the roller coaster of both portfolio swings and investor emotional highs and lows presents a compelling story to clients—a far more com-pelling and beneficial story than the ones they are seeing, reading, and hearing every day from the media.

11September 4, 2014 | proactiveadvisormagazine.com

The opinions and forecasts expressed herein are those of the author and may not actually come to pass. Any opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. The analysis and information in this edition and on our website is for informational purposes only. No part of the material presented in this edition or on our websites is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any portfolio constitutes a solicitation to purchase or sell securities or any investment program.

EditorDavid Wismer

Associate EditorElizabeth Whitley

Contributing WriterDavid Wismer

Graphic DesignerTravis Bramble

Contributing PhotographerTodd Douglas Photography

September 4, 2014Volume 3 | Issue 10

Proactive Advisor Magazine is dedicated to promoting and educating on active investment management. Distribution reaches a wide audience of financial professionals who advise clients on investments and portfolio management. Each issue features an experienced investment advisor who offers insights on active money management, client service, and investment approaches. Additionally, Proactive Advisor Magazine offers an up-close look at a topic with current relevance to the field of active management.

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Proactive Advisor MagazineCopyright 2014 © Dynamic Performance Publishing, Inc. All rights reserved. Reproduction of printed form, whole or in part, without permission is prohibited.

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In financial data, small is the new big Forward-thinking advisors are experimenting with analysis of “small

data” mined from their own in-house software programs, finding a wealth of information relevant to their practices.

Ranking the Top 10 “differentiators” for advisory firms

When prospects are looking for an advisor, what are the most important—and least important— characteristics of an advisory

firm in the increasingly intense competition for their business?

Americans more than twice as likely to choose a financial advisor over a websiteWe’ve all heard about how the technological revolution is disrupting conventional business models. But when it comes to the realm of financial advice, there is still a very high value placed on personal touch.

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