Month: April 2012

At a recent client review meeting, the term “Relative Strength” was used extensively.  The client was patient and listened closely.  However I could tell that there was some hidden assumption that I was making, that I was not doing a good job of communicating.  So I decided to go back to the basics of market analytics to see if I could clear up the confusion.  Let me share with you what I said.

An article from James Minich…

Essentially all security analysis is broken down into two schools of thought:  fundamental analysis and technical analysis. Fundamental analysis looks at the fundamentals of corporate structure, and balance sheet numbers.  In a sense, fundamental analysis is what a CPA would do if you hired him to go over your books and give you his opinion about the fiscal soundness of your business.  Debt levels, cash flow, account receivables, cash on hand, gross sales etc.  In the world of the capital markets, AKA the stock and bond markets, the issue that fundamental analysis addresses:  Is the corporate stock fairly valued?  Fair value is defined as the total value of the corporation divided by the number of shares of that same corporation that are outstanding- total of all publically owned shares of stock.  Let say that the price of the stock was $50.00 and the appraised value was $40.00, that would mean the price of the stock was overvalued, and vice versa, if the stock was valued at $40.00 and appraised value was $50.00 the stock would be considered undervalued.  Fundamental analysis determines whether the current price of a stock is a fair price based on the fundamentals.  Bargaining hunting is the best analogy for what fundamental analysis is all about. 

Let’s assume that we do our fundamental analysis and determine that XYZ stock is undervalued.  We buy the stock at $40.00.  Naturally we expect the price to go up based on the homework we did.  In fact what happens is the price goes to $35.00.  Ouch, a 12.5% loss.  We vow never to let that happen again.  And in the process we discover that there is another school of thought called Technical Analysis.  Technical Analysis looks only at the price of the stock.  There is nothing fundamental, in a sense, about tracking the price of the stock.  The price of the stock reflects what buyers and sellers think a fair price for the stock should be.  If you have ever been to an auction, you have seen Technical Analysis in action.  The price says it all.  Supply and demand, the core ingredients of economics, sets the price.  If there is more demand than supply the price goes up.  If there is more supply than demand, the price goes down.  Technical analysis is essentially the process of tracking security prices.  The tracking takes the form of charts and graphs.  We use a charting process call Point and Figure.  When price is going up then a column going up is shown in X’s.  Just think of the graph paper you used in school with all the little boxes filled in X’s going straight up when the price is going up.  And when the price is going down, a line of boxes going down is filled with O’s.  This produces a graph.  The graph when properly understood tells at a glance the price history.  If the trend of the graph is down, getting back to our $40.00 purchase of XYS stock, then yes it is a good value, but just not a good time to buy.  There may be further decline in the price, and you want to buy when it has bottomed and the trend is up!

Merging fundamental analysis and technical analysis, gives the answer to the question:  is this a fiscally sound company, is its current price a bargain, and has demand asserted control of the supply such that the price is headed up.

OK, now we get to the issue of relative strength.  Let’s assume that there are many stocks that are undervalued and are in a positive price trend.  The question becomes: which one of these stocks should we buy.  The answer may well depend on which of the stocks has the strongest relative strength.  Relative strength belongs to the technical analysis school.  The analysis is all about the price.  Let’s say XYZ stock goes from $10.00 a share to $80.00 a share.  And for comparison we have ABC stock, in a similar sector, which goes from $10.00 to $100.00 a share.  From a relative strength point of view, we say that ABC stock has a stronger relative strength.  You and I may be very strong.  But when we have a contest at a local gym, you can lift more weight than I can.  I can lift a lot, just not as much as you can.  You have stronger relative strength!

You know the expression, “It’s all relative.”  That is precisely the point.  You want to buy the stock that relative to all other similar stocks has the greatest potential for price appreciation. 

(Next Time:  I will address the issue of Growth vs. Value stocks.  Can a growth stock continue to appreciate when the price seems to be so high currently, and can a value stock ever be TOO much of a bargain?)

Your financial advisor plays a significant role in how your financial future and, to some extent, personal happiness will play out in the years ahead.

Given the influence they bear on your life, you might think it important to understand what drives the decisions they make. But if you’re like most folks, you probably don’t.

Fortunately, finding out what motivates your financial advisor isn’t that difficult. With the three simple questions that follow you’ll get a little closer to understanding how your finances are being handled and if their choices are based on your future happiness and not just theirs.

1. How do you get paid?
Understanding how your financial advisor gets compensated is important as it can affects the rules they must adhere to and the advice they might offer.

There are a few different payment schemes with the two broadest (and most common) categories being commission-based and fee-based.

Commission-based advisors charge you a fee every time you add money to your account or buy or sell a product. A very traditional payment model, this method works great if you are taking a buy-and-hold approach and don’t need much in the way of ongoing advice. However, if your advisor is recommending moving your money around on a regular basis, you might want to reconsider the advice or even the relationship as the only person adding to their account in that scenario is the advisor.

A fee-based advisor typically doesn’t charge any commissions based upon transactions but instead charges a set percentage fee based on the assets being managed. Since the advisors compensation is based upon the account value, you both have the same goal: making you money.
The potential downside to this approach is that over time and depending on the percent fee being charged and how much proactive advice is being offered, the annual fee may end up being more than a one time commission up front.

2) What fees will I pay?
Ah, the hidden fees of financial management. A friend once described the cumulative effect of fees as like “being pecked to death by ducks”. I would modify that analogy slightly to “being pecked to death by invisible ducks” as most of us never see them coming but we sure feel them.
The reality is all investment products (mutual funds, ETF’s, annuities, etc.) have some sort of internal expense associated with them. While they’re all listed in each product’s prospectus, most investors don’t read them. However, a forthright advisor will openly share with you what the true cost of each investment is and how any associated fees may or may not impact your potential gain. Nonetheless, ask for this information in writing and clarify that the document you receive represents ALL potential fees.

3) What is your approach to investing and what specific services can I expect?
While it might sound like a “fluff” question, this one’s important. You need to be absolutely clear that you understand their investment approach is. Is it based on buy-and-hold, tactical rotation based upon the calendar quarter, or is it based on some other style? Do they use individual stocks and bonds, mutual funds, ETFs, or other products on a regular basis? Do they focus on financial planning and less on portfolio management or vice versa? A good advisor will be able to quickly and thoroughly articulate their style and give you a sense of ‘fit’. But just to be sure, ask for this information in writing and be wary of anyone who shies away from answering your questions.

While these three questions alone won’t ensure your financial future entirely, they can go a long way to helping you choose and stay with the right financial planner.