Morningstar Advisor - October/November 2013 - (Page 28)

In Practice Avoiding the Simple Mistakes It’s easy to get caught up in new or trendy products. But in many cases, advisors and their clients can take a pass. Here’s a quick look at what to do when temptation may get the better of you. Alternatives Don’t Do This: Buy into the hype surrounding alternative funds. Many are expensive, unproven and offer no more downside protection than a traditional bond fund. Do This: Focus on strategies that diversify client portfolios or leverage a talented manager’s unique skills. Above all, keep costs low. Income-Plus Strategies Don’t Do This: Get caught up in a singular quest for yield. Many income-plus strategies stretch into low-rated, long-duration or illiquid securities that could get crushed when investors shed risky assets. Do This: Focus on risk-adjusted total return instead of income alone. That exercise will open investors’ eyes to the type and magnitude of risk they are assuming. Structured Products Don’t Do This: Buy into what can be a fiendishly complex product. Structured products argue that traditional investing methods are passé. But in many cases, investors can get a better risk-reward payoff with a more plain vanilla option. Do This: Explain to clients the range of potential outcomes with a particular investment. That should enlighten them to the tradeoffs between different portfolio mixes of stocks and bonds. They’ll see they can achieve the same results of the complex structured product without all the baggage. 28 Morningstar Advisor October/November 2013 Guarantees Don’t Do This: Overprescribe guaranteed products such as annuities to wary investors. Many times, investors wind up paying too much for downside protection even though a long time horizon can usually help them ride out market gyrations. Do This: Use a ladder strategy with high-quality bonds. While this option isn’t perfect, it should give clients peace of mind since they will get a competitive return and their capital back at the end. Non-Traded REITs Don’t Do This: Chase the yields on these products, which can be pricey and illiquid. Do This: Opt for a low-cost, diversified portfolio of dividend-paying stocks from companies with competitive advantages. And continue to buy these stocks when their prices get cheap. Closed-End Funds Don’t Do This: Most investors don’t need a juiced-up municipal bond closed-end fund, even if there is a truly pressing need for income. Do This: Level with your clients. Expenses reduce yield basis point for basis point so pinching pennies is a surefire way to make their money go farther. From there, duration-management, sector-rotation, and issue selection should come into play, albeit within reason. Tail Protection Don’t Do This: Overdue it trying to plan for when disaster strikes. Simpler can be better, especially if the investor has a long enough time horizon to shake-off the occasional drawdown. Do This: If you think markets are going to pull back significantly, look at the bonds of high-quality sovereign issuers. as investing in out-of-the-money put options. In the right hands and judiciously applied, tail protection can make some sense by adding ballast to a portfolio to fortify it against a shock, however improbable. The problem is usually one of magnitude, though, with portfolios awash in long-duration bonds, precious metals, inverse ETFs, or other fare designed to pay-off when disaster strikes. In these cases, simpler is probably better, especially if the investor has a long enough time horizon to shake-off the occasional drawdown. If you think the world, or at least global capital markets, are going to pieces, chances are you’ll do fine owning the bonds of high-quality, sovereign issuers. Remember that bonds enjoy their safe-haven reputation because there is greater certainty as to the timing and magnitude of future cash flows, unlike stocks and other risk assets. A bar of gold is undoubtedly a store of value, but that value isn’t intrinsic, as it doesn’t generate any cash flows or have commercial applications. It’s worth what the crowd thinks it is worth. And while put strategies can be useful in certain circumstances, mind the price—many tail-protection strategies cost an arm and a leg, greatly dimming their appeal. K Jeffrey Ptak, CFA, is president and chief investment officer of Morningstar Investment Services. The opinions expressed herein are those of Morningstar Investment Services, are as of the date written and are subject to change without notice, do not constitute investment advice and are provided solely for informational purposes and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar Investment Services shall not be responsible for any trading decisions, damages, or other loses resulting from, or related to, the information data, analyses or opinions or their use. ©2013 Morningstar Investment Services, Inc. All rights reserved. Morningstar Investment Services, Inc. is a registered investment advisor and wholly owned subsidiary of Morningstar, Inc. The Morningstar name and logo are registered marks of Morningstar, Inc.

Table of Contents for the Digital Edition of Morningstar Advisor - October/November 2013

Morningstar Advisor - October/November 2013
Contents
Contributors
Letter From the Editor
How to Make Social Media Work for You
Do Mutual Funds Still Have a Role?
More Personal Than Finance
How to Handle Your TIPS Positions
A Real Estate Veteran Starts From Scratch
Investments á la Carte
Investment Briefs
When to Say No
Take a Guarded Approach to Homebuilders
Fund Distribution Has Been Turned on Its Head. Now What?
Winning the Distribution Battle
Active ETFs Wait for Their Heyday
A Fund Firm Defies Indexing Trend
Piloting New Channels
A Good Fit
The Predictive Power of Fair Value Estimates
Does Being Prudent Pay Off?
Utilizing Utilities’ Total Return
Stuck in the Middle Is Not a Bad Place to Be
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
The Good Guys Win

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