The following article discusses who is considered a fiduciary and what some of the investment fiduciary responsibilities include.

Meeting Your Fiduciary Responsibility

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So you volunteered to serve on the board of your local charity or other organization and you consider yourself especially lucky to have secured a seat on the investment committee. Perhaps you initially had reservations about your new appointment - but if you have a keen interest in the financial world, some investments of your own, you’re a business person, you watch CNBC and you read the Wall Street Journal, you may feel that you’re qualified. However, while this may be a great way to attend investment committee meetings and receive the latest investment research from the charity’s advisor, this job shouldn’t be taken lightly.

Being a fiduciary comes with a certain level of responsibility. An investment fiduciary is any person who has the legal responsibility for managing somebody else’s money. What this really means is that you have been placed in a position of trust and there may be consequences for betrayal of that trust. In this article, we’ll discuss who is considered a fiduciary and what a fiduciary’s responsibilities entail.

Who is considered a fiduciary?
As a member of the investment committee, you may share some of the responsibility with the committee’s investment advisor. If your advisor is a Registered Investment Advisor, he or she does share fiduciary responsibility with the investment committee. A broker, on the other hand, may not. Some brokerage firms don’t want or allow their brokers to be fiduciaries. This uncertainty makes it important to ask the advisor. Ultimately, it is the advisor’s actions that determine whether he or she is a fiduciary. Giving continuous, comprehensive advice is considered acting in a fiduciary role, while simply selling products is not. 

Engaging an advisor who is willing to accept fiduciary responsibility is desirable because investment committee members reduce their liability by delegating some of their responsibilities to an expert. However, hiring an expert does not relieve the committee members of all of their duties. They still have an obligation to prudently select and monitor the activities of the expert; therefore, committee members still must understand what constitutes a fiduciary investment process.

A Fiduciary’s Responsibilities
A fiduciary’s main responsibility is to manage a prudent investment process. A prudent process is not as nebulous as it may sound. A fiduciary demonstrates prudence by the process through which investment decisions are managed. This means fiduciaries must have a basic outline for how they go about their responsibilities. In response to the need for guidance for fiduciaries, the nonprofit Foundation for Fiduciary Studies was established to define the following prudent investment practices:

Step 1: Organize
The process begins with fiduciaries educating themselves on the laws and rules that will apply to their situations. For example, fiduciaries of retirement plans need to understand that the Employees Retirement and Income Security Act (ERISA) is the primary legislation that governs their actions. Once fiduciaries identify their governing rules, they then need to define the roles and responsibilities of all parties involved in the process. If investment service providers are used, then any service agreements should be in writing.

Step 2: Formalize
Formalizing the investment process starts by creating the investment program’s goals and objectives. Fiduciaries should identify factors such as investment horizon, an acceptable level of risk and expected return. By identifying these factors, fiduciaries create the framework for evaluating investment options.

Fiduciaries then need to select appropriate asset classes that will enable them to create a diversified portfolio through some justifiable methodology. Most fiduciaries go about this by employing modern portfolio theory (MPT) because MPT is one of the most accepted methods for creating investment portfolios that target a desired risk/return profile.

Finally, the fiduciary should formalize these steps by creating an investment policy statement, which provides the necessary detail to implement a specific investment strategy. Now the fiduciary is ready to proceed with the implementation of the investment program as identified in the first two steps.

Step 3: Implement
The implementation phase is where specific investments or investment managers are selected to fulfill the requirements detailed in the investment policy statement. A due diligence process must be designed to evaluate potential investments. The due diligence process should identify criteria used to evaluate and filter through the pool of potential investment options. The implementation phase is usually performed with the assistance of an investment advisor because many fiduciaries lack the skill and/or resources to perform this step. When an advisor is used to assist in the implementation phase, fiduciaries and advisors must communicate to ensure that an agreed upon due diligence process is being used in the selection of investments or managers.

Step 4: Monitor
The final step can be the most time consuming and also the most neglected part of the process. Some fiduciaries do not sense the urgency for monitoring if they got the first three steps correct. Fiduciaries should not neglect any of their responsibilities, because they could be equally liable for negligence in each step.

In order to properly monitor the investment process, fiduciaries must periodically review reports that compare their investments’ performance against the appropriate index, peer group and whether the investment policy statement objectives are being met. Simply monitoring performance statistics is not enough. Fiduciaries must also monitor qualitative data, such as changes in the organizational structure of investment managers used in the portfolio. If the investment decision makers in an organization have left, or if their level of authority has changed, then investors must consider how this information may impact future performance. In addition to performance reviews, fiduciaries must review expenses incurred in the implementation of the process. Fiduciaries are not only responsible for how funds are invested, but they are also responsible for how funds are spent. Investment fees have a direct impact on performance and fiduciaries must ensure that fees paid for investment management are fair and reasonable. 

Conclusion
Through proper execution of the prudent investment process outlined in these four steps, trustees and investment committee members can reduce their liability by being confident that they are fulfilling their fiduciary responsibilities. Fiduciaries should embrace their responsibilities and understand that they will not be judged on the returns of their portfolio, but on the prudence employed in the creation of the returns. If fiduciaries get the process right, they should be able to achieve admirable returns for their organizations. In the end, it’s not whether you win or lose, it’s how you play the game.

The following article gives a brief explanation of the different types of investment strategies and the general philosophy behind them. 

Defense is the Best Offense: Basic Investing Strategies

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There are times when investing looks like such a sure thing that limiting your rewards with any sort of defensive strategy seems foolish. But venturing into the markets fully exposed is like giving up your health insurance policy to pay for a family hiking trip — one slip, and you’re done for.

As we discussed in Time vs. Risk, the longer you have to invest, the more the clock will make up for the inevitable short-term losses. But these three classic defensive strategies are still crucial if you want to maximize your gains while limiting your risk.

Diversification
The single best way to protect yourself from a meltdown in one stock or industry is to spread your risk across several different investments. The more diversified your portfolio is, the less any one stock can hurt you by blowing up.

If you’ve got the time and energy, you can create your own diversified portfolio. But it will mean keeping track of at least 20 different stocks or bonds at once — a daunting task, to say the least. A much easier solution is to buy a range of mutual funds and leave the diversification worries up to professional management. As we discuss in depth in our Mutual Fund section, by purchasing a fund that invests in large, blue-chip companies, another that looks for smaller growth companies and yet another that invests overseas, you can easily spread your money across hundreds of separate stocks. You’ll pay a little in fees, but the savings in time and aggravation are probably worth it.

Dollar-Cost Averaging
Dollar-cost averaging is another form of diversification — only instead of spreading your money over a bunch of different stocks or bonds, it diversifies your investments over time. The natural human tendency is to buy lots of stock when prices are rising and to stop buying them altogether when prices are on the downswing. Dollar-cost averaging forces you to do the opposite — you end up buying the most stock when prices are low.

Here’s how it works: Suppose you decide to put $300 a month into a mutual fund that invests in the stocks of large companies. Your broker or fund company can set up an account for you and the money is pulled straight from your paycheck on the same day each month. After a while, you hardly know it’s gone.

If a share of the fund costs $50 in October, your $300 will buy six shares. If the price rises to $75 in November, you buy four shares. If the price drops to $25 in December you buy 12 shares. The idea is that your money buys more shares when the price is cheap and fewer when the price is high. That lowers your total cost and, assuming the fund’s overall trendline is upward, you capture more of the upside.

That’s not to say dollar-cost averaging protects you from a falling market. If the fund’s value crashes, so does your overall investment. But the strategy does ensure that you invest new money when prices are low so that you can enjoy the runup when the market recovers — as it always does with time.

A lot of people also use dollar-cost averaging when they want to move a big chunk of money into the market — an inheritance, say, or a year-end bonus. The idea here is to protect yourself from putting all your money in at once and having the market crash days or weeks later. It’s true that if the market moves sharply higher, you’ve missed an opportunity. But in volatile times, that risk is worth it.

Of course, if you’re moving money from one stock account to another — as many people do when they change jobs and roll over their 401(k) accounts — dollar-cost averaging doesn’t make much sense. If your money is already in stocks, you’re not assuming any more risk if you simply transfer it into a new account.

Asset Allocation
Asset allocation is yet another way to diversify. It takes advantage of the fact that when it comes to risk and reward, financial categories like stocks, bonds and money-market accounts all behave quite differently.

Stocks, for instance, offer the highest returns among those three “asset classes,” but they also carry the highest risk of losses. Bonds aren’t so lucrative, but they offer a lot more stability than stocks. Money-market returns are puny, but you’ll never lose your initial investment. An asset-allocation strategy looks at your particular goals and circumstances and determines what asset mix gives you the optimal blend of risk and reward.

Here’s an example. Say your goal is retirement. When you’re young — in your 20s or 30s — and have time to make up for short-term market losses, an asset-allocation scheme would put you heavily into stocks, maybe 100% of your savings. You might even spice it up with a mix of large-company stocks, small-company stocks and international stocks to diversify your exposure within the category.

As you moved into your late 30s and early 40s, however, you’d probably want to add some bonds to give your portfolio some stability and income. Maybe you’d shift to a 75/25 blend — still favoring growth, but not overdoing it. The closer you got to retirement age, the more you would ratchet up the bonds and taper off the stocks. And in your last few years, when you simply could not afford big market losses, your portfolio would be heavy on short-term bonds or money-market funds — the least risky of all investments.

If you’re serious about it, allocation models also help you buy low and sell high. Say, for instance, small-company stocks are on fire one year, but large-company stocks are merely standing still. If the stock portion of your allocation model called for a 50/50 mix between the two, this sudden surge in small-company values would upset the balance. To make things right again, you’d have to sell some expensive small-company stock and buy some cheaper large companies. If you “rebalanced” this way each year, you’d always be trading expensive assets for those with more growth potential.

There are many factors in addition to your risk tolerance to take into consideration when it comes to developing your personal investment philosophy. The following bullet points are based on Paragon Wealth Management’s experience actively managing accounts for more than 20 years. 

• To succeed over the long term in dynamic markets that are constantly changing and evolving, the investment approach must be both disciplined and flexible.
• Stock market forecasts are entertaining and make nice headlines, but they are not useful for making money.
• Making investment decisions based purely on fundamental analysis is a mistake. Even if your analysis is completely correct, nothing happens until investors begin to buy or sell. At Paragon, quantitative models drive our investment process, followed by technical and fundamental analysis.
• Application of behavioral finance investment theory is useful in determining portfolio allocation. Crowd sentiment is an important factor that must be constantly measured.
• Traditional methods of fund selection focus on long-term track records, even though research has repeatedly shown that such data in not indicative of future performance. We focus on what the sector is doing now, not what it has done over the past three to five years.
• Spreading a portfolio across all major market segments in the name of diversification is a cop-out. Why invest in sectors that are going nowhere?
• Most low turnover managers are overpaid for what they do. How difficult is it to buy some stocks and watch them go up and down forever?
• Portfolio turnover, in and of itself, is not a bad thing. Also, simply focusing on fund expenses, rather than what an investor earns, is a big mistake.
• Matching the performance of the S&P 500 is not particularly impressive. If that is the objective, investors may as well purchase an index fund.

Simply put, your investment risk tolerance is the amount of stress you experience when your account declines. In other words, how do you feel if your account declines five percent? How about ten percent? What about 20 percent?

If you invest too aggressively for your risk tolerance, then at some level of decline you may reach a breaking point. When that point is hit, many investors feel the need to sell their investments in order to protect themselves. As a result, they make the classic mistake of selling out right at the market bottom just before the market rebounds. This causes them to lock in their losses and miss out on future gains.

Investors have no problem watching their portfolio go up. Most mistakes are made when the markets go down. Setting your risk tolerance before you invest helps you to avoid those costly mistakes.

If your risk tolerance is set too low, you won’t generate the returns you should. If it is set too high, should market conditions become difficult, you will feel pressure to sell your investments, which could cause you to miss out on superior long-term returns.

Risk Tolerance needs to be set at the right level for each individual investor. Couples should each take the test individually, and then combine the results, in order to identify what both individuals will be comfortable with.

Determining your risk tolerance can be difficult. Setting a proper objective risk tolerance level will help you avoid making emotional decisions during difficult markets. We have put together a 10-question survey that will help identify yours. Click on the link below to complete this short, but effective survey.

Paragon Wealth Management is a provider of managed portfolios for individuals and institutions.  Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy.  All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice.  This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.  Past performance is not a guarantee of future results.