Beware Performance-Chasing Financial Planners

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That exhilarating desire to chase hot stocks and mutual funds usually pits smitten investors against their more sensible financial advisers. But what happens when the tables turn?

A well-diversified investment portfolio probably will always have some stake in a top sector. But financial planners who embrace the latest market darlings — such as technology shares in 1999 or energy stocks today — may be buying under the influence of the latest winning trend.

Nearing the end of this mediocre year for stocks, your adviser may feel extra pressure to swing for the fences. But investment experts warn that you should view such zealousness with alarm.

How do you know if your financial pro is overexposing you to a hot area? If you don't ask questions and the bet pays off, "then you never really know," says Ross Levin, president of Accredited Investors Inc., an Edina, Minn., financial-planning firm. "It's only after a bad experience that you say, 'How could I have fallen for that?'"

The painful truth hit many investors in 2000 when the technology bubble burst. Some financial planners had strapped into this stratospheric sector, abandoning convictions for a new set of beliefs.

Know What's Hot

Investors' faith is strong again for stars such as energy, housing and developing international markets, according to many strategists. But rather than pare portfolio winners and add underperformers poised to rebound, as prudent investment wisdom dictates, some advisers may defy convention and walk a tight wire with their clients' money.

"If you have an inordinately high percentage of investments in a hot category — more than twice the weighting of the Standard & Poor's 500 Index — I would start to get suspicious." said Scott Kays, president of Atlanta-based wealth manager Kays Financial Advisory Corp.

Energy, for instance, represented 9.3% of the S&P 500 as of Nov. 30. "If somebody has a 20% weighting, that's a red flag." Kays said. "Consistency is key. I want a guy who's going to stick to his knitting and not change with every fad. When someone's loading up on a hot area, I have a hard time seeing how that's staying consistent with a strategy."

The push to fill portfolios with international stocks has Levin especially piqued. For many years, Levin has committed up to 30% of clients' assets to non-U.S. markets — a stance that until recently landed him squarely in the minority.

Since global markets have become among the best places to invest, however, more financial planners have joined the chorus. "These are advisers that had nothing internationally," Levin said. "You start to wonder."

Accordingly, Levin has been shifting strategy abroad. For instance, he's moving clients' money to Asia from Europe and easing up on emerging markets.

"All of us have our own bias when it comes to investment planning," Levin said. "I believe in diversification. If something does too well, it becomes too big in the portfolio and we're forced to sell. The first thing is to really understand your adviser's philosophy. Hopefully that will be laid out in an investment policy statement that will match your goals."

Some financial planners see hot sectors as fat pitches to hit out of the park and establish a reputation. Others who've fallen behind look for chart-toppers to save their reputation. Either way, investors are shouldering excessive risk.

"Being in what's hot is a way to build assets and clients," Kays said. "When you're right, you're a hero. When you're wrong, clients lose money."

Another reason why financial advisers may stay too long in overheated sectors, Kays added, is that they just don't know when to sell. Kays cites four reasons to dump a portfolio holding: overvaluation, deteriorating financial strength, to make room for a better prospect, and a case where the investment is clearly a mistake.

"Every investment adviser should have a good buy strategy and a good sell strategy," Kays said. "Do they let their winners ride? How long? A lot of advisers don't have a sell strategy. You need to ask these questions up front."

Honest Talk

Too often, questions about advisers' decisions go unanswered and unresolved. Peggy Cabaniss, president of investment manager HC Financial Advisors in Lafayette, Calif., said she occasionally meets prospective clients who are unhappy with their current adviser. After hearing their complaints, Cabaniss asks these doubters if they've told their planner the same things.

Most often, they haven't. "I tell them to go to the adviser, have a good, honest discussion, and then proceed with either making a change or setting the ground rules again," Cabaniss said.

But how do you talk about money with someone who seemingly mishandles your money?

Play it straight, said Cabaniss. "Say, 'I've been feeling uncomfortable. It would make me feel better if we reviewed my portfolio, my objectives, and the way we're going to work together.'

If the adviser isn't amenable, "that's a worse red flag and then you really need to move on," Cabaniss added. "You need to be proactive. As a client, you deserve an explanation. It's your money."