These days, many people are distrustful of Wall Street– and with good reason. But since most of us need stock market returns to reach our goals, we find it necessary to be equity investors.
The question is — where should you invest? If you answer that question by saying that you choose the best performing mutual funds, it may be that you think you have achieved a level playing field, because you can easily check past fund results.
Be careful! It”s not that easy.
Let me introduce you to the investment practice called “Window Dressing.” Window dressing is the practice of significantly changing the composition of a portfolio just prior to a reporting period. Perhaps it is filling the portfolio with outstanding performers, or adding large positions from the latest hot sector’s stocks, or just dumping losers. That’s window dressing — getting rid of bad stock picks by excluding them from the list of holdings and filling the portfolio with stocks with great returns, all to imply that the portfolio is doing better than it actually is.
Whether it occurs in a mutual fund or a managed portfolio, window dressing can significantly reduce your real returns.
Here’s an example:
Before Window Dressing
After Window Dressing
What are the other tricks of the window dressers of the investment world?
If you’re following current events, or reading the business section, you won”t be surprised to see that recent window dressing efforts have erased stocks such as Enron and Tyco, while positions in stocks like Apple, Google or Linked In suddenly appear, or become a more significant percentage of the portfolio.
How about the companies with large families of funds who close their poorly performing products to make their overall investment performance better? Or investment advisors who show you portfolio performance reports that are based on holding a specific allocation for 3, 5 or 10 years, when it is much more likely that the investments in the portfolio have changed significantly over that time.
How can you protect yourself from window dressers?
Watch for mutual fund returns that don”t relate to what you are seeing in your portfolio. If you have a managed account, watch for trades that occur right before investment results are reported. Better yet, insist that your advisor discuss any trades in advance, and get your permission to sell or buy.
As for self-directed investors, you can protect yourself from window dressing by refusing to chase returns. If you use funds, make your choices based on long term returns i.e. five- and ten- year averages. Even better, use passive investment strategies with index mutual funds and ETFs that reflect a very visible market.
No matter how or where you invest, an independent hourly financial planner can help. We will review the appropriateness of your investment portfolio as it relates to your financial goals. Best of all, since we do not operate on commission, we are independent from the investment process, and so we have no need for window dressing.