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BAM Intelligence

When Assessing Investment Advice, Consider the Source

It can be very difficult to separate the good advice from the questionable and the questionable from the downright irresponsible. Unfortunately, good advice doesn’t always walk around wearing a sign, but there are some red flags to help you avoid the so-called advice that’s actually irresponsible.

Case in point: What do you think when you hear someone is “forced” to do something? For me, it implies that there’s no other choice. So imagine my surprise when I read a quote in The Wall Street Journal last week that suggested that low interest rates are “forcing folks into riskier strategies in which they feel they will be more richly compensated.”

Seriously? Last time I checked, there’s very little that can force us to do anything as investors, and there’s definitely nothing that can force us to take greater risk. To be clear, I’m not against people taking more risk, but let’s not pretend that it’s a requirement to take on more risk than we’re comfortable handling.

This questionable statement was made by Ford O’Neil, manager of the $14.5 billion Fidelity Total Bond fund, and it implies that investors don’t have a choice about the risk they must take to be “richly compensated.” Sure, if you want the reward of a higher return, it will come with greater risk. But you do have a choice in the matter.

I assume the point is that the low interest rate environment we’re in is forcing some people, particularly those who are living off the income they get from their investments, to make some really hard decisions. One hard reality for this group is that the income they can get from bonds and would traditionally use as spending money in retirement has shriveled over the past 10 years. But that is completely different from the implication that, as a result, investors are forced to take the risk of owning mutual funds like the one that Mr. O’Neil manages, which is edging ever closer to being a junk bond fund.

The problem becomes more obvious when, in the same article, we read the incredibly irresponsible statement from Jonathan Golub, RBC Capital Markets’ chief United States market strategist. According to Mr. Golub, “REITs and utilities are just crushing it.” He added, “These stocks act as a bond substitute.”

Can this statement possibly be what he really meant? One possibility is that he believes that investors are making the mistake of thinking of REITs and utilities as actual substitutes for bonds. But what he said is quite different from that. He said, “These stocks act as a bond substitute.” That is not only factually incorrect but irresponsible.

My real concern is for investors who take this statement at face value, particularly if they’re trying to make the very difficult decision about what to do with a portion of their retirement money that they depend on for everyday income. With REITs already up double digits in 2014, letting them substitute for bonds sure seems like an appealing idea. Who wouldn’t want a “bond substitute” like that?

But hold on!

Several weeks ago, I laid out all the reasons it’s a horrible idea to buy one type of investment assuming it will behave like another, particular if greater risk is involved. In this situation, Mr. Golub appears to be making the classic mistake of trying to convince investors that something that’s most definitely not a bond will behave like a bond in a portfolio. That’s a fast track to investor disappointment.

For example, saying REITs can play the role of bonds ignores a huge reality. They go down, sometimes a lot. In May 2013, investors left REITs in a huge wave. In one month alone, the Dow Jones REIT index lost 16 percent. There is even grimmer history in the not too distant past. In 2008, that same Dow Jones REIT index took a horrible hit with losses for the year of 40.07 percent. The time between April 2008 and March 2009 was even more painful for the same REIT fund. It was down more than 60 percent during that 12-month period.

That doesn’t sound like a bond substitute to me.

The worst decline in what many consider the benchmark for bonds, the Barclays Government/Credit Bond Intermediate Index, happened all the way back in 1979. For the 12 months starting in April 1979, bonds were down 2.25 percent.

■ Largest decline for bonds: 2.25 percent

■ Largest decline for REITs: 60.22 percent

That is a big difference!

Based on these numbers, it’s a little difficult to see how REITs “act as a bond substitute.”

My argument here isn’t really about risk or even investing in REITs and utilities. The problem I’m focused on today is what happens when we accept all advice equally and don’t look past the surface to some of the uncomfortable realities.

More risk, even if you’re “forced” into it, does not guarantee being “richly compensated.” And treating REITs and utilities like bonds is nuts because — reality check — they’re NOT bonds. Both of these statements are excellent examples of really bad ideas being presented as advice, but because they appear in a respected publication, investors may be tempted to assume that it’s a prudent strategy.

Our job as investors is to ask at least one more question if what we’re hearing sounds either too good to be true or contradicts what we already know to be true.

This commentary originally appeared May 27 on NYTimes.com

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© 2014, The BAM ALLIANCE

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Carl Richards is the creator of the weekly Sketch Guy column in The New York Times and is a columnist for Morningstar Advisor. Carl has also been featured in The Wall Street Journal, Financial Planning, Marketplace Money, The Leonard Lopate Show, Oprah.com and Forbes.com. His simple but meaningful sketches served as the foundation for his first book, “The Behavior Gap: Simple Ways to Stop Doing Dumb Things with Money.”

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