A buyer's guide to choosing an investment vehicle

By David Peartree The Daily Record Newswire Most investors lack, or perhaps just can't articulate, a reliable set of criteria for evaluating their choices among various investment vehicles. It's odd because most of us have no trouble sorting through the options for ordinary consumer products and services. If shopping for a car, we consider factors such as price, dependability, performance, and functionality. Pretty straightforward and virtually second nature for most of us. However, with an investment portfolio on the line, many investors lack a similar basis for evaluating investment vehicles. This can spell trouble and frustration. By investment vehicle, I mean how assets are owned. The first step in a basic investment decision is figuring out what to own, what asset classes and in what proportions. The next step should be to decide how or where those asset classes should be held. The considerations are closely related. Whether an investor should hold a particular asset class depends, in part, on whether suitable investment vehicles to own that asset class are available. Stocks and bonds, for example, can be owned directly as individual securities, indirectly through a fund (open-end, closed-end or exchange traded), through a separately managed account, or perhaps through an annuity sub-account. Here are four basic attributes that ordinary investors should look for in an investment vehicle. 1. Transparency: You need to know what you own. That means knowing what the holding consists of, its value, its expenses, its risk level, and how it performs. That information is readily available, albeit with some effort, for most common stocks and bonds. The same is true of most open-end mutual funds and exchange-traded funds holding stocks and bonds. In addition to public information such as the prospectus, the Statement of Additional Information and annual reports, there is a wide range of subscription services and analyses available to the investing public. There is far less transparency, however, with hedge funds, limited partnerships, venture capital,or private equity funds. These are murkier investments, where most individual investors, other than the very wealthy, should tread very carefully, if at all. 2. Liquidity: Liquidity here refers to the ability to quickly and easily get out of an investment at the prevailing market price. Non-publicly traded REITs (Real Estate Investment Trusts) and limited partnerships are prime examples of investments that may be quite illiquid. The lack of liquidity may be the price for receiving a higher income payout, but it may be a stiff price. REITs and limited partnerships may offer only limited redemption dates or redemption dates that are projected many years out. Or, they may offer regular, even monthly, redemption dates, but often at a steep discount to fair value. With limited exceptions, only the very wealthy can afford to own illiquid investments. During a market downturn or a time of particular need, illiquidity can mean having to sell at a significant discount to fair value. 3. Reasonable expenses. Keeping investment expenses under control may be the easiest way to enhance investment returns. Excessive expenses are a bit like pornography, hard to define but easy to spot. Annual fund expenses vary considerably among fund companies and share classes, from less than .25 percent to nearly 2 percent. Variable annuity expenses can easily exceed 3 percent, but low cost (under 1 percent) no-load annuities are available also. Management and advisory fees and trading costs may be additional expenses. Professional advisors and money managers can add tremendous value in the form of knowledge, structure and discipline, but only if the overall cost structure doesn't strain the investor's returns. 4. Proximity: This is really just another angle on the expense issue. There should be as few layers or intermediaries as possible between the investor and the investment. Each additional layer adds expense and needs to be justified. Direct ownership of stocks and bonds is as proximate as it gets. Ownership through fund investments or a separately managed portfolio is only a step away from that and can offer greater diversification, efficiency and management. An increasing number of financial advisors outsource their investment services by signing up their clients with other investment firms who have assembled various institutional money managers into packaged portfolios. In this case there are at least three layers between the investor and the investment -- an advisor, an investment firm, and the money managers who handle the day-to-day investing. This is not to dismiss the merits of financial advisors and money managers, far from it. But even assuming that the money managers are all top performers, investors would be well served to scrutinize these arrangements carefully. Total expenses for some of these programs can easily exceed 2 percent annually. There are good reasons why most individual investors tend to stick with the basic asset classes -- stocks, bonds and cash. Whether owned directly or indirectly through a fund or a managed account, investors can find investment vehicles to own these assets classes that meet the essential criteria of transparency, liquidity, reasonable expenses and proximity. Investors should relinquish any one of these very reluctantly and only in return for some certain benefit. ---------- David Peartree, JD, CFP is the principal of Worth Considering, Inc., a registered investment advisor offering fee-only investment and financial advice to individuals and families. Offices are located at 160 Linden Oaks, Rochester, N.Y. 14625, or email david@worthconsidering.com. Published: Tue, Oct 25, 2011