In Search of Yield, Investors May Be Taking More Risk than they Know

http://online.wsj.com/article/the_intelligent_investor.html This article from the Wall Street Journal explains the risks investors are taking today as they stretch outside of traditional investments to achieve current yield.

Investors purchased a one-year note designed by broker-dealer UBS, yielding 8.03%. UBS got paid a 2% fee. The only problem is that the return of 8% was premised on Apple's stock price remaining above a trigger level. Given Apple's drop in value, the investors in the note have lost 30% of their principal investment as of the date of the article.

It is hard to imagine that investors understood the real risk of loss when purchasing such a note. This story also points to a larger, underlying issue. Broker-dealers such as UBS may find themselves pushing products that are profitable for their businesses but not necessarily what is best for their clients.

At Arixa, we generally prefer to follow the approach of Registered Investment Advisors (RIA's) rather than broker-dealers. Unlike broker-dealers (which include the largest Wall Street firms), RIA's have a fiduciary responsibility toward their clients. This means that they must always put their clients' interests before their own.

The major Wall Street firms have long resisted having this standard applied to their business. They are more like an antique dealer—in business to acquire inventory for the lowest price possible and sell it for the highest price possible (while avoiding doing anything illegal). They are held to a much lower standard—the "suitability" standard rather than the fiduciary standard.

The main reason that most investors never stop to think about this difference is that Wall Street firms have a lot more marketing budget to spend than RIAs, which tend to be smaller, independent companies. However, as this article suggests, in today's difficult investing environment, the day might soon be coming when investors finally realize that broker-dealers don't necessarily have their best interests in mind.