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Management Structure

Observations On the Traditional Management Structure: Active Management

There is something intuitively appealing about analyzing stocks and making what seem to be smart trades. However, research shows the truly smart thing to do is to invest in a properly diversified portfolio.

Conventional wisdom is to find the best mutual fund, pick the best stocks, or hire the best manager to get the best investment results. The investment process revolves around picking what are hoped to be “winning” stocks and bonds and avoiding the rest. It usually involves trying to buy when the market seems like it might be going up and selling when it seems like it will go down. This is the essence of active management. Most investors believe that by doing some homework they can outsmart the market to make money when it rises and avoiding losses when it declines. As the above quote infers, this is perceived to be the smart thing to do.

Unfortunately for most investors, study after study shows this is an extremely difficult game to play. Commissions, taxes, failed investments and missed opportunities take a significant toll and the typical investor will underperform the market or worse. Fortunately for investors, there is a better way. The rest of the Philosophy section will continue to discuss a passive style of management. Passive management is an approach which concedes to the fact that there will be good times and bad times in the market but that no one can consistently, reliably, or efficiently exploit these conditions. Portfolios are intelligently engineered to take the good times with the bad times and in most cases will still come out ahead. Advisor Compensation: Transactional, Fee-Based, Fee Only

Any investment carries some level of cost. In an advisory relationship there are typically three ways to pay for the services one receives - Transactional, Fee Based, Fee Only. Careful attention should be paid to this because there is an inherent conflict of interest in two of these structures. An advisor who is compensated each time a trade is placed has an incentive to make frequent trades. They are not incentivized to achieve the client’s goal. In fact, they are incentivized to turn your money into their money. Transactional advisors have this problem. Fee-based advisors collect a fee for managing the account and collect commissions so they are also subject to this conflict of interest.

In contrast, a fee only advisor is not compensated when trades are placed. They are compensated based on a fixed percentage of the account value. Therefore they have no conflict of interest. In fact, this gives the advisor and the client an alignment of interests because as the account grows, so does the advisors compensation. This is tremendously important because the goal of account growth is mutually beneficial. Because of this, Prime Capital Equities has chosen to be a Fee Only advisor.

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