Choosing An Advisor. Why should you choose a fee only RIA firm led by investment professionals as your advisor?

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1 Choosing An Advisor Why should you choose a fee only RIA firm led by investment professionals as your advisor? Television, newspaper, radio and Internet advertisements constantly bombard us with messages from investment companies, telling us to fund retirement, plan for college funds, and buy enough insurance. In our local banks we come into contact with investment advisors. On practically every street corner there is a financial services firm. It seems there is no end to the range of options that the average consumer has available to them to plan for their financial future. And that s the tough part. How do you know which firm to trust? Which one will really look out for your interests without charging an arm and a leg? At Barnes Capital, we d like to suggest that you take a close look at Registered Investment Advisors, or RIAs. RIAs are in a class of their own in the financial services industry. We believe that the RIA model, among all financial services models, is most closely aligned with the interests of the individual investor. Of the many RIA firms, we believe that those led by Investment Professionals (those with a background in individual securities analysis and portfolio construction) provide the optimal mix of excellent service and excellent, consistent wealth building returns for their clients. This white paper describes the different financial sales people in the U.S. securities industry. This paper seeks to illustrate the motivations and business models that frame and pre-define each type of advisor. Based on our years of experience, and independent research from Tiburon Strategic Advisors, we build a case for Fee-only RIA s run by investment professionals as the preferred provider for wealth management and advice. By the way: RIA s never hold client securities. Independent custodians such as Pershing Advisor Solutions, Charles Schwab, Fidelity or TD Ameritrade hold and handle all client assets. The custodian is insured, provides access to securities products, trading, account forms, and generates all distributions, statements, etc. for Advisor clients. Advisors instruct custodians on behalf of their clients, but the custodian plays an important gate-keeping function, a safeguard missing in some parts of the securities industry.

2 The Securities Industry The securities industry is large. There are more than 00,000 people selling financial services in the U.S. alone. They are not all cut from the same cloth. Independent, Fee-Only Registered Investment Advisors attract the most qualified of investment professionals. In fact, investment professionals, defined as those who are a part of the investment decision making process, by and large do not stay in positions where they are simply selling someone else s product. Investment Professionals core business model is to create and craft investment strategies that meet the needs of the client. The experience of working with an independent registered investment advisor is qualitatively different than working with other purveyors of financial services. RIA Advisors are not Brokers; but rather fiduciaries. No other group of investment advisors is as closely aligned with the objectives of the individual family as are Registered Investment Advisors. The purpose of the following list and accompanying descriptions is to describe the business models behind the different financial sales people in the United States. Independent Representatives 82,000 Wirehouse and Other National Broker-Dealers 68,000 Bank Representatives 61,000 Property & Casualty Insurance Agents 5,000 Life Insurance Agents 5,000 Regional & Boutique Broker-Dealer Representatives 2,000 Bank Trust Officers 21,000 Discount Brokerage Representatives 7,000 Family Offices 5,000 Partners at Fee-only Advisory Firms 25,000 Investment Professionals with Fee-only RIA s 5,000 Independent Representatives Independent Representatives are licensed by a sponsoring broker dealer. You can identify them because their business cards will say securities offered by The typical independent rep has a variety of product that is accessible to him/her through their sponsoring. However, almost all independent reps receive commissions from the product that they place their customers in. Furthermore, the independent rep is highly regulated by their sponsoring firm. As such, their ability to create a custom investment plan is strongly framed by the powers that are at their sponsoring Broker/Dealer. Some large Broker /Dealers with many Independent Rep s include Linsco Private Ledger (LPL), Associated Securities, Jefferson Pilot, Sloan Securities; and others.

3 Of note, The 50 largest mutual fund companies pay $1.5 billion annually to these Broker/ Dealer firms through revenue sharing or shelf-space agreements. Shelf space agreements are the cozy arrangements for which brokers such as Edward Jones have recently been prosecuted for by the SEC for failure to adequately disclose financial incentives to sell mutual funds from preferred families of mutual funds. Wirehouses Wirehouses are Merrill Lynch, Smith Barney, and Goldman Sachs. Wirehouses are large and very profitable firms that offer securities and a variety of other products. The typical experience of a Merrill Lynch customer is that the brokers (and they are all brokers) will sell you into product so that he produces enough revenue to justify his position. A good Merrill Lynch broker grosses about $00,000 of production (revenue) per year, taking home perhaps $200,000. Those revenues come from the sales commissions of the products, such as mutual funds that the broker sells you. Branch Bank Representatives Bank Rep s are typically known as financial consultants. They usually have a background in banking and have been promoted to financial sales. Bank reps sell their clients into mutual funds, sometimes their bank s own mutual funds. All larger banks have product managers who create packaged investment products for their Branch Reps. It is the job of the Branch Rep s to solicit the bank s clients for their securities and annuities business. While high quality investment professionals can undoubtedly be found at the investment advisory boards of banks asset management divisions, the bank representatives that you will encounter in banks are salespeople who have a limited amount of financial planning training, and virtually no experience in investment analysis or investment-decision-making capacities. These 61,000 Representatives are fully reliant on their product managers to create product that might hopefully come close to meeting the investment needs of their customers. Simply said, banks are in the business of securities, because they have large existing customer bases who can be cross sold most any kind of product. We are biased. In our view, Banks offering money asset management is akin to that Scarlett Johansson and Dennis Quaid movie In Good Company where the sports magazine is forced to advertise cell phones in order to validate the alleged synergies of Deal-maker owner Teddy K s vast conglomerate. At the end of the day, service will accommodate the lowest common denominator. Banking has as little in common with wealth building as cell phones have in common with baseball.

4 Property & Casualty Insurance Agents There are 5,000 Property & Casualty Insurance Agents. Most of them focus on their core business of insurance, and they by and large do not attempt to build out their securities businesses. The nature of insurance is quite different than the art of investment management. Suffice it to say, that we find it a stretch to believe that your investment needs will be best served in the good hands of an insurance specialist. Life Insurance Agents There are 5,000 life insurance agents. A fairly significant number of them offer securities through products called Universal Life and Variable Annuities. Most insurance agents are truly well meaning, and very conservative sales agents. While it is true that insurance does indeed play a critical role in most financial plans, it is never an optimal substitute for a wealth building plan. Many financial sales people including Bank Branch Reps, and Independent Reps, acquired their Insurance licenses when the bull market in stocks died after 2000/2001. They thus added a revenue stream. Unfortunately, they sold their customers annuities. Annuities are capital preservation strategies, not wealth building strategies. They are ill-suited to retirees or pre-retirees, simply because after taking into account the fees that come off the top, and the effects of inflation and taxes on the backend, there just isn t any real return left. Few people understand the math behind the insurance products. The underlying securities in a variable annuity are the same as those in a custom stock portfolio (General Electric, AT& T, Coca-Cola), but in the annuity, you are giving away 1/ of those returns to your sales person and his firm. In our view, that s way too much to give away, we don t care how nice the guy may be, it s your money! An annuity is simply a product that uses the same underlying securities in Dow Jones Industrials and the S&P 500. Then they take those underlying securities, and buy an insurance wrapper (a hedge), subtract a 7%-10% sales commission, add a big legal contract, which specifies your surrender charges should you try to exit the annuity in less than 10 years, and declare to you how safe and secure this investment is. To summarize, annuity returns will invariably approximate the returns on underlying securities of which the fund is composed, less the associated costs, which eat up between 2% and % every year, from your return. Annuity products do have one great benefit however. As a jobs program they function splendidly, providing ample income for tens of thousands of households.

5 If you would like to learn more about how financial sales people took advantage of investor fears following to Enron, 9/11 and the Mutual Fund scandals earlier this decade, take a look at: Regional and Boutique Broker-Dealer Representatives Regional and Boutique Broker/Dealer Rep s are sales representatives that are associated with independent regional broker/dealers. These 2,000 Representatives tend to have greater flexibility and independence than national carriers. However, at the end of the day, they are stuck with the broker business model; a transaction focused business that is more often than not, run and managed by a bunch of old-time brokers. The broker dealer model, is a finely tuned sales model, where by the emphasis is on selling product. While there are many fine brokers and regional and boutique broker dealers, the heavy hand of the transaction focused brokerage model, inevitably makes custom investment management and financial planning a difficult endeavor at broker dealer firms. Broker Dealer firms are terrific with assisting in unique and alternative investment opportunities such as private placements, but fundamentally for a long term relationship, their business model is flawed, as it fails to align client interests with the Broker s interest. Bank Trust Departments Bank Trust Departments are one of the older groups of securities professionals. Traditionally banks developed somewhat sophisticated Trust Departments to manage the estates of former corporate and entrepreneurial clients and their heirs. In the late 190s, Blue Chip companies were yielding 6% dividends because most Trust Departments more or less forbid investing in stocks. Bank Trust departments held to the notion that equities were inappropriate investments for most widows and orphans, and other beneficiaries for whom they managed money. At that time the mutual fund industry didn t exist, and brokers were solely focused on a transaction business, There was no financial planning or much asset allocation. As a consequence of the immaturity of the securities industry, perpetuated by the laws and practices of bank trust departments, the Dow Jones Industrials traded at a level of 150 as late as 199 with 6-10% yields on strong growing common stocks. The inherent values were immense. But Bank Trust Officers and their Managers were much more comfortable placing their client s wealth in corporate and government bonds yielding % to 5%. Suffice it to say, that little wealth gets built in the hands of a bank trustee. The real returns of those late 190 s investments in government and corporate bonds were negative for the next 50 years. Perhaps we are unnecessarily cruel; indeed bank trust departments have many highly trained investment professionals. In fact, bank trust practitioners pioneered much of the work of private, custom wealth management relationships managed on a fee-only business. Alas though, their s is a heavy-handed fee business.

6 Most trust departments desire to become Trustee to the accounts they manage. As corporate trustees, their approach to money management is heavy handed, and very expensive. The fees that bank trust departments charge are high, typically more than 1%. Their investments are focused more on capital preservation, than on wealth building. More egregiously, Bank Trust Officers invariably endeavor to be assigned the Executor of Trusts with the passing of the estate. This role entitles them to additional fees for the settling of the estate that will amount to another 2%-% of the estate assets. At the end of the day, choosing a bank trust officer to manage your investment affairs is an expensive and unempowering option. Discount Brokerage Representatives Your Charles Schwab investment counselor is probably a nice young lad or gal, perhaps 5 or even 10 years out of school. They have one purpose, to get you to keep as many as of your assets as possible,, to be held (custodied) at Charles Schwab. Now Charles Schwab is a terrific organization. They pioneered the discount brokerage model, in 1975 which really liberated Wall Street from the greedy clutches of the full-service, commission-focused, brokerage model. Before 1975, the standard commissions on brokerage fees were more than $1 per share. Today the standard fee is less than 2 cents per share. Charles Schwab is the largest custodian for registered investment advisors. In fact, the registered investment advisory custodial business, is Schwab s fastest growing business segment. That s why we scratched our head, when we saw Charles Schwab getting into the private account management business in 200/200. They entered the business as a competitor to the fastest growing part of their business. Go figure. If you choose to use Charles Schwab you will be getting a standard asset allocation, very similar to what Merrill Lynch would offer you. You will get follow up phone calls, but very minimal assistance with the complexity of building wealth and financial planning. The fees that Charles Schwab charges are reasonable, and for strongly motivated-self directed investors, those who joyfully, or at least willingly spend many hours every week, crafting, monitoring and implementing their investment strategy, discount brokerage can be a good option.

7 Family Offices There are more than 5,000 Family Office advisors. Family Offices manage the money and coordinate the personal affairs of our wealthiest families. Often a Family Office advisor has only one client, the family for which he has built his practice. Family offices are defined by the custom investment management and service that they provide. Family Offices represent the best services and management expertise that the best RIA practices can emulate. Family offices are almost always built on the life-long fee-based model that fee-only RIA s also use: a model, which so elegantly aligns advisor interests with client interests. Partners at fee-only Investment Advisory Firms. There are more than 0,000 partners at Fee-only Investment Advisories. Most of these firms are Registered Investment Advisors. This may come as no surprise. We believe that fee-only RIA firms have the business model that best aligns advisor interests with the client interests. Most RIA firms are run by financial planners with a background in financial products, financial planning, and sales. These principles have neither the inclination, nor the skill set to build custom portfolios using individual securities for their clients. That costs their clients an extra layer of fees, namely the embedded fees of mutual funds. To date, affluent and middle-income clients have not demanded what high net worth clients expect, sophisticated and customized individual security-based portfolio management. While we believe that clients at fee-only RIA s are well served. Their performance is likely to be mediocre. More than 60% of all client assets managed by Fee-only RIA s are managed using exclusively no-load mutual funds and exchange-traded funds (ETF s). These are not great investment vehicles. While mutual funds and ETF s are very useful instruments, they are blunt tools. They simply can not be used to effectively custom tailor client portfolios in the same way that individual securities can. There is nothing more efficient than a portfolio of individual stocks and individual bonds. Fee-only RIA Firms led by investment professionals In case we haven t been clear enough: to achieve the best long-term results in capital preservation and wealth building, service and trust, we recommend that you develop a relationship with a RIA with a career background as an investment professional, with at least 7 years of experience with individual securities and portfolio management. While most RIA advisors have a background in financial planning, there is a select group of advisors who used to be analysts and portfolio managers. Those with a planning background can be very excellent quarterbacks for the clients. They however tend to construct mediocre portfolios that incur higher total fees compared to those managed by investment professionals.

8 Investment professionals can often be identified through the professional designation of Chartered Financial Analyst (CFA). Less than 15% of RIA partners hold the designation of CFA. CFA Charter holders are typically higher skilled advisors at crafting custom investment strategies. Their skill translates into lower fees for the client. Some of the fees that a skilled advisor can help you avoid include the standard management fees of mutual funds; ETF s, annuities, insurance and brokerage wrap fee products. These savings are passed on to clients whose overall fee burden can be reduced by 50% when working with a skilled investment professional. Over the long term, this constitutes a meaningful difference. Over 0 years, the long-term impact on a typical retirement account may be $1 million or more. Wealth Building Example: Let us explain: over 0 years, if the real return of your portfolio, after inflation, taxes and management fees is 5%, instead of.5%, a $500,000 portfolio will grow to $2.5 million. A real return portfolio only increasing at % will only grow to $1.25 million. Obviously the difference of $1.25 million can be the difference between a comfortable retirement, and a busted retirement plan. Summary Most financial consultants, other than Registered Investment Advisors, are paid commissions on the products they sell their clients. In other words, once they sell you something, they have no vested interest in what happens with it, other than hoping it does well so they can sell you something again in the future. Their only downside, if your investment loses principal, is that they lose a customer. They rarely have the time or the inclination to watch out for their client s interests long-term because they are necessarily focused on the next sale. In fact, they have no choice in the matter, if they are not paid to act as a fiduciary; they are paid to close the next transaction. Barnes Capital is a fee-only Registered Investment Advisor (RIA). Fee-only RIAs get paid a fee based on the aggregate value of a client portfolio, typically quarterly. RIAs are very different from other financial consultants because: If a client s portfolio loses value, the RIA loses income, and possibly the whole client relationship. This is material, because a typical RIA annual fee of 1% is only 1/ the typical financial consultant s % commission for selling a basket of mutual funds. (Insurance Annuities frequently generate a 6% commission!) RIAs are incentives to grow their clients wealth long-term. If their clients wealth does not grow, the compensation of the RIA does not grow either. RIAs are incentivized to actively monitor and protect the principal of their individual client s wealth.

9 . 5. RIA compensation is not tied to a particular company who provides commissions. This means RIAs are free to suggest the best possible combination of financial products that align with their clients needs. Because RIAs are commission free, long-term oriented, and fundamentally tied to their clients wealth goals, they are in the unique position of being able to listen. The hallmark of a good RIA is the ability to consider complex, multifaceted financial goals and create a unique investment strategy that no other financial consultant could, or would, create. If you are looking for an advisor to help you build and protect your wealth, we recommend that you look at Fee-only Registered Investment Advisors run by Investment Professionals. One way that you can identify an investment advisor is by his credentials. Most Advisors who hold the designation of CFA are well versed in the art of portfolio management. Many other advisors may not have a CFA, but they may be seasoned investment managers. If an advisor is not comfortable working with individual securities, that should be a redflag. Either you have found an advisor who is a closet indexer/asset allocator, in which case you are paying them for the financial planning skills, not their investment skills. Using mutual fund and ETF products can be a great business model for the Advisor, but rarely is it the optimal path for clients in the emerging Affluent (Above $500 thousand) to High Net Worth (above $1.5 million) categories. Most of the best investment professionals will be happy to discuss how an individual securities portfolio may work for you. We hope this has helped orient you at the service providers out their and the business models underlying their representative institutions. September 2007 Daniel Barnes,CFA CEO Barnes Capital Lafayette, California (925) Mt. Diablo Blvd, Suite 201 Lafayette, California 959 Phone: Toll Free: Fax: info@barnescapital.com Copyright Barnes Capital LLC, All rights reserved.

10 Types of Financial Advisors in the Marketplace Family Offices Fee-only RIA Firms led by Investment Professionals Partners at Fee-only Investment Advisory Firms Bank Trust Department Regional & Boutique Broker Dealer Representatives Discount Brokerage Representatives Independent Representatives Wirehouse and Other National Broker-Dealers Life Insurance Agents Property & Casualty Insurance Agents Branch Bank Representatives Why Choose A Registered Investment Advisor? Example Approximate Number of US Advisors Abilitity to focus Long-term Fiduciary Focus Wealth Building Long Term Focus Financial Planning Expertise Investment Expertise Impact of Fees on Wealth Creation (higher score = lower impact ) Ability to Build Wealth through a Recession Gates Family Office 5, Barnes Capital 5, MW Invest 25, Wells Fargo 21, AG Edwards 2, Charles Schwab 7, Linsco Private Ledger 82, Merrill Lynch 68, New York Life 5, State Farm 5, Washington Mutual 61, Understand Client's Unique Situation Active monitoring of Individual Accounts Freedom to create a custom portfolio Score