On the other hand, a long term strategic allocation to the world’s equity markets has once again proved to be the appropriate strategy. I certainly don’t want to minimize the trauma of the near meltdown events five years ago, but those investors that had the conviction, confidence and fortitude to remain committed to a long term strategy had a happy ending.

As you can see, all equity asset classes (as represented by the live DFA funds) came roaring back. It’s interesting to note that for all the talk about a real estate disaster, REITS were the top performing fund. Commercial, Apartment Buildings, and Retail did just fine during the entire period. Who would have guessed?

Disclaimer: The information contained in this report is intended to be used for information purposes only. The data in this report was obtained from a third party which we believe to be reliable. No guarantees can be made as to the accuracy of the information provided. No adjustments have been made for management fees, dividend and interest payments, custodial fees or transaction costs. Because each client holds a different mix of assets no representation has been made that any one client has achieved the results shown in this report. The Commodities are representative of the PowerShares DB Cmdty Index (DBC) and the Pimco Commodity Real Return Instl (PCRIX). The Limited-term muni bond is Vanguard’s Admiral shares. The remaining asset classes are a representation of the DFA index funds.

In building my case, let’s start by examining the universe of public data on mutual fund performance. Almost everything you could want to know about mutual funds and their performance has been tabulated by Standard and Poor’s, Morningstar, The Center for Research on Security Prices (CRSP) or similar organizations. It’s all widely available. It’s not necessary to torture the databases in order to obtain reliable, actionable, timely intelligence.

The active manager claims that through either market timing or individual security selection he can add value to your investment portfolio in excess of his costs. If active management were a viable investment strategy, it should reliably outperform a purely passive index. That’s the acid test. After all, why pay a manager when you could economically purchase an entire market basket and get better performance?

Yet the record will prove that active management is a catastrophic failure to achieve that goal. Here’s the data from the annual Standard and Poor’s Index vs Active Funds Scorecard on the number of active managers that fail to match their appropriate benchmark in equities:

For active managers it doesn’t get much worse than that. The lone exception is the international small fund manager category during the period. As indicated in the graph, 26% of this group failed to beat the respective benchmark, which is the S&P Developed ex-US Small Cap index.

More detailed analysis reveals that many managers in the international small category had significant holdings in emerging market stocks, which is a different asset class that had stronger performance during the period. The large percentage of out-performance among international small managers may result from a large portion of them holding a different asset class and being compared to the wrong benchmark.

An even more devastating pattern emerges when we look at fixed income. Several show failure rates in excess of 90%.

I can hear the skeptics now. What about the “good” managers that beat the averages? Let’s stipulate that somebody always beats the averages, just like somebody always wins the lottery. But your chances of picking that manager in advance are dismally small. What would you use to distinguish skill and cunning? Past performance? Please! While it’s possible to run up quite a string, that chances of a star manager repeating are somewhat less than average.

There are two things we know for certain about past performance: First, past performance is no guarantee of future performance. That’s about the only thing Wall Street will tell you that you can take to the bank. And they are forced to tell you that. Second, past performance attracts lots of new money. The longer the string of performance lasts, the more money pours into the fund. And then the string runs out leaving the new arrivals to wonder what happened. How could this hero have lost his mojo? Perhaps he never had any in the first place. The record if full of stars that imploded costing investors billions as their funds got sucked into a black hole. I cite Bill Miller as one of the latest wonder boys banished in ignominy.

Peter Lynch is one star that bailed out at the top of his fame. He grew Fidelity’s Magellan Fund from obscurity to the largest mutual fund on the planet. After his retirement he stayed on at Fidelity to nurture and mentor Fidelity’s aspiring fund managers. If there was anybody who could pick a good fund manager it would be Peter Lynch. Yet the abysmal performance of Magellan Fund in the interim is mute testimony to the impossibility of picking winners in advance.

Across the entire universe of funds, active management costs investors from one to two percent compounded per year. We should expect under-performance. It would be bad enough if the opportunity cost was a steady one to two percent per year. But, it gets worse. Active management adds another layer of risk on top of market risk. There is a wide variation around the index return which at the tail can be devastating. Imagine if your retirement were invested in one of the funds at the far right of the distribution.

The distribution above is actually far worse than it looks. The funds listed were the survivors and Morningstar doesn’t include the several hundred funds that failed along the way. These failed funds normally get merged into other funds with better records making their performance magically disappear from the results. Survivor bias badly skews the illustration.

I grew up believing that managers added value, so it took a lot of evidence to change my view. But, literally hundreds of studies indicate it’s not so. Not one credible shred of evidence supports active managers. I believe that the case has been proved beyond a shadow of a doubt, and even higher standard than necessary in a criminal case.

The evidence is available to anyone that cares to examine it. And the data speaks for itself. I rest my case.

If you know where to look, Wall Street can crank out some amazingly good products. but they would much rather sell you garbage. Armstrong’s Second Law states that the awfulness of the product is directly related to the profits to the firm and commissions to the broker. Just as sex sells, toxic pays. And no amoral, profit maximizing, commission driven broker or institution can afford to ignore a good toxic product.

On the other side of the transaction is a client that has suspended disbelief to embrace the comforting notion that he has been offered the exception to the risk reward line. The common thread, the seductive mantra is “upside potential with limited downside”.

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Wall Street is wonderful in creating products to respond to perceived wants and needs out there in the marketplace. If they can rip you off for 5 percent of your objective every year by providing downside protection, they’re only too happy to sell you that. And you probably won’t understand it

Harvest your investment losses. An important tax-saving practice allowable under the code called “tax loss harvesting” allows investors to reduce their IRS payments substantially—but it’s one that most people ignore, says Frank Armstrong, founder of investment advisory firm Investor Solutions. The strategy allows taxpayers to sell an investment like a mutual fund at a loss and then use the loss to offset either capital gains on other investments or their regular taxable income (in the case of regular income, you can apply up to $3,000 of the loss in a single year). Best of all, any losses that you don’t use now against other income can be carried forward to offset gains in future tax years.

If you have your employer’s stock at a low basis inside your retirement plan, there is a little known provision that may be very valuable. You may withdraw your employer stock from the plan paying tax only on your basis.

This provision may allow you to transfer a significant value out of your plan at very favorable tax rates. The lower your average cost basis, the more dramatic the tax savings.

For example, suppose you have $1 million in company stock inside your retirement account, but the basis of the stock is only $100,000. You can take it all out and pay taxes on only $100,000! So, $900,000 was liberated at no tax cost. You pick the date when you pay taxes on that portion. Whenever you sell the stock the profit is subject to the very favorable 20% capital gains rates.

Even if the distribution is subject to a 10% penalty tax, it is only based on the basis of the stock. If the basis is very low, the penalty tax may be a trivial consideration.

If the stock pays dividends, then they are subject to the maximum 20% favorable tax treatment, which is far better than if they had accumulated inside and IRA and then distributed at ordinary income tax rates.

Another important benefit of the NUA strategy is that for any shares not liquidated after distribution, a step up in basis is available at death. So, the total appreciation will escape capital gains tax. This advantage is not available to an IRA, and may be a substantial estate planning benefit.

Keep in mind that this special provision for company stock must be part of a total distribution from the plan and must be accomplished in one calendar year. You may not pick and choose shares with different cost basis. Any shares distributed are valued at the average cost basis of the stock. The balance of the distribution may be rolled over into an IRA just like any other total distribution. However, if you roll over the stock into an IRA, the option is lost forever.

Note: It’s important to consider that the distributed shares may represent a substantial concentrated stock position with all the risks associated with any concentrated position. Normal risk management techniques are essential to prevent potential catastrophic loss due to the undiversified nature of the position.

As always, consult with a professional tax advisor to avoid any unpleasant surprises. But, don’t overlook this strategy if it applies to you.

Brokerages have realized the potential and have been serving this market for 50 or 60 years because they’re transaction-based. But given the technology that’s out there now, RIAs can serve this market as well.

When you talk about the mass affluent most advisers think of some poor kid out of college making $40,000 a year. In reality, more than 50% of the mass affluent make $100,000 or more. Most of them are young, but that works out in the adviser’s favor because they are accumulating assets, as opposed to older, high-net-worth individuals who are going to be withdrawing their money.

There are 120 million households in the United States, and 50% of them are mass affluent while just three million are millionaire households.

But RIAs avoid this market because they don’t think they can make a profit. There’s a status quo that suggests you work with clients with assets between $500,000 and $1 million. The market started out this way because the cost to service a smaller client was too high, and the technology wasn’t there to make it profitable.

Advisers should take the time to figure out how much it really costs to serve a client – many will discover it’s a lot cheaper than they think. Most advisors charge 1% because that’s what everyone else does, but some RIAs charge a fraction of a percent to manage client assets and still make a profit. The key is utilizing the new technologies that allow you to manage portfolios on a massive scale, instead of having four or five analysts do the balancing by hand.

Also the number of new RIAs created is well above the rate of new millionaires in the United States, and at some point there are going to be too many RIAs going after too small a pool of assets. On the other hand, a couple who has a $100,000 saved up—say a husband and wife, young professionals who probably make around $150,000 a year—could be millionaires in 13 years if they max out their retirement accounts and save a little bit extra on top. They become the perfect client the RIA wants, and the RIA gets its branding in front of these clients before they become wealthy and before other financial advisers get involved. This strategy can dramatically lower acquisition costs.

The mass affluent currently have two options available to them when it comes to financial advice: They can go to a broker, which is more expensive, or use do-it-yourself software and online RIAs. But at the end of the day, people want to talk to someone about their money when the going gets tough. And that is where RIAs can step in.