Objective, unbiased advice is the ideal that investors seek when consulting an expert for retirement planning. The popular press insists that only a person compensated through a fee-only agreement can provide such advice. Ironically, this misconception is itself a form of biased and subjective thinking. In fact, for retirees with less than $750,000, fee-only planning may incur more expense and more volatility than products which pay planners through a commission schedule.

The only way to determine which choice is the best for your situation is to examine both paths and make an informed decision based on numbers instead of prejudice.

If you seek objective advice, then you need an impartial assessment that exhausts all of your options. A prudent expert will dispassionately examine the vast universe of investment products in order to find those which will help you attain your objectives and reduce your risk through diversification. In order to examine all of your options, none can be eliminated out of hand. That paring process comes later.

Fiduciary Planning Takes a Holistic View

Since 1994, prudent investor law eliminated the entire concept of an "unsuitable investment." Now, in order to preserve wealth, more specifically spending power, an expert has to push beyond considering a small universe of perhaps 3 - 4,000 stocks and expand her thinking to include some of the following instruments:

• Global Stocks (Across all markets, foreign and domestic)
• Mutual Funds
• Pooled money, such as Annuity sub-accounts
• REIT's (Real estate investment Trusts)
• ETF's
• Government Bonds (Domestic and Foreign)
• Corporate Bonds (Domestic and Foreign)
• Options
• Futures Contracts
• Life Insurance Policies linked to Market Returns
• Short Term and Long Term Money Market instruments
• More arcane instruments, like Warrants, Limited Partnerships and Hedge Funds.

Rather than asking if these are suitable, the advisor needs to evaluate each in terms of various risks and possible rewards, always keeping in mind that the reasoning must be documented and reasonable. Risk in these instruments entails more than just looking at volatility.

Expert Advisors Ask Hard Questions

• Does it help to capture equity risk premium across the span of the investment life?
• Does it work towards reducing the overall volatility of the portfolio, or does it require other investments to help mitigate its extreme volatility?
• If it’s a managed product, can we evaluate the manager without relying solely on performance measured against the SP500?
• If it’s contractual, what are the business risks as well as the value of the guarantees or terms?

It’s not unusual for a particularly diligent advisor to use pools and other instruments to devise a portfolio of literally hundreds of stocks in order to provide the income and protection that someone would need for a 30 or 40 year retirement.

In case of a trust, the “risk tolerance” of the beneficiary is not a consideration. Certainly, market behavior will not change based on a widower’s opinion of the economy nor will the market behave particularly politely if many nervous investors participate. The risk tolerance issue involves the purpose of the portfolio, usually lifetime income and not how someone will feel as she spends it.

Conservative Investors May Violate Prudent Standards

Most conservative investors, guided by a subjective and unique feeling of what should be done with their funds, will exhibit a diversification bias. They will tend to select investments with similar characteristics even as they think they are diversifying. The bias shows up as a preference for Blue Chip or Large Cap Domestic stocks, national chauvinism and value (or growth) orientation.

Impartiality in regard to investments is one of five major differences between a prudent and a conservative investor.

Most of the people we speak with consider themselves conservative investors. You probably do too. And if you were asked if you were also a prudent investor, you might answer "yes," and see no difference.

But the difference is huge. And ignoring the difference can be hazardous to your wealth.

"Conservative" is a Feeling; "Prudence" is Objective

Calling oneself conservative is a generally subjective opinion. It has a fluid definition that basically says, "I'm trying to be careful." On the other hand, prudent investing refers to a technical term whereby your investments, estate plan, spending plan and goals are all aligned according to the Uniform Prudent Investor Act. One major difference is that the prudent standard is objective, while each conservative investor has ideas of his own. prudent portfolios have more structure to them and have definite similarities among them, because they follow the rules of law. In our experience of looking at hundreds of various portfolios over the years, all belonging to conservative investors, no two ever seemed alike.

Conservative and Prudent Investors Want Safety Differently

In a casual conversation, both Conservative and prudent investors will agree on the importance of safety. The conservative will initially think he is risk averse, but he takes more risk than the prudent investor. When the subject of taking on aggressive stock positions or "risky investments," comes up, a sometimes heated disagreement will arise.

Before we talk about how prudent investors like institutional pension funds manage risky assets, let's address the way most conservative investors handle them: They don't.

A conservative investor, because he wants to preserve principal at all costs, usually shies away from what his gut tells him is "too risky."

Prudent Investors Seek to Capture Return Safely

If you want to be a prudent investor you have to think harder than that. A prudent fiduciary will calculate an optimum choice of which stocks to buy and how much money should go into each stock. To figure out this optimum mix, he will need to know the covariance of every investment with every other investment. An expert keeps track of these many covariances in a large table of numbers, called a covariance matrix.

You need to capture equity premium everywhere you can find it, and then figure out how to reduce the risk at the same time.You'll reduce the risk by finding out how each investment relates to every other one in terms of its return over time. In shorthand, you'll determine the covariance of the investments with each other.

Your total investment portfolio should have a lot of different investments to consider. The key to prudent risk reduction is to determine how the investments may correlate with each other over time. Some stocks, like Berkshire Hathaway A and Berkshire Hathaway B, have perfect correlation. There's no point in owning both. Lately, there have been a number of Exchange Traded Funds that have almost perfectly negative correlation with a particular index. Those are more interesting and we hope to have a discussion about those posted soon. Effectively, those funds can cancel all or part of the risk across a wide variety of investments.Everyone knows that to be safe your investment portfolio should be "diversified."

Diversification has Measurable Parameters

Diversification is a technical term which means you have a variety of investments that don't correlate with each other very well.

How do you choose among possible different investments? You could just throw twenty darts at a stock market page and buy the same dollar value of the twenty stocks that you hit. Journalists and some pundits would tell you that this would not be a bad choice.

Unfortunately for the casual investor, "not bad" is not good enough.