Financial adviser's legal responsibility

I believe it depends on two things: accepted parameters for diversification; and the company your advisor works for. It seems to me you have a good argument, depending on the amounts of money involved, that your bond holdings were under-diversified. E.g. if you had 100k in bodns, it should have been 20k in each of five issues. If the amounts involved were not enough for adequate diversification, he should have put you into CD's or a savings account. If the firm your paid advisor works for is good, they may agree to settle in mediation proceedings.

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Technically, the OP wants to know if there is recourse *because the risk level was unsuitable*. For that question (perhaps the wrong question) the answer is likely "no". Losses from investments that were otherwise suitable to the client at the time pf purchase are not recoverable. "Diversification suitablility" aside, if an adviser performs due diligence on an investment and makes all the proper disclosures (prospectus, etc) he is not likely to be found liable for subsequent market losses.

For the record, I too think that the advisor failed to properly diversify the bonds. As you said, if the dollar amount in question was so low that transaction costs became prohibitive, then invididual bonds should have been forgone for other fixed income investments. If the OP has a claim it's through this avenue, not because his investments lost money.

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wrote re an investment in late 2007

snip

My answer would depend on how much you originally invested. If we are talking about, ballpark, $15k or less invested in the WaMu bonds, then I would be less inclined to protest the advisor's actions. Given small amounts such as $15k or less, diversifying with bonds could be said to be tricky, due to transaction expenses of buying several companies' bonds. OTOH, if the amount was this low, arguably the advisor should have put you in a bond mutual fund. On the third hand, the yield likely was not as good on the bond mutual fund. Did he compare the two yields (WaMu bonds and a bond fund) for you? Did you say anything about preferring the higher yield?

If we are talking about more than about $15k, then I agree with dapperdobbs and kastnna's point re diversifying.

But, the situation is further complicated by the difficulty of reading financial institutions' accounting statements. I do not mean that these are complex (though they are). I mean that even those well acquainted with the complexity were fooled. Warren Buffett bought around half a billion dollars of Bank of America stock in mid-2007. It declined by around

50% in the next year. It has recovered some but it is still far below Buffett's purchase price. If Buffett and his people could not see the massive writedowns (for commercial banks) on subprime mortgages coming, who could?

This argues for exculpating your advisor. It is an anomalous time. Many (most?) are taking a beating in their portfolios. Nearly everyone is furious and looking for satisfaction. That bailout bill that went to the House today failed IMO as much because people do not trust anyone right now. The merits of the bill being a viable solution to the credit crisis were hardly considered.

We all "want our money back." The wise among us will concede, "I knew there were risks. Black swan events etc. do occur. Easy come, easy go. Here is what I will do next time to avoid this loss."

For the little it is probably worth, the following site says that the FDIC will pay 30 cents on the dollar for some, but not all, WaMu bonds. I would not get my hopes up; just noting that it's worth checking.

Elle Individual Investor; I am not paid for my comments.

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Elle those are good points...one thing you brought up that I want to get feedback about - this issue of individual bonds vs. bond funds. I'm repeatedly surprised by the willingness of individual investors to buy relatively large & concentrated bond positions, when it's so easy to own a diversified portfolio of hundreds of bonds via a low-cost mutual fund. I have this discussion with clients too and this comes up from time to time here on MIFP - one frequent poster was quoted in the WSJ about losses on WorldCom bonds some years ago.

The principal objection I hear is this idea of a bond having a fixed maturity date, but the bond fund not having that. For some strange reason that's bad and there is this appeal of "well if I hold it I get my money so who cares what happens along the way." In talking it through it's easy to show the bond fund's lack of a maturity date as being somewhat irrelevant, and the bond's "fixed value" being illusory, but I can understand the idea anyway. And as we see from this thread what happens along the way can introduce a lot more risk/uncertainty than any bond mutual fund will have.

The notion of a potential 100% downside should give people more pause, especially when the difference in yield is relatively small. And by definition, the more higher corporate bond yields are associated with the riskier issues so it seems this scenario comes up more than it should.

The other thing I've seen, which I also find surprising, is how many of the capital raises by distressed firms end up in individual investor portfolios - i.e. the bonds are sold to retail rather than institutional investors. Ford was one example as I recall. These financial issues over the past year have been another. I don't understand why an individual investor looking for an investment in the fixed income (read: conservative) part of the portfolio would gravitate to that kind of offering instead of say a Treasury bond or a high-grade corporate bond mutual fund. Again, lots of downside potential with a limited upside for what is supposed to be the "stable" piece of the asset allocation pie.

To the OP - did you consider this issue at time of purchase - that holding one bond implicitly increases your risk vs. holding a few hundred of them? Why did you go that route?

-Tad

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When I first started investing, a financial manager told me about getting his parents to buy a bond mutual fund. He explained it thusly: if you buy a cow for the amount of milk it will give you, why do you care how much the cow is worth on any given day?

This made it vastly simple for me to understand the volatility that might arise in income funds. Not that I was buying income funds back then, but it's something I've never forgotten, and has really helped me in the nerves department for investing in general.

Elizabeth Richardson

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