The wealth management practices of the Wall Street firms and big banks are broken. Again.

But first a bit of history. In the 1970s, full-service brokers were compensated largely on commissions. In the 1980s, mutual funds were the rage, complete with sales charges (loads). When no-load companies began taking market share later that decade, Wall Street firms and big banks looked towards more creative offerings like private equity and closed-end funds. By the late 1990s, they marched like lemmings to get in on the tech craze. For their best customers, they would offer a few shares of the latest hot IPO that could be flipped for a hefty profit in matter of days-or hours or minutes.

Then came March of 2000 and that game was up. The next "new new thing" (to use Michael Lewis' line) was hedge funds. These funds promised to earn money in up or down markets-never mind the astronomical fees, limited liquidity or leverage required to produce those eye-popping returns. That worked for a few years-until it reached the point of saturation, with most funds participating in similar trades, resulting in mediocre returns and liquidity traps. By then real estate was in vogue.

Investors couldn't get enough. Then commodities. Then structured products and other "fixed-income substitutes." It's this last iteration that may finally be the straw that breaks the camel's back-if investors are paying attention.

To understand this point, it's important to step back and remember that regardless of which particular investment was the flavor of the month, the common theme that was heard over and over again in the Mahogany-paneled offices of the big investment houses for the past 25 years was that by dividing your assets among many different categories that won't move in the same direction at the same time, you were going to reduce the risk of the overall portfolio.

This premise seemed to have some validity and certainly was appealing to the average investor-until October 2008, when virtually every category got caught in the same downdraft. With one exception that is, high-quality short/intermediate fixed-income investments.

Put another way, the Wall Street wealth management model failed its biggest test. Investors who were told that they were diversified suffered losses of double or triple the magnitude of what they were a told to expect during a tough year.

What went wrong? The fixed-income substitutes pushed by the major investment houses weren't really fixed-income substitutes at all. These fixed-income substitutes took many forms: "low volatility" hedge funds, preferred stocks, asset-backed securities or other structured products, closed-end bond funds, income/mortgage REITS, and master limited partnerships, to name several. There was no shortage of creativity in developing/selling products that allegedly could be substituted for boring high-quality, lower-yielding bonds.

While the defects inherent in each of these vehicles vary, the commonality is that none of them is a substitute for the most important characteristic that investors should by looking for from the fixed-income portion of their portfolio: safety of principal.

Lost in the hand wringing and carnage of the market meltdown of 2008 is the fact that some diversified portfolios of short/intermediate high-quality bonds were actually up slightly (depending on duration and credit quality). You didn't have to be only in CDs and Treasuries to make money in bonds in 2008. Many managers who stayed with high-quality short and intermediate-term municipal bonds also posted positive returns in 2008.

Unfortunately for many investors, the wizards of Wall Street had convinced their clients you could shed some of these boring, old high-quality bonds, because they could help you earn higher returns via a combination of "fixed-income substitutes" and diversification among classes of risk-based assets (commodities, real estate, hedge funds, private equity etc.).

This takes us back to why the Wall Street firms' wealth management models are obsolete. First, investors may finally wake up to the fact that these firms have incentives to sell complexity and that most bad advice (including that related to fixed-income substitutes and the push to include less traditional high-quality fixed income in investor portfolios) can be traced to bad incentives. For example, hedge fund managers were incentivized to take risk through their "two and twenty" structures.

There are no claw-backs of the outrageous incentive fees paid to those fund managers who levered their portfolios 25 to 1, had a couple of great years when things were good, and then proceeded to blow up in 2008. Structured products, including the mortgage-backed securities that took down Lehman and have crippled bank lending, are another example. Wall Street firms and the big banks were all too happy to create these pools of asset-backed securities that were already loaded with fees, chop them up, and then generate large fees and commissions by selling them off to yield-hungry investors. They were all too willing to buy something which promised high yield and looked like AAA credit that, in hindsight, they didn't fully understand (nor did their advisors or those selling these securities).

Then there were the private equity wizards who would waive their magic wands and through the marvels of financial engineering (which turned out mostly to be simply a matter of leverage), create profits out of thin air, while taking acquisition, disposition, management and incentive fees along the way. Principal-protected notes and equity index annuities were also among the hot-selling fee-laden products. It wasn't until Lehman failed that investors began to realize that the guarantees were only as good as the firms providing them. As Warren Buffett has said, it is not until the tide rolls out that we can see who is swimming naked.

For too long, Wall Street has, in the name of "innovation" and winning the competitive race, dreamed up products with marketing sizzle versus looking for far simpler products to meet customer needs. Or put another way, they have strayed from the mission of helping investors meet their goals. It's far less sexy to tell someone to invest one-third of his/her assets in bonds and buy a basket of high-quality companies (or an index fund) with the other two thirds and then have the discipline to rebalance, thereby taking fear and greed out of the equation. Not only is it less sexy, it's less profitable.

Finally, it's important to distinguish between the use of high-quality fixed-income securities as a timing vehicle and the more worthy purpose of having it as a fixed-income portion of the investor's asset allocation model, and rebalancing to that allocation target annually. Wall Street and its biggest cheerleader, the 24/7 television news media, have over time convinced investors that "Is now a good time to invest?" is the key question that people should be asking (ad nauseum).

The implication is that they are going to help the investor time the market and their seers will somehow help ascertain when to jump between stocks, bonds and cash based on what they see in their crystal ball. Playing the "Is now a good time to invest?" game, no matter how it gets dressed up, is market timing. And market timing is a loser's game.

The reason no one can name the three most successful market timers of all time is because they don't exist. High-quality bonds shouldn't be used as a placeholder until the investor is ready to jump into equities. Rather they should be a fixed percentage of an investor's portfolio that should be derived from a thoughtful assessment of the investor's volatility tolerance and the need to assume volatility in order to meet investment goals. Note the use of the word volatility here instead of the more common term risk.

Though modern financial theory would equate the two, Buffett for one disagrees. In his mind, and in the minds of many Graham and Dodd investors, risk relates to the potential permanent loss of principal-not how much a portfolio zigs and zags over any given month, quarter or year. We agree.

Here's hoping that investors finally wake up to this game and get serious about what percentage of their portfolios belong in high-quality fixed-income securities and then find inexpensive, transparent ways of implementing that strategy (be it privately managed bond accounts, bond ladders, or low-cost, no-load mutual funds). If investors get that piece right, the next time we have a year like 2008, there will be far fewer surprises. And we will have taken one large step toward restoring genuine safety to the art of investing.

Bruce A. Weininger CPA, CFP, is a principal in the Kovitz Investment Group and can be reached at (312) 334-7334 or [email protected].