You’re fired! D. Trump
The incredible – and incredibly long – bull market in both stocks and bonds that has persisted since the end of the Global Financial Crisis is now teetering. Whether or not the market bloodbath that occurred in October continues, the bull will in fact come to an end one of these days.
When that happens, financial advisors who looked like geniuses for the better part of a decade will suddenly look like dunces. All those wonderful positive returns we’ve gotten used to seeing will morph into losses. When that happens, should we fire our financial advisors?
The answer, you will not be surprised to hear, is, “It’s complicated.”
Why You Should (or Shouldn’t) Fire Your Advisor
Let’s look at the question of why we should (or shouldn’t) fire our financial advisors, and then we’ll take up the questions of when and how.
The analogy to money managers. We know from large and consistent research that when investors fire money managers – as opposed to financial advisors – those decisions are almost always wrong. By that I mean they are wrong in the simple sense that the terminated manager outperforms the replacement manager over the next market cycle.
This happens with money managers for a simple reason: investors are behaviorally programmed to fire managers who have produced recent poor performance and to hire managers who have produced recent good performance. Since manager performance tends to revert to the mean as investment styles come and go, this is exactly the opposite of what we should be doing.
When it comes to financial advisors, we want to avoid making the same mistake – i.e., being very happy with our advisors during bull markets and firing them during bear markets.
Evaluating Our Managers’ Investment Performance. In thinking about reasons for firing our advisors, most of us think about how well or poorly they have performed in managing our portfolios. If they’ve done well we should keep them, and if they’ve done poorly we should go elsewhere. But figuring out which is which is a lot harder than it looks.
Let’s start with the first part of that question. Should we have been happy with our advisors during the bull market? Remember that our advisors didn’t have anything to do with the markets going up, they were just along for the ride. By the same token, our advisors won’t have anything to do with the markets going down, either – they will just be along for that ride, too.
Thus, the question isn’t whether our advisors produced good returns in an absolute sense during the recent bull market – they certainly should have done so. Nor is the question whether our advisors can produce absolute good returns during the next bear market – they almost certainly won’t.
Instead, the questions are these: Did our advisor design a portfolio that is right for our needs? (This is by far the most important issue, and it is defined by whether or not the strategic portfolio design is the right one for us.) Did the advisor implement, monitor and adjust our portfolio effectively over time? Is our advisor responsive to us, do they communicate well with us, and do we trust them?
Let’s start with the first question: Did our advisors design the portfolio that was right for our needs?
Cautious investors. If the portfolios that are right for us are quite conservative, those portfolios won’t have shot the lights out during the bull market. That doesn’t mean our advisors were stupid, it simply means that they listened carefully to us, that they understood our goals and tolerance for taking investment risk, and that they designed an appropriate portfolio for our needs. Quite probably, they could have made us a lot more money during the long bull market, but only by ignoring our needs.
If we are cautious investors and did quite well during the bull market, that suggests not that our advisors have done a good job, but that our advisors haven’t been paying attention to us. It means that our portfolios are likely to perform very badly during the next bear market, and instead of waiting for that to happen, we should consider firing our advisors now.
Aggressive investors. Similarly, if we are more aggressive investors our portfolios should have done extremely well during the bull market. If they did, that might mean that our advisors have been doing a good job or it might mean nothing more than that they have been mindlessly riding the bull. We won’t know for sure until the next bear market.
Middle-of-the-road investors. Most investors fall in-between the “conservative” and “aggressive” investors just discussed, and this makes it even harder to know whether our advisors have created the right portfolio for us. Middle-of-the-road portfolios, that is, those that are designed to preserve capital (first goal) but also to grow it net of inflation and all costs and fees (second goal), should have done very well in absolute terms over the past decade. They should have beaten inflation handily and therefore should have increased our real wealth substantially.
On the other hand, those portfolios shouldn’t have done too well. If they did, one of two things was likely going on. First, our advisors might have over-exposed our portfolios to equities and especially US equities. Those stocks have done extremely well, especially relative to economic growth which, until recently, was pathetic. But a portfolio that is over-exposed to equities is going to get clobbered when the bear market comes around.
A second likely mistake our advisors may have made to juice performance is to overweight tech stocks. Tech boomed in recent years, but when the reckoning comes it’s going to get ugly quick – remember the infamous Tech Bust earlier this century.
Let’s assume that we are typical, middle-of-the-road, capital preservation investors. Since the end of 2008 our portfolios should have compounded at – in round numbers –the high single digits on a per annum basis. Cautious investors would have gotten a bit less, and aggressive investors a bit more.
Those numbers sound terrific compared to inflation, which averaged only about 1% per annum. However, they sound lousy compared to the S&P 500, which compounded at 15% per annum. But the crucial point is that a 100% US large cap stock portfolio was way too risky for us. So the comparison is utterly irrelevant.
Next week we’ll look at several other reasons – not investment performance-related – why we should or shouldn’t fire our advisor.
Next up: Firing Financial Advisors, Part 2
[To subscribe or unsubscribe, drop me a note at GregoryCurtisBlog@gmail.com.]
Please note that this post is intended to provide interested persons with an insight on the capital markets and other matters and is not intended to promote any manager or firm, nor does it intend to advertise their performance. All opinions expressed are those of Gregory Curtis and do not necessarily represent the views of Greycourt & Co., Inc., the wealth management firm with which he is associated. The information in this report is not intended to address the needs of any particular investor.