I have posted on How to Evaluate an Investment Advisor but thought it was worth another, somewhat different take on it focused more on recent investment performance.
There are many things that we do that we believe will add value to the portfolio performance over time, but the big two are:
- Broad diversification across a variety of asset classes.
- Factor tilts (particularly to value) that have outperformed over time (and seem likely to going forward).
Lately both of those have underperformed just holding large U.S. stocks. Our challenge as investment professionals is to keep everyone on track through this period of underperformance – and it’s not just us, all of my peers that I consider competent are in exactly the same position. My guess is that we will lose some clients in the short run that will come back to us in the long run after their performance suffers from doing what has worked lately. (Investing by looking in the rearview mirror is generally a mistake.)
Coincidentally, Anitha had lunch recently with an advisor that works with very high net worth clients (just under $20 million in average assets per family). Because of this periodic underperformance problem they (quite understandably) don’t tilt to value, even though they think that is best long-term, because it is so hard to explain even to their sophisticated clients. Arguably, if clients don’t stay clients, and they chase performance (buying high) somewhere else you haven’t really helped them. (The advisor intends to refer us “smaller” clients because she likes our approach, and Anitha.) It’s a marketing and sales problem for us, but since we tend to have more sophisticated clients (not necessarily in net worth, but in knowledge of investing principles) I come down on the side of doing the long-term right thing even though it will periodically make our clients feel worse – and potentially cost us a few who don’t understand – in the short run.
So, if you can’t rely on recent performance to know whether the advisor is doing a good job, what can you do? I suggest asking two questions:
1) Is the advisor competent? In other words, do they seem to have:
- A high enough IQ to do the job. They don’t have to be geniuses necessarily, but smarter than average is good.
- Sufficient knowledge in their field. Someone can be smart but know nothing about investments or financial planning, so this is where you should look for credentials like CFP, CFA, etc.
- The right temperament. Many (most?) advisors who have the above two items can’t stick with a well-thought-out investment strategy through the inevitable periods of underperformance. (William Bernstein made a similar point in one of his books a few years ago, as did Larry Swedroe recently in an article.)
2) Is the advisor trying to do a good job? In other words, do they:
- Have a business model as unconflicted as possible. If there are no incentives to do the wrong thing (sell expensive products for high commissions for example) that is obviously good.
- Eat their own cooking. Advisors who have their personal portfolios invested like their clients seem likely to be trying to do the very best they can.
- Seem like they aren’t lazy. Very occasionally an advisor will do a sub-optimal job out of simple slothfulness because they just ignore their clients and the portfolios. I don’t mean hyperactive trading is good, but paying attention to things like tax loss harvesting and rebalancing is important.
So, to recap, if the advisor has every reason to do the best job they can (not lazy, not conflicted, invest personally just like their clients) and are competent (knowledgeable and smart, with the right temperament for investing) – that is a good advisor, regardless of short-term performance.