Lately in my workshops and presentations, I have heard an increased amount of dissatisfaction from investors about their financial advisors. The last 10 years have been tough on investors because the markets have been choppy and when you take both the up and downs into consideration many investors are still left feeling disappointed about their results.
I’ve heard a lot of complaints of lousy performance and unfortunately, for their financial advisors, they become the easy scapegoat.
Is your advisor to blame for bad performance?
In many cases, people hire financial advisors to help them manage their portfolios and make good investment decisions because they feel like a professional should and can do better than they would on their own.
Ironically, however, investment returns is one of the things that financial advisors cannot control or predict because the markets by nature are unpredictable. This is one of the great disconnects of the financial industry. Investor expectations cannot be met if they expect their advisors can select investments that do not lose money or beat the markets consistently. Some investors think advisors are better equipped to understand the markets, predict the markets or even to have insider information. This is a fallacy in thinking!
So the irony is that firing and hiring an advisor on performance and investment return may be the worst reason to do so. Moving to a new advisor that promises better returns is destined for failure because most advisors are in the same boat.
Welcome to the world of relative benchmarking
When you experience bad performance, is it because your advisor picked bad investments? Or is it really because the environment is not conducive to strong performance? For example, when the stock market goes through a broad correction, it happens because most of the individual stock prices have dropped. You could be the best stock picker around but in a bear market, you are probably going to still lose money. If you think about it, most advisors are highly subject to the market performance which they can’t control or predict.
As a result, most of the financial industry thinks in relative terms. How well you do is dependent on how well everyone else does or how with environment allows you to do.
Relative performance is simply looking at the performance of your investments or your portfolio and comparing it to the performance of other benchmarks. Two of the most common relative benchmarks are the index comparisons and peer group (average) comparisons.
So how well have you done compared to others?
I met Steve two weeks ago at one of my workshops and he is frustrated because he wants to retire but over the past 10 years, he feels like his portfolio has gone nowhere. The first question I asked Steve was “What is your personal rate of return?” Steve did not know.
How can you know if you are doing well or poorly if you have no idea what your personal rate of return is? Ask your advisor to give you your personal rate of return. That does not mean a list of the investments you own with the performance of those investments over the past 1, 2, 3 , 5 or 10 year returns. Those are called investment returns (or something I call newspaper returns) which can be very different than the investor returns.
Once you know how you are doing, then you can compare those returns to an appropriate benchmark. This is where it gets tricky. I’ve always said I can make any investment looks good with real statistics, it just depends on what statistics I show you. Let’s use a real example to help you understand what you need to know to figure this all out.
Let’s say Steve has a balanced portfolio with about 60% equities and 40% stocks and over the past 10 years, he has only made a 2.5% compound return. By Steve’s standards, that is really disappointing. Is Steve’s disappointment justified?
Well, if you compare that return to the average Canadian Balanced Fund with a 60/40 mix, the average 10 year return to the end of September 2011 was about 4%. If you compare Steve’s return to the 10 year return to the Morningstar Canadian Balanced 60/40 index, the index made a 7.7% compound average annual return.
In this example, I think Steve has a valid case to be disappointed but he has to also make sure that he knows the numbers. I’ve seen people fire and hire advisors on the basis of emotion and judgement only find that the grass may not be greener on the other side.
Before you are going to fire you advisor, make sure you get some data and make sure it’s not just about performance. Make sure you are looking at other things like service, creating financial plans, communication, advice beyond just the portfolio. It’s OK to get a second opinion too but it’s hard for advisors other than the current advisor to determine your personal rate of return. Make sure you know why you are firing an advisor so when you interview new ones, you know what questions you should be asking.