Most ads for financial products and services focus on their impressive rates of return, usually accompanied by images of very serious-looking people wearing designer glasses and $2,000 suits.
The unspoken implication behind these ads is that these perfectly-tailored men and women are the financial equivalent of professional athletes. Clearly, these ads seem to say, we can play the game much better than you, so if you know what’s good for you, you’d better hire us to manage your money – and do it quick.
After all, these are intelligent, educated and informed individuals, who – in addition to their expensive wardrobes – have years or even decades of experience and expertise. It just makes sense that, when it comes to picking investments, they would have an insurmountable advantage over your average working stiff who just walked in off the street. Right?
This may come as a surprise, but in fact, an average of 80 to 90 per cent of all those highly paid, serious-looking experts are routinely bested each year by even the most basic stock market indexes.
Stock indexes are called “passive investments” because there’s nobody behind them trying to actively time when to buy or sell a particular security. Instead, stock indexes just buy a small piece of every company in a given market, and then hold onto them regardless of what the analysts are saying.
At first glance, this disparity between expectation and performance doesn’t seem to make sense. Why are all these extremely capable and intelligent people being paid so much for their expertise, if they can’t even beat an average market benchmark?
The answer lies in the fact that trying to time the market requires you to be able to predict the future, and even the highest-paid experts have as much trouble as you or I in guessing what’s going to happen tomorrow. As the saying goes: “economists have successfully predicted 17 of the last two recessions.”
Stock markets are affected by a vast number of different variables, each of which is constantly in motion. The sheer number of possible outcomes that can result from the interaction of all of these variables is what takes stock picking out of the realm of disciplined financial analysis, and turns it into little more than a high-stakes guessing game.
What does this mean for the average investor? If market indexes can give us a rate of return in the top 10 percentile, can’t we just fire all our managers, buy some big-box index funds and live happily ever after?
Unfortunately, this approach – as tempting as it may sound – has one very big catch. If there’s one conclusion I’ve been able to draw from my 20-plus years in this business, it’s that people need financial experts the same way professional athletes need coaches. It’s not that NHL hockey players don’t know how to score a goal. They rely on their coaches to help them with everything that comes before, during and after they take their shot on net.
To put it another way: left alone, investors have an alarming tendency to do the wrong thing at the worst possible time.
Take, for example, the huge net liquidation of equity mutual funds that has occurred over the past two years. Most investors are aware in theory that buying high and selling low is a bad idea. But in practice, that’s exactly what they’ve been doing for the past 24 months, to the tune of more than $100 billion.
In my opinion, the reason we’ve seen so many otherwise intelligent investors bail out of the markets at the bottom of a cycle isn’t because they truly believe that the markets will never recover. It’s because they think that their advisor or manager should have seen it coming.
Think about it – if you hired a world-class travel agent to plan your dream vacation, and they overlooked the fact that the resort they were sending you to was about to enter its monsoon season – wouldn’t you be more than a little upset?
Similarly, if you hired a top financial manager, with all their accolades and expertise, shouldn’t they have been able to foresee what was coming, and warned you to get out of the markets before the storm hit? Isn’t that what you’re paying them for?
Instead, when the inevitable drop came, and all those carefully analyzed and hand-picked stocks went down with it, investors lost confidence in the whole system and bailed out of the markets in droves, thinking that they must have been misled in some way.
The fault for this loss of confidence lies in large part with all those managers and advisors who claim – either directly or, as with our friends in those serious-looking ads, by implication – that they can predict the future, and therefore protect their investors from any unpleasantness it may bring with it.
The future is, by definition, unknowable. That’s why, in the markets as in life, risk and reward always go hand in hand.
The short-term ups and downs in the stock market, for instance, are a natural and necessary part of what enables equities to produce such high returns over time. Higher returns can only be achieved by taking some measure of risk.
If you want to avoid taking any kind of risk – say, for example, by stashing your savings under your mattress (or in a bank account that pays 0.001 per cent interest, which amounts to pretty much the same thing) – then you have to be prepared to give up the higher returns along with it.
So if financial advisors can’t be counted on to accurately predict the future, what exactly is their role in all this? To me, the crucial role of a financial advisor isn’t to hide the reality of market fluctuations from their clients. It is to prepare them for it, so they know what to do when it inevitably happens.
Markets will go down. They will go sideways, sometimes for an extended period of time. And, yes, they will go up, too – by an astounding amount over the long term. To attempt to predict when any one of these three outcomes will occur is to become a soothsayer, and when the prediction turns out to be wrong, the most likely outcome is that the investor who bought into it will lose confidence right when they need it the most.
Instead of predictions, a real financial plan’s success or failure depends on things you can control – like your asset mix, the quality of your holdings, and the goals you want to achieve.
The role of your advisor is to help you prepare for the unknown, so you’ll have the discipline you need to stay the course when the going gets tough – no matter what tomorrow may hold in store.
Alan MacDonald is an investment advisor with Richardson GMP Limited. Alan helps investors with over $500,000. of assets make smart decisions about money. He is the co-author of “The Copperjar System, Your Blueprint for Financial Fitness” available on Amazon.
All material by Alan MacDonald. Alan MacDonald is an Investment Advisor at Richardson GMP Limited. The opinions expressed in this article are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP or its affiliates.
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