Question: I have an investment advisor, and my portfolio has been underperforming the stock market. Should I switch?
Answer: Most advisors will design a portfolio tailored to risk tolerance and sufficient to meet your investment goals, which might include growth, income, or a combination of both. I call this outcome-based investing as opposed to performance-based. In this way, you measure your portfolio performance against your need for income and growth, not some arbitrary index.
Let’s assume you have an all-stock portfolio that’s not keeping up with the stock market. If you hired your advisor to beat the market, you will be disappointed. Few, if any, do so consistently over time.
If you fire your advisor for not beating the market, who would you hire? You could always find someone who outperformed the market last year. But studies show that doesn’t work. Past performance doesn’t really seem to matter, and there is no academic research or study I am aware of that shows otherwise.
According to Mark Hulbert, editor of the Hulbert Financial Digest: “If you switched your money every year into the prior year’s best-performing portfolio tracked by the Hulbert Financial Digest, you would have lost money in eight of the past 10 years and produced an average loss of 16% annually, during which time the S&P 500 returned an average of 8% annually, including dividends.” Hulbert also says that every advisor trails the market at times.
You may have seen the recent New York Times articles by Jeff Sommer where he describes a new S&P Dow Jones Indices study, “Does Past Performance Matter? The Persistence Scorecard.” The study examined 2,862 broad actively-managed stock market mutual funds that had been operating for at least 12 months as of March 2010. The study examined the top 25% of performers for the year ending in March 2010 and looked to see how many of those funds remained in the top 25% for the next four years. It turned out that only two of the 2,862 funds were in the top 25% for all five years.
Sommer quotes Keith Loggie, senior director of global research and design at S&P Dow Jones Indices, stating, “It is very difficult for active fund managers to consistently outperform their peers and remain in the top quartile of performance over long periods of time. There is no evidence that a fund that outperforms in one year, or even over several consecutive years, has any greater likelihood than other funds of out-performing in the future.”
In a subsequent article, Sommer goes one step farther. He compares the results of the S&P Dow Jones Indices study with flipping a coin. When you flip a coin, you have a 50/50 chance of heads and tails. You can read his article for more details, but his bottom line results show that the coin flipper did better than the mutual fund managers because roughly three funds – not two – would have been expected to end up in the top quartile for five years in a row.
No doubt your investment advisor is a smart guy. So are the thousands of highly paid analysts with postgraduate degrees in finance and certifications such as “Chartered Financial Analyst” that rate stocks and pick them for fund companies. If they can’t consistently beat the market, who can?
Kenneth B. Petersen CFP®, EA, MBA, AIFA® is an investment manager and Principal of Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investing, taxes, retirement, or estate planning. Send your questions to: Ken Petersen, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to firstname.lastname@example.org.