One of my jobs is to analyze performance and solicitations that clients occasionally get from outside money managers, mutual funds, and other “advisors.” I sometimes hear the saying “you can do better” or “you can do better than what you’re currently doing.” It drives me nuts.
That overly simplistic and intellectually insulting approach is common in the sales industry. It strikes an emotional chord for sure with a client or investor, and even me. I’m human; who wants to be left behind? When you add it all up and make people feel like they’re losers or that they’re missing out by “not doing better,” you can stir up all sorts of reactions. Those reactions generally benefit the solicitor and not you. Reacting to someone striking an emotional chord is almost always a bad decision.
So how might you address a solicitation?
Start with the awareness that many proposals focus on return and offer little to no consideration to risk management or benchmarking performance to suitable indexes, or more importantly your goals. The worst proposals are the ones that are data-mined to show the best results possible of the past based on the knowledge we have today. Be sure to understand that risk and return are related and not independent of each other.
The following are some of the better questions you might want to ask if you’re ever inspired by the idea that “you can do better.”
1. Can you prove this?
Always start with the proof. There’s no sense in looking further until you have substantiation for the claim.
You generally want to see either a historical track record of the performance of the proposal or the track record of corresponding indexes around the proposal. Ideally, the proposal should compare its performance to benchmarks that are also consistent with the allocation.
For example, if someone shows you a theoretical portfolio that’s returned 9% a year over the past 10 years, but compared it to only the S&P 500, it’s highly likely that portfolio is not an apples-to-apples comparison. The S&P 500 is essentially a large-cap U.S. stock portfolio. This is not considered a diversified portfolio. A diversified portfolio usually consists of U.S., international, small-cap stocks, emerging markets, real estate, bonds, etc. You can see comparing the performance of one asset class like U.S. Large Cap to a portfolio of many asset classes is like comparing a moped to an SUV. As an aside, anybody on the planet could have outperformed the S&P 500 over the past 10 years – all you had to do was not invest solely in the S&P 500.
2. How would this portfolio honor my goals and risk tolerance?
Okay, they were able to answer No. 1 to your satisfaction, but does the proposal actually meet your unique needs?
I purposely picked a 9% return target for my discussion for two reasons:
- In my made-up example, a portfolio that returned 9% a year over the last decade could have had a significantly high allocation to highly volatile stocks and/or high-yield bonds that in 2008-09 may have seen paper losses of over 50%. Were you made aware of that? Are you cool with this? Would you have stuck it out? You better be sure you know how this thing behaves and how you will behave as a result of owning it. You better understand that something with this high of a return history may in fact not do it again and could have a high probability of loss. Just because you take “risk” does not entitle you to a “return.” The greater the potential return, the greater the potential for loss. Real loss – as in your money is permanently gone.
- Coincidentally, given that we’re at the tail end of a 30-year bull market in bonds, another completely opposite portfolio that returned 9% a year over the last decade could have been invested in long-term investment-grade and below-investment-grade bonds. Well, bond yields 10 years ago were double to five times the yields they are today. There is only a small mathematical possibility that bonds today that yield 0% to 5% are going to return 9% in the future. In this case, the portfolio doesn’t honor your return goals of 9% because it simply won’t happen.
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3. Can you show me either a proposal or model you recommended five to 10 years ago to someone in my situation and then show how it ended up doing over time?
This is the ultimate smell test. In all the years I’ve helped clients review proposals, this one usually gets rid of the time-wasters because they’re either showing you data-mined proposals that measure success with perfect hindsight – which no one has – or they don’t have a track record that long.
I am usually put at great ease if managers are willing to answer this, even if the performance wasn’t stellar. This tells you two things if they answer it: They are honest and they are comfortable in their thinking.
As an aside and to be fair, it is often very hard for financial advisors to answer this question in specific detail because of compliance reasons, although they can show you their way of thinking five to 10 years ago. Money managers and mutual fund companies, though, should have no problem providing compliant track records.
In the end, “better” is very subjective. Better compared to what is what matters.
Michael Dubis is a fee-only certified financial planner and president of Michael A. Dubis Financial Planning, LLC. He is also an adjunct lecturer at the University of Wisconsin Business School James A. Graaskamp Center for Real Estate. Mike can be reached at financialperspectives@gmail.com.â¨â¨ This article contains the opinions of the author. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products or services described in this website or that of the author’s. Mike Dubis does not guarantee the relevancy, appropriateness, or accuracy of any outside information or links. Mike Dubis does not render or offer to render personalized investment advice or financial planning advice through this medium. All references that might be made to an investment or portfolio’s performance are based on historical data and one should not assume that this performance will continue in the future.â¨THIS COMMUNICIATION MAY NOT BE USED BY YOU AS A RELIANCE OPINION WITH RESPECT TO ANY FEDERAL TAX ISSUE DISCUSSED HEREIN AND IS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED, BY YOU FOR THE PURPOSE OF AVOIDING PENALTIES THAT MAY BE IMPOSED ON YOU BY THE INTERNAL REVENUE SERVICE.
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