Image Credit: Christophe Vorlet
By Jason Zweig | June 9, 2017 10:29 am ET
With the Department of Labor’s fiduciary rule going into effect on June 9, investors should recognize what financial advisers can, and can’t, do.
The new regulation requires anyone getting paid to provide investment guidance on a retirement account to act solely in the investor’s best interest.
To be sure, individual investors can be their own worst enemies, flinging money at whichever assets have gone up the most and then bailing out at the bottom, locking in losses.
The performance of a mutual fund, exchange-traded fund or other financial asset is typically calculated as if you put all your money in at the beginning and kept it there, without adding or withdrawing anything, until the end of the measurement period.
But investors add and subtract money at will along the way — often at the worst possible times, when they are in the grip of greed or fear. Such buying high and selling low leads to what is often called the “behavior gap” between the performance of an investment and its investors.
That gap can only be estimated. However, by adjusting a fund’s returns for the amount of money investors put in and took out along the way, researchers can at least approximate a number.
Investors in mutual funds, for example, earn average annual returns roughly 1 to 1.5 percentage points lower than those of their funds. Investors in hedge funds may lag those vehicles by up to 7 percentage points annually.
In theory, that’s what a stockbroker or financial planner should prevent. “Advisers provide a human element that gives clients confidence and comfort in not deviating from a plan,” says Dave Butler, co-chief executive of Dimensional Fund Advisors, a firm in Austin, Texas, whose funds aren’t available to individual investors without an adviser. “The reaction to markets can be completely different when the adviser is in the loop.”
Unfortunately, some advisers might not behave that way in practice.
Here’s a tale of two funds. Fidelity Select Biotechnology is an $8.6 billion portfolio that largely serves investors making their own decisions. It averaged a 14% return annually over the past 10 years. The fund’s investors fell considerably behind, averaging 10.1% annually.
Investors who got professional advice appear to have done worse. Fidelity Advisor Biotechnology Fund I, a $1 billion portfolio nearly identical to the Select fund, caters — just as its name implies — to financial advisers. Over the 10 years through May 31, it gained an average of 13.6% annually. But its typical investor earned only 0.7% annually, estimates Morningstar, the research firm.
Here, it seems, so many advisers may have bought high and sold low that their clients made next to nothing. (All these numbers ignore any annual fees advisers may charge directly to clients.)
It’s important to note that at most of Fidelity Advisor’s biggest funds, investors did better than at sibling portfolios where individuals probably didn’t use an adviser.
Unadvised investors might have earned higher returns at the Select biotech fund “because they didn’t have the benefit of understanding the extra risk that can be associated with this kind of fund,” says Roger Hobby, head of private wealth management at Fidelity Investments. With no adviser to stop them, perhaps they took excessive risk that happened to pay off this time.
Or take Davis New York Venture Fund, also sold through advisers. The Class A shares earned an average of 5% annually over the 10 years through May 31. The typical investor, however, lost 0.1% annually.
That’s largely because many abandoned the fund years after its 40% loss in 2008. The Class A shares, which had $20.1 billion in assets at the end of 2010, had $6.7 billion at the end of last month — even though the fund would have nearly doubled your money had you stuck around the entire time.
Shareholders remained more loyal than they did at many adviser-sold funds that had comparable performance, says Christopher Davis, chairman of Davis Advisors in New York, which manages New York Venture.
“Some investors did panic out,” he says, “but probably in much lesser numbers than they otherwise would have if they didn’t have an adviser.”
Not all advisers chase performance, but all too many still do. Buying what’s hot and dumping what’s not, they are no less human than their clients.
So you should hire an adviser not for his or her investing prowess, but to help organize your finances, prioritize your goals, minimize your taxes, and navigate the shoals of retirement and estate planning. Done right, those services can make you far richer — and happier — than the pipe dream of investment outperformance is likely to.
Source: The Wall Street Journal, http://on.wsj.com/2rUkq18
Definitions of FINANCIAL ADVISOR and INDIVIDUAL INVESTOR in The Devil’s Financial Dictionary
Chapter Ten, “The Investor and His Advisers, in The Intelligent Investor
John C. Bogle, “The Arithmetic of ‘All-In’ Investment Expenses”
“Mind the Gap” (annual analysis of the returns of investors vs. their investments, by Russ Kinnel of Morningstar)
Geoffrey C. Friesen and Travis R.A. Sapp, “Mutual Fund Flows and Investor Returns: An Empirical Examination of Fund Investor Timing Ability”
Ilia D. Dichev and Gwen Yu, “Higher Risk, Lower Returns: What Hedge Fund Investors Really Earn”