Image Credit: Christophe Vorlet
By Jason Zweig | Oct. 30, 2010 12:01 a.m. ET
On a weekend that is all about dressing up as somebody else, consider whether your financial adviser has been masquerading all along.
Investment professionals are supposed to exercise independent judgment; in Warren Buffett’s words, they should be fearful when others are greedy and be greedy only when others are fearful.
It doesn’t always work that way. Corporate pension funds had 69% of their assets in stocks in 2007 as the market hovered at record highs. They have slashed that exposure to 45%, as my colleague E.S. Browning recently reported.
Advisers, too, have been buying higher and selling lower. Those who use TD Ameritrade had an average of 26% of clients’ assets in bonds and cash on Oct. 9, 2007, the day the Dow Jones Industrial Average hit its all-time high of 14164.53. By March 9, 2009, the day the Dow scraped rock bottom at 6440.08, the advisers had jacked up bonds and cash to 51%.
The movements of the markets alone can’t account for these swings. Had you left a similar portfolio untouched, you would have had 47% in bonds and cash in March 2009. And, reckons William Bernstein of Efficient Frontier Advisors, you would have ended up with 34% in bonds and cash this Sept. 30.
The stampede into bonds coincided with a rush out of stocks that may be intensifying. A recent survey of financial advisers by Charles Schwab found that 77% planned, over the second half of 2010, to maintain or even raise the proportion of their clients’ assets that are invested in bonds — up from 71% in January. Yet bond prices are near all-time highs and future returns are likely to shrink.
Financial advisers contend that one of their most important functions is encouraging clients to “rebalance,” or sell whatever has gone up and buy whatever has gone down.
The TD Ameritrade and Schwab numbers suggest, however, that financial advisers have been unbalancing instead of rebalancing their clients’ accounts. By selling stocks as they fell and buying bonds as they rose, advisers may have ended up exposing clients to more risk, rather than less.
Tom Bradley, president of TD Ameritrade Institutional, rejects any suggestion that the advisers have been trying to time the market. But, he concedes, “there certainly seems to be a greater interest among the advisory community in fixed-income securities than there was in October 2007.”
What might account for this sheepish behavior among people who ought to know better? There are two possibilities.
First, traumatized clients may be watching their advisers more warily. Knowing this, brokers and planners may be more reluctant to incur the extra risk of stocks. A recent experiment found that financial advisers were much more willing than college students to invest at high risk but with an expected return of 17%. That was true, however, only when the investment results were disclosed infrequently. When the outcomes were shown more often, the advisers became even less willing than the students to invest.
Second, instead of holding your hand, some advisers might prefer to pull you by the hand in the direction you are already headed.
In 2008, researchers led by Antoinette Schoar, an economist at the Massachusetts Institute of Technology, trained two dozen mystery shoppers in the basics of investing. Masquerading as potential clients, the shoppers had initial meetings with nearly 300 financial advisers in the Boston area.
Each “client” showed up with a portfolio and a preferred investing strategy. About a third pretended to like chasing hot returns.
“Instead of undoing or leaning against that bias,” says Prof. Schoar, “advisers were actually very supportive of chasing past returns.” The more a prospective client had pursued hot performance, says Prof. Schoar, the less likely the average adviser was to suggest a different approach.
“Chasing past returns is kind of a nice bias from an adviser’s point of view,” she adds. “It generates more fees” — especially for advisers who earn commissions each time they sell stocks or mutual funds.
One danger is that if you voice a strong opinion, your adviser might not give you a second opinion. He might merely echo your own, making you think he is smart because he agrees with you — and clearing the path of least resistance to his next commission. Sometimes, acting like a sheep just pays better.
Source: The Wall Street Journal, https://www.wsj.com/articles/SB10001424052702304879604575582540743655262
Resources:
Definitions of FINANCIAL ADVISOR, HERDING and REBALANCING in The Devil’s Financial Dictionary
Chapter Ten, “The Investor and His Advisers, in The Intelligent Investor
The Key to the Best Financial Advice: ‘Humility in Large Doses’