Can your advisor answer this question?














Previously, we discussed research showing that the average equity investor (measured by the largest data pool available, which is the money in equity mutual funds) has a twenty-year performance record which is barely ahead of inflation, and which is far below the record of many index funds and actively-managed funds over the same twenty-year period. You can read our analysis of this problem here and here.

Today, we offer another angle on this issue: In light of this research, do investors ask potential advisors what the long-term rate of return experienced by their clients has been?

Can an advisor even tell you what the long-term rate of return experienced by his clients has been? He should be able to, but can he?

It is very easy to pull out a track record of a fund or a manager that his clients own right now, and show the twenty-year record (or shorter time period, if the record doesn't go back that far) of that particular fund or manager, but as we have pointed out before, the advisor's clients may very well have just entered that fund or portfolio and thus the history before that time does not reflect returns that the clients themselves experienced.

And, unless that advisor has a very consistent system for all of his clients, it is very possible that some of his clients don't own that particular manager's fund or portfolio at all, and that those who do own that manager's fund or portfolio entered it at very different points in time.

Based on the results of research studies like the Dalbar studies, as well as our own experience in the financial world, we would suggest that most advisors you encounter are not able to tell you what the twenty-year rate of return experienced by their clients has been. If they have not been in the business for twenty years, then we would likewise assert that they are not able to tell you what the fifteen-year, or ten-year, or five-year rate of return of their clients has been (or whatever period of time is appropriate for their time in the business).

The reason for this inability is that most advisors today do not actively manage assets themselves, but rather select managers who do the actual management of the assets. While it is easy to find the record of those third-party managers, it is harder to find the record of the advisor who spends his time moving clients in and out of those managers. And that makes it very hard to know the record that the client (who may have had several managers at one time, and dozens of different managers over the course of twenty years) experienced over the same period of time. And, unless the advisor has a very systematic process which he has used consistently for all his clients as he goes about "picking managers" over the years, he will not be able to tell you what the twenty-year record of his clients was.

The results in the graph above suggest that this is a very important question! It is especially significant in light of the data discussed earlier which suggest that a large percentage of the investors whose data is reflected in the chart above are using professional advisors!

A likely rebuttal from an advisor who is not able to show what all of his clients experienced in returns over the past twenty years might be, "But every one of my clients is different, so of course I cannot tell you what the rate of return everyone received over that period of time! Each one may have had different managers, because each one has a unique situation."

Of course it is true that each investor has different needs based on different time horizons and different specific situations, but is it really true that each needs a completely different system for the equity portion of their investments? Do they need a completely different system for their bond investments? How about for their cash investments?

We would argue that while the allocations of equities and bonds and cash differ from client to client, and even account to account for one client or client family, it does not follow that clients should each have a different process governing the portion of their market assets which are allocated to equities (or to bonds either). To do so makes it impossible for an advisor to see what kind of twenty-year returns his clients have experienced.

And it is the long-term returns that are clearly the problem for investors, as you can see in the graph above. A family's wealth is not determined by its one-year rate of return, but by the rate of return experienced over decades.

for later posts dealing with this same topic, see also:

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