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Friday, March 11, 2011

An investment advisor's most important job

Before deciding to have a child, my wife and I did a tremendous amount of research on how best to parent.  It occurred to us both, early on, that one of our jobs would be to comfort her when she was cast down, and challenge her when she was feeling too self-satisfied.

This reminds me, in a lot of ways, of what an investment advisor must do for clients.

Too many investment advisors are eager to give clients what they want, not what they need (we all know how that parenting style works).  In such a relationship, the advisor benefits at the expense of clients.  Not good.

Most investors get overly excited about market prospects after investments have made big gains, then become overly despondent when investments tank.  This is not some great sin on the part of investors--it's a well tested and documented human tendency.

Investors who don't exhibit this tendency, and there are quite a few, don't really need an investment advisor.  If they tend to zig when others are zagging, their investment results are likely to be very good without the help and expertise of an advisor.

Investors who exhibit the all-too-human tendency referenced above, however, do need the help of an adivsor.  In fact, I would argue it's the advisor's most important job to prevent clients from buying at market tops and selling at market bottoms.

I've made this focus the centerpiece of client communications.  When markets look frothy, I write client letters and blogs that express concern and cautious action.  When markets look abandoned, I express enthusiasm and a need for bold action.

This is vitally important, because most investors won't get anywhere close to meeting their retirement goals if they buy at tops and sell at bottoms.  If you need concrete examples, please see any of the multitude of studies showing how unprepared baby boomers are for retirement.

So, it was with great distress that I read an article in SmartMoney today highlighting that 1/3 of advisors moved client dollars out of the stock market and into conservative investments (cash and bonds, mostly) in 2009 and early 2010. 

In other words, those advisors were doing just the opposite of their most important job.  Instead of talking clients off the ledge, they were facilitating their jump. 

Even if you could argue that those clients needed to get out of the market for psychological reasons (can't sleep at night), I would further suggest they didn't belong in the market to begin with, and that their advisor should have been the one to figure that out before the market tanked.

Any advisor worth their salt should have been able to see that in early March 2009, the stock market looked likely to provide 20% annualized returns in the future (10% earnings yield, plus 6% economic growth, plus 4% dividend yield).  This is not rocket science, but many investment advisors panicked just like their clients.

It's like a pilot running up and down the isles of an airplane with an engine fire instead of soberly resolving the problem.  Such a pilot is clearly not doing their job, and neither is such a panicky investment advisor.

Can you imagine if 1/3 of pilots panicked like passengers when problems occurred?  No one would be willing to fly on an airplane!

And, yet, investors have and will continue to pick investment advisors based on their community involvement and winning personality, instead of their sober-minded expertise and an ability to deal successfully with psychological stress.

Perhaps investors will learn their lesson this time, and turn to advisors who give them what they need, not what they want.

After all, isn't that a parent's job, too?

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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