Andrew Hallam
17.12.2020

When Financial Advisors Punch Themselves
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When Marilyn Arsenault and her husband, Joe, decided to save for their retirement, they booked an appointment with a financial advisor. Marilyn, a university running coach, and Joe, a symphony orchestra conductor, expected the advisor to look after their interests.

And on the surface, that’s what happened. The financial advisor asked the couple about their goals, much as Marilyn asks her athletes every year. Then the advisor outlined a plan, much as Joe does when he prepares an orchestra. But there were a couple of differences. Marilyn doesn’t feed her athletes buckets of ice cream before every workout. Joe doesn’t pour water into trumpets.

But most financial advisors do something similar. They stuff actively managed funds into their clients’ accounts. That’s baffling. After all, decade after decade, low-cost index funds beat most actively managed funds. According to SPIVA, over the 15-years ending June 30, 2020, the S&P 500 index beat 87.23 percent of actively managed funds invested in U.S. stocks.

That, however, still leaves 12.73 percent of them beating the index over the past 15 years. So why not buy those winners? Most of us have seen dogs chasing tails. This “pick the past winner” plan is much like that. For example, imagine it’s 2014. You find a list of funds that were among the top 25 percent of performers between 2010 and 2014. Most of them beat the S&P 500. But if you bought those funds in 2014 and held them five years, only one in five maintained their top quartile performance ranking from 2015-2020. As a result, most of the people who selected funds based on how they performed in the past bought (mostly) future losers. The SPIVA Persistence Scorecard regularly updates this data. And every time they do, the results are much the same. Picking actively managed funds, based on their past performance, is one of the silliest things an investor can do.

So, does that make most financial advisors bad people? I questioned their integrity. But new research sheds a different light. On November 28, 2020, researchers Juhani T. Linnainmaa, Brian T. Melzer and Alessandro Previtero published, “The Misguided Beliefs of Financial Advisors in The Journal of Finance.”

They assessed data from more than 4,000 Canadian financial advisors and about 500,000 clients between 1999 and 2013. The two participating financial institutions provided personal trading and account information for the majority of their advisors. Of the 4,688 advisors, 3,282 had their personal portfolios with their firms. Most of those who didn’t were just starting their careers.

I was surprised to learn the advisors ate their own cooking…and burned their own food. They bought themselves actively managed funds instead of index funds. In other words, they bought the same things for themselves that they recommended to their clients. That doesn’t reveal a lack of ethics–just a lack of knowledge. Olivia Summerhill is a Certified Financial Planner (CFP) with Summerhill Wealth Management, in Washington State. She says, “During the Certified Financial Planning extensive training, the focus is not on investment vehicles. A CFP candidate does not get any training in their program if actively or passively managed funds are better for clients.”

So, the advisors punched themselves when they bought actively managed funds. Then they kicked their own shins by chasing past performance. And this self-infliction cost them a lot of money. According to the study, these professionals (and their clients!) underperformed equal-risk adjusted benchmarks of indexes by about 3 percent per year over 15 years. When compounded, that’s about 55 percent!

If you had (or have) an advisor who invested your money in actively managed funds, you might feel like tossing some punches of your own. But, as I’ve just learned, we shouldn’t be quick to judge.

Make peace with these people. But don’t let them invest your money. Instead, give them a book about index funds or ETFs. Christmas is coming. Your gift might help them and their future clients.

The 20 Best-Rated Books On Index Fund or ETF Investing*

*Ratings were as of December 3, 2020. Selections were made from books with index fund (or ETF) investing at their premise. Each book title required at least 100 Amazon ratings and at least 100 ratings on Goodreads to be considered. The sources included Amazon.com and Goodreads. If you know another book that fits these requirements, and has an average rating of 4.23 or higher (averaging Goodreads and Amazon’s ratings together) please connect with me on LinkedIn to let me know: https://www.linkedin.com/in/andrew-hallam-44b81627/

Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas

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Please note the value of investments can go down as well as up, and you may not get back all the money that you invest. Past performance is no guarantee of future results.