Many investors, letting their emotions get the best of them, fall into the trap of chasing investment returns. After a sustained period of strong results, they buy, and after a painful downturn, they sell. Of course, no investor likes to admit to acting this way. But do financial advisors suffer from the same issue? Is your financial advisor an emotional investor?
There is a simple test.
Simply look at their actions.
Five years ago, for the period ending March 2011, U.S. large companies (represented by the S&P 500 Index) had produced a paltry return of 2.62% per year over the previous five years. This means that $10,000 invested in the S&P 500 Index from April 2006 to March 2011 would have grown to $11,380 over the course of five years.
On the other hand, another major asset class – Emerging Market stocks, the stocks in the developing nations like China, India, Russia, Brazil, Turkey, etc. (represented by the MSCI Emerging Markets Index) – had just produced a five-year average annual return of 8.25% during the same period. In this case, $10,000 would have grown to $14,864 over the course of five years.
Looking back it was obvious what had performed the best, so what did your advisor do? Did your advisor buy more Emerging Market investments five years ago?
How about something more recent?
Fast forward to the end of March this year. The S&P 500 Index produced a return of 11.58% per year over the last five years. A $10,000 investment would be worth $17,295. On the other hand, the MSCI Emerging Markets Index fell 4.13% over the last five years, turning $10,000 into a disappointing $8,099. Was your financial advisor selling your Emerging Market investments in January, February or March?
If the answer is “yes”, then your advisor is an emotional investor. Professional advisors are not supposed to behave like emotional investors. Of course, this doesn’t mean that you should expect your advisor to know which direction the market is going, as no one knows, but it would be reasonable to expect your advisor to act in a disciplined and unemotional way.
By the way, Emerging Market stocks rose 13% in March 2016. Of course, past performance is no guarantee of future performance, but that is exactly the point. We all want more of what has given us comfort and profit, and less of what has given us pain and loss. But the financial markets do not reward comfort. In order to “sell high,” you have to “buy low.” It is the disappointing returns that set up the opportunity for higher future returns. And, it is also true that high recent returns increase the likelihood of lower future returns.
Emotional investing, whether it’s by you or by your advisor, is very costly.
You have a right to expect more from your advisor. Is it time for a change?
(Note: You cannot invest directly in an index. All returns in this article are presented before the deduction of any mutual fund or financial advisory fees)
Cern Basher, CFA
President & Chief Investment Officer