Is your wealth advisor an ‘Investment Vulcan’?
Wealth advisors often talk about biases and investments habits of investors that lead to poor investment performance. They talk about cognitive biases such as hindsight bias and mental accounting; about emotional biases such as overconfidence and regret aversion, leading to bad investment habits such as trading too much and not diversifying sufficiently. Research by Vanguard1 (the bastion of passive investing no less) among others, has indeed shown these biases and habits significantly reduce portfolio performance over time. Research analysts at Vanguard believe that advisors, through financial planning, behavioral coaching and guidance can consistently provide value to their clients. They quantify the value added to be on average equal to 3% per year, net of all fees. Over time, that can add up to a very sizable difference to an investor’s portfolio.
But, what makes wealth advisors immune to these biases and habits? Listening to them talk, you would think they are like Mr. Spock from the planet Vulcan, in the sci- fi series Star Trek- living by logic and reason with little interference from emotions.
In reality, advisors suffer from the same biases and habits that they advise their clients against. Some suffer the consequences in their personal portfolios2 (Hopefully, not in their client’s portfolio). What can and does prevent them from making the same mistakes in their client’s portfolio is having a time-tested process and sticking to it.
In all the discussion about beating benchmarks and passive versus active investments, what is lost is what investors do as opposed to what they should do with their investments. What investors do with their investments in aggregate, hurts their performance and by a wide margin. You just have to look at the difference between fund returns and investor returns of mutual funds on Morningstar to see by how much3. A wealth advisor that follows a well thought out process can prevent this from happening. Further, advisors that provide financial planning services can additional value to their clients.
It is no surprise then that understanding an investment advisor’s process and his/her commitment to it, is one of the most important steps investors should take when hiring an advisor4. One of the ways that commitment can be judged is to enquire if he/she uses the same process for managing a significant part of his/her wealth. At Sarsi, most our personal assets are managed in the same way as we manage our client’s assets. We also believe in goals based financial planning, which minimizes the potential harm of client’s ad hoc, aspirational investments5 and emphasizes a reliable investment strategy in line with client profile.
1. Please send us a note if you would like a copy of these research reports.
2. We have had the good fortune to work with successful investment managers that did very well for their clients but themselves needed help for their personal portfolio.
3. According to Morningstar research the average annualized difference between investor returns and fund returns for 10-year periods ended 2012 to 2015: negative 1.13%.
4. www.riastandsforyou.com is a good website with information on what value a registered investment advisor (Such as Sarsi) can add to a client and how to go about selecting one.
5. These are investments with very high uncertainty but potential for outsized returns.