We have all grown up to respect the customer, to accept that the customer is always right. But in the case of investment advice, it is often the clients themselves who have given their advisors the wrong objectives for ensuring long-term growth of their portfolios.

Industry reports periodically criticize investment advisors for underperforming long-term global performance indices. The strong implication is that most financial advisors do not do a good job in managing money.

However, clients largely push advisors to make decisions that ensure that they beat short-term performance criteria each year. Even worse, many clients tell their advisors that they don't want any volatility (unless it is on the upside). As a result, advisors must manage a portfolio that will underperform the global multi-asset class indices over the long haul.

It is understandable that so many clients set such unattainable goals. Most people are taught to evaluate performance on a frequent basis; in this context, one year seems like a long time frame. People naturally want to know who won last year and who underperformed. Even when investors know they are supposed think long term, they are (quite naturally) afraid of picking a loser -- so if you're not a top performer, clients think they must have a bad advisor.


The problem is that this kind of thinking takes investors down the wrong path when it comes to constructing and monitoring a long-term investment portfolio. And understandably many advisors can't help but react in a suboptimal manner in an effort to keep their clients happy each year.

Here's what we know from looking at investing over the past century.

First off, asset classes routinely will underperform for a number of years, perhaps even as long as a decade, before suddenly becoming the best performer in a year. Of course, it would be great if an expert could consistently pick the future best-performing asset class each year. Yet despite having worked for 40 years on Wall Street, I have yet to meet a person who can do this every year. (As my brother likes to say when we're playing golf together and I make a good shot: “Congratulations, that's one in a row!”)

Clients want their advisors to avoid exposure to asset classes that either are too volatile or have not performed well in recent years. Yet most money managers that try to tactically move in and out of asset classes to beat the market tend to underperform the global indices. Money managers are often out of the market at the right time, but they fail to get in at the right time.

So although many advisors do know the best approach to investing, they can't convince investors to trust them to follow the best path for a lifetime financial plan.


Research shows that the key to solid long-term growth is as follows:

  • Carefully put together a portfolio across a variety of asset classes globally.
  • Except for minor rebalancing, leave the portfolio core allocation range alone for a period of a decade or more.
  • After retirement, only withdraw from the portfolio each year the amount you need to live off of.

With this approach, your return will be greater than leaving it in the bank.
Let's see how this approach would have fared during the worst possible time to be investing the last century.

Let's say a client began investing $1,000 each year into a diversified global portfolio when she was 45 years old -- once she had enough to invest -- and continued to invest about the same amount each year until she retired at 65. Now let's assume that she started investing in 1910, and was ready to retire in 1930.

The chart below shows what would have happened if, at 65, she retired fully invested -- at what was perhaps the most unlucky time to retire during in the 20th century -- but remained disciplined and only withdrew a steady $2,000 per year for living expenses.

Notice that it didn't matter if she had the worst luck of all and was fully invested at the beginning of the Great Depression. She still came out ahead and, even if she lived for 30 more years, never exhausted her nest egg. She simply didn't buy or sell too much at either the wrong or the right time.

In the final analysis, it is time and diversification that absorb the risk.


However, if this investor was a client who had constantly put pressure on her advisor -- first during the rising market years to take on more risk, to avoid falling behind the more aggressive managers, and then from 1930, pressuring her advisor to take on less volatile asset classes -- she naturally would have underperformed and inadvertently introduced more risk into her long-term portfolio.

So how should clients evaluate their advisors each year? When I speak to consumer audiences, I tell them that the most important evaluation points to consider are: How broad is your diversification? And are you investing enough to meet your long-term retirement goals? In other words, I try to help them understand that they should be goal- and outcome-oriented, rather than focused on short-term performance.

If you, as an advisor, are doing a good job explaining and managing these factors, then your clients should be OK. You just have to get them to ignore their brother-in-law's needling at the next family gathering.

Here's one effective approach: I have seen advisors educate clients by showing them examples in which top-performing asset classes (and related funds) subsequently become underperformers. This helps clients see that trying to pick top-performing funds over a short term and dramatically changing the portfolio mix each year puts additional risk into the portfolio. By contrast, of course, a stable portfolio that holds a variety of asset classes actually performs just as well over time -- and without the volatility of rapidly traded portfolios.

Such an approach can help an advisor demonstrate why it is better for clients to evaluate a portfolio against its long-term targets -- and strive to keep volatility relatively low -- than to worry about one-year relative performance.

Another technique: Talk about other products that need to be evaluated over longer periods of time. For instance, everyone knows that you don't evaluate a fine wine or scotch after only a year in the barrel. And you certainly realize that an orchard just planted last year will not yield any fruit this year.

If your clients insist on trying to beat the market each year, make sure they are using only a small portion of their total investment portfolio -- perhaps 10% to 15% -- for their market bets.

Timothy F. McCarthy, author of The Safe Investor: How to Make Your Money Grow in a Volatile Economy, was previously the CEO of Nikko Asset Management and is a former president of Charles Schwab and the Fidelity Investment Advisor Group.

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