Maybe we shouldn’t be judging investment advisers according to whether or not they can beat the market.
That’s an incredible admission from someone such as myself who has devoted his career to judging advisers in precisely that way. Nonetheless, I have been exploring this possibility more and more in recent years. I was prompted to do so by a comment that Benjamin Graham—the father of fundamental analysis—made in his investment classic “The Intelligent Investor”: “The best way to measure your investing success is not by whether you’re beating the market,” he wrote, “but by whether you’ve put in place a financial plan and a behavioral discipline that are likely to get you where you want to go.”
Graham’s comment puts index funds in an entirely different light. Their desirability becomes less a statistical one of whether buying and holding such funds will outperform those who engage in active management. That statistical question was long ago resolved, of course, with index funds winning hands down.
But buying and holding an index fund comes up short if few investors are willing to stick with the strategy through thick and thin. And, indeed, it appears that few actually are.
On the contrary, most who say they believe in a long-term buy-and-hold strategy end up discovering — at or near the bottom of the bear market — that they don’t have what it takes. That means they suffer most or all of the bear-market’s losses and benefit from only a portion of the market’s subsequent rebound.
In comparison, an adviser whose record looks inferior from a statistical point of view might be a better bet than the index fund. The key is whether an investor finds the adviser’s approach sufficiently compelling to stick with it through a bear market. Since the key to long-term success is actually following the strategy over the long term, such an investor could actually make more money over time than the buy-and-hold investor who throws in the towel at the latter stages of a bear market.
This alternate way of viewing investment success focuses our attention on what an investor should be looking for when choosing an adviser. The key question is whether you’re willing to follow an adviser through the dark days of a bear market. Though there of course is no way of knowing in advance for sure, there are several key questions investors should ask to gain insight:
• Are you following the adviser because of his track record alone? This is a danger sign, because no adviser makes money all the time. There inevitably will be a time when the adviser is out of synch with the market. And if your only loyalty to that adviser is based on performance, then you’re very likely to ditch him at his first misstep.
• Do the arguments and investment rationales the adviser provides meet a smell test of plausibility? This seems a low hurdle to ask an adviser to jump over, but you’d be surprised by how few investors demand their adviser to clear it. Especially revealing is when an adviser contradicts himself from one communication to the next. For example, if he says he’s bullish because of a particular indicator — say, the S&P 500 SPX, +0.79% is above its 200-day moving average — then see if he becomes bearish when the market drops below it. If he thinks so little of his own arguments to not follow them, then you’re unlikely to be loyal to him when the going gets tough.
You’re looking for someone who can persuade you to stay the course when that’s the last thing you want to do.• Do you respect the adviser? This is an amorphous and ill-defined question, to be sure. But it’s a crucial part of the puzzle. You’re looking for someone who can persuade you to stay the course when that’s the last thing you want to do.
The bottom line? When focusing on advisers in these ways, there’s no right or wrong answer but, rather, a question of better or worse fit. An adviser who one investor finds compelling might be considered inappropriate by another.
The key to satisfaction with an adviser is to keep asking the right questions. Whether or not your adviser beats an index fund is not the only question — or the most important.
For more information, including descriptions of the Hulbert Sentiment Indices, go to The Hulbert Financial Digest or email mark@hulbertratings.com .Create an email alert for Mark Hulbert’s MarketWatch columns here (requires sign-in).
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