Your Financial Advisor is No GeniusSubmitted by Concierge Financial Planning, LLC on October 2nd, 2018
“Ann, it's great to see you!” exclaimed Sally as she burst into my office for her annual review. Like many of my clients Sally enthusiastically gives me credit for the past year's financial markets performance. I first did Sally’s plan 9 years ago and she has been this effusive whenever we have our check-in meetings. Although I’d like to take personal credit for the financial markets performance since 2009, I usually spend the first 30 minutes of our time together explaining to her why I’m no genius.
If there is a genius in the equation, it is the financial market gods. Since I started with Sally, the S&P 500 has returned approximately 11.90% annualized, 14.11% if you include reinvested dividends. Had Sally come to me ten years prior, our nine year relationship would have taken place over a period in which the S&P returned approximately -3.71% annualized, -1.92% if you include reinvested dividends!
I remind Sally of this every time we meet in the hopes that this historical perspective will enable her to be mentally prepared for the inevitable—a sustained period of market correction.
Like most of my current and potential clients, Sally indicated on her initial questionnaire that she is more comfortable with investments that have recently done well. This tendency to believe that recent market trends and patterns will continue is called recency bias, and it can lead to portfolio complacency and emotionally based investment decisions that can undermine long term success.
For example, Sally’s rebalance action plan requires that she sell off a portion of her inflated stock positions and reinvest the funds in bonds and short term fixed income vehicles to fund living expenses over the next few years. When I suggested she sell her equity mutual fund, she looked horrified and said, “Why would you want to sell that! It’s been performing so well!”
“That’s exactly why I want you to sell it,” I replied. Rebalancing to your target asset allocation inevitably involves selling off positions that have done well and reinvesting those proceeds in other investments that have not performed at the same level. Rebalancing may in fact lower your returns since you are diminishing a high performing position, but more importantly it is also reducing your risk, which could be at an all-time high! Rebalancing forces investors to buy low and sell high, which is infinitely easier said than done due to behavioral predispositions like recency bias.
All investors and particularly retirees need to understand that despite their stellar recent performance the financial markets will likely not continue to outperform. Various technical indicators which are beyond the scope of this post indicate that returns over next 15 years will be much lower than the past 15 years. A 60% stock/40% bond portfolio can only reasonably expect to return on average 5.35% annually over time. Don’t forget that’s an average number—half the time it will be lower than that! 5.35% contrasts with recent returns of 13.73% in 2017 and 17.91% in 2013 for a similarly allocated portfolio. The average annual return for a 60% stocks/40% bond portfolio over the past 15 years has been approximately 6.77%.
I suggest taking a page from my son’s George’s book. He’s a recent college grad interviewing for jobs. After an interview has gone particularly well he turns to me and says, “I’m just going to assume that I didn’t get that job.” Investors would be wise to do the same by overcoming their recency bias to assume that future returns will not be as robust as they have been in the past.
I can only hope that Sally greets me as enthusiastically when we meet after a year of negative stock market returns. In my dreams I hear, “Ann, you’re a genius! You told me this was going to happen, and I was prepared for the inevitable!”