Should I Change Financial Advisors Over Poor Performance?

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Periodically some investors will decide to change financial advisors, especially after a drop in the markets. Sometimes the reasoning is sound, and sometimes it is not. In this series, I am reviewing the primary reasons why investors change financial advisors.

The main reason why investors switch financial advisors is poor performance. Here are three problems with firing your financial advisor over poor performance and some reasons why poor performance may be an indicator of why you should fire your financial advisor.

First, markets go down often.

The fact that markets are down isn’t a good reason by itself to fire your advisor or abandon your investment strategy.

Generally speaking people don’t switch investment advisors when the markets are up, even if they should. Many advisors, especially commission-based salespeople know this. Possibly as a result, many advisors recommend conservative portfolios of 60% stocks and 40% bonds or even more conservative portfolios of 50% stocks and 50% bonds. Such a portfolio will be down less in down markets and up less in up markets. When the market is down, this advisor’s clients will be less likely to fire him as everyone else’s portfolio will be down more. And, because people normally don’t fire their investment advisor in up markets, the advisor will keep his client base even though the returns are poorer.

We recommend priceless asset allocations based on meeting your withdrawal needs. We do not shy away from what is necessary to meet your goals. You should have enough in your bond allocation for at least 5 to 7 years of your future withdrawals. The remainder should normally be invested in appreciating stocks.

A priceless asset allocation will be up more in up markets and down more in down markets. Because up markets are more common than down markets, you should have better returns over long periods of time. Alas, you will have poor performance during down markets. This opens the risk that you may incorrectly blame your investment advisor. However, you shouldn’t blame your investment advisor for decisions about asset allocation that you make together. And you shouldn’t be fearful of normal market returns.

Second, you are worrying at the wrong times.

When you start investing in the markets, you are very likely to see many highs and lows as the market gyrates before you see permanent gains. Review the article “When Should I Worry About Performance?” and see if your case is one of the many where you shouldn’t be worried.

Your investment strategy should be a mutual decision made with your financial advisor. Together you should craft an asset allocation along the efficient frontier. When market performance falls within normal market movements, you should not abandon that asset allocation. Down markets are the wrong time to worry about your asset allocation.

The stock market is inherently volatile. The returns of the markets are like a whip being cracked up and down by someone riding an escalator. The escalator trends upward, but there may be many moments where the whip cracks low enough to make you uncomfortable. If you take a long-term perspective, you will better be able to relax and enjoy the ride.

Third, most investors do not know how to judge performance.

Asset allocation decisions will, for the most part, determine the returns your portfolio will experience. And over any ten-year period some portions of your portfolio will do better than your portfolio as a whole. One way to think of this is to realize that if you flip a coin ten times, on average you will experience about five heads and five tails. But you will experience exactly five heads and five tails less than 25% of the time. More than one time in twenty you will experience zero, one, or just two heads out of ten tosses.

Similarly if you have twenty or more components to your asset allocation, it is likely that one of them will perform very poorly over any given decade. A diversified portfolio means you will always have components to complain about.

Successful investors do not worry about the markets. Those who worry wrongly think that it will be obvious when to get out and when it is safe to get back in. But due to this belief, the average investor underperforms the very funds they are invested in. On average they purchase funds at a premium which have already gone up and sell funds which have already gone down at a discount. Their attempts to time the markets results in the worst returns.

Instead, if you have built a portfolio along the efficient frontier and the returns your portfolio are experiencing are normal market movements, you should normally just rebalance.

Reasons you should consider switching financial advisors.

There are reasons to switch financial advisors which are related to performance.

If your advisor is not using low-cost funds, you should consider making a change. A study by Morningstar found that the best predictor of future returns, better than Morningstar stars, was low cost.

If your advisor is not attempting to craft an asset allocation along the efficient frontier, you should consider making a change. You may not need a portfolio of 40% bonds and 60% stocks. You may not need junk bonds either.

If you do not understand your investment strategy or your advisor cannot explain it, you should consider making a change. With a good advisor, your investment approach should be simple and straightforward enough that you understand why the approach is being taken and how it is being implemented. It should never be a black box where you put your money in the top, let the advisor crank the handle, and hope the return that comes out the bottom is good enough to meet your goals.

Additionally, if your current advisor answers “No” to any of the “Ten Questions to Ask a Financial Advisor,” you should consider making a change. These are serious red flags when it comes to safeguarding your money.

Lastly, your advisor should be honest with you about the returns in your portfolio. You should separate from advisors who sugarcoat reality. You need the truth. Without it, you can’t make realistic financial plans. Getting an accurate accounting of your portfolio’s return shouldn’t be optional.

Photo by David Marotta.

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President, CFP®, AIF®, AAMS®

David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. In addition to his financial writing, David is a co-author of The Haunting of Bob Cratchit.