The Most Important Investment Question

July 1, 2012 | Financial Planning |

Is my advisor adding value?  Investors make a serious mistake if they assume there is enough information on their monthly statement to determine if their advisor is adding value.

How do you know if your advisor is adding value?  Your advisor adds value if the performance of your investment portfolio matches or exceeds the performance of a passive ‘couch potato’ exchange-tradedfund (etf) benchmark.  There is no other industry in the world where clients pay high fees, year after year,without expecting to receive a report which shows whether or not anything of value has been received.

Asking this question puts you in control.  With this information you can manage your money like a professional.  To manage your money wisely you don’t need to know a lot about individual stocks or bonds – it’s your advisor’s job to know these details – all you need to do is to act like a manager and see that the people you pay tomanage your money do their job.

You wouldn’t pay for a weight loss program where your weight loss and progress was not measured.  You wouldn’t continue with an advertising program if you couldn’t determine if the ad was working.  And yet many investors pay thousands in investment management
fees year after year without knowing whether or not their portfolio is being properly managed.

Containment of investment management fees is not the only critical aspect to the successful management of your investment even greater cost is likely to be under performance caused by being in the wrong asset class, the wrong currency, poor stock selection, or bad market timing.  Over your lifetime, if your investments are poorly managed, the compounding effects can cost you millions.  Fortunately there is a simple way to see if your portfolio is meeting the bare minimum acceptable standard.

The correct strategy is to compare your actual results with the proper benchmark – one which reflects the same asset mix and the same level of risk.  However, since many investors don’t know what benchmark they should compare to – we suggest the following as a simple and lowest minimum acceptable benchmark –one that no investor should consistently underperform.

By no means are we recommending that Veterinarians invest a large portion of their capital into any of the balanced mutual funds that are readily available.  We think there are many better choices. however, a balanced mutual fund is such a simple solution it could be
viewed as the worst case scenario.

Over the last three years, investors who followed even this basic inefficient strategy would be up by about 43% (12.7%per year).   Balanced mutual funds have high management expense Ratios (MERs) – thus informed investors should expect to exceed these return targets simply by utilizing lower cost investment products.

When you are monitoring performance keep in mind:

1.  Short term returns (less than 3 years) can be very misleading.  Evaluating performance based on one month or one quarter is imprudent and short-sighted.  Make an appropriate
comparison annually and if you are consistently under-performing over a three year period you should consider changing managers, or doing it yourself by investing in an ETF couch potato portfolio.
2.  It is the performance of your total portfolio that is important.  In a well designed portfolio some asset classes, sectors, and styles will perform better than others during various economic cycles.  That’s the whole idea of diversification –it is difficult to accurately predict which types of investments are going to perform well in the next quarter.  By spreading the portfolio over different sectors, styles, and asset classes it is almost certain, that some securities will outperform and some will underperform.
3.  The long term cost of underperformance is staggering.  If you’re 45 and have an investment portfolio worth $500,000, and you consistently underperform by 2% per
annum, – the value of your estate will be lower by about $2,000,000.
4.  If you are exposed to the risk of the market, you want to earn the return of the market. But it can also be argued that the most important rate of return is your absolute
return requirement.  This is the average return you need to earn to achieve your financial goals.  You determine your absolute return requirement (say 5% per annum) by
preparing a financial plan.  Some investors say they don’ care what happens in the market as long as they earn the absolute return needed to achieve their financial goals.

Action plan:

(assuming your portfolio is approximately 50% stocks and
50% bonds).

1.  Review your statements and determine your annual average rate of return for the past 5 years. (If your statements don’t show this information ask your advisor or you can calculate it yourself at
2. Compare that number with the average return of the balanced mutual funds shown above.
3.  If you’ve underperformed by 1% or more over a three year period – you should start looking for a new advisor or start doing it yourself using a couch potato portfolio.

In these highly volatile times it makes sense for most investors to be well diversified, to keep things simple and to focus on the investment process rather than searching for the best investment product.  To be able to focus on the investment process and to ensure you have the correct response to market swings – the most important tool is a properly prepared investment policy statement.

Bottom Line: This article outlines a step-by-step approach to assess your financial advisor, your investments and offers an action plan
to take.