The Ten Worst Mistakes Advisors Make
I’ve seen many positive changes in the advisory business over the past three decades. Fees have gone down and diversification has gone up. Advisors are a large part of the reason flows are moving from expensive active to low-cost passive funds. This has been good for our clients. Still, we have further to go, and having advisors address these 10 failures in their practices will help us get there.
All of these suggested changes are in the best interests of our clients, which ultimately benefits our business:
- Taking too much equity risk. The bull market is now well over eight years old. The total return of the U.S. stock is 363.3% as of October 6, 2017, as measured by the Vanguard Total Stock ETF (VTI), since it bottomed out on March 9, 2009. It turns out that advisors timed the market poorly during the real estate bubble and plunge. Advisors took on a ton of risk at the 2007 market high on October 9, with only 26% bonds and cash but upped the amount to 51% on March 9, 2009, just in time to miss out on the recovery.
Today, many advisors and investors have a high tolerance for risk and I’m seeing portfolios even more aggressive than in 2007. Risk-profile questionnaires are inherently unreliable as clients tend to be risk-takers in good times only to run to cash when stocks tank. Further, they don’t measure the client’s need to take risk.
- Buying risky bonds or bond funds. Much like in 2007, I’m seeing managed portfolios with bonds and bond funds either barely investment grade or junk. This is a dumb strategy and shows how short our memories are. In 2008, just when we needed our bonds to act as a shock absorber when stocks tanked, Morningstar reports the average bond fund lost 8% while the average high-yield (junk) bond fund lost 26.4%.
By contrast, a high-quality bond fund like the iShares Core US Aggregate Bond ETF (AGG) gained 7.9% and served the role of bonds as a shock absorber. But unlike 2007, it’s even harder for advisors to put clients in high-quality bond funds because rates are so low. As of October 9, 2017, AGG is yielding 2.27% which makes it hard for the AUM-based advisor to justify taking nearly half of that return in fees. So advisors fall for the argument that bond indexing has failed, ignoring the fact that many funds take on far too much default risk.
- Doing what our clients want. I often hear an advisor say their clients want high equity exposure or higher paying bonds. In fact, I heard many advisors tell me they turned to cash after the 2008 stock plunge because their clients demanded it. But working with our clients’ best interests in mind doesn’t mean always agreeing with them. Though it’s important to listen to our clients and understand their concerns, it’s critical that we push back when we disagree. We need to be prepared to be fired or even to fire a client.