qandaQ:  I am meeting with a new investment advisor next week.  What should I ask them about their track record?



Question:  I am meeting with a new investment advisor next week.  What should I ask them about their track record?

Answer:  This can be a difficult question to get answered.  Most brokers will not tell you how their client’s accounts have performed.  They take the position that every client is a custom account and not representative of your situation.  Also, most brokers have accounts that are made up a combination of holdings they recommended and holding the client asked the broker to buy.  So, in reality the results are relatively meaningless.  It is possible the stocks or funds the broker recommended did poorly and the ones selected by the client performed well.  It’s also possible the account contained holdings that the client had when they opened the account with the broker.  But how can you judge their expertise (or luck) without a genuine track record?

On the other hand, most registered investment advisors have returns of their strategies so it should be possible to get actual returns that can be used to see how you would have done, based on the risk you were willing to take.  For example, my own portfolio is 50% in equity funds and 50% in bond funds.  My advisor and his firm can produce returns for the average of all 50/50 accounts for the last 10 years.  They also have returns for more aggressive as well as more conservative strategies.  The key is for you to compare the returns of strategies that have a similar risk as yours.

But, as every investor knows, any strategy has a risk of loss that goes hand in hand with the expected gains.  It is imperative you know the expected loss as well as the expected gain.  The last 10 years will certainly give you several examples of what a strategy could look like in the worst of times.  One of the reasons I am only willing to hold 50% in equities is that combination produced losses that represent the worst I’m willing to accept and not panic.  I believe if every investment recommendation came with an expected long term gain and expected short-term loss, most of the terrible losses of the past would not have been experienced by investors.  If I told you a diversified all equity portfolio is expected to lose 50 to 60 of it’s value from time to time, can you imagine making that decision?

I can accept hypothetical returns as long as the period of time includes a long enough period to expose likely losses you are likely to experience during the worst of times.  When I was an advisor, I thought it was necessary to review the returns, and losses necessary to get the long term return, going back to 1970.  It was not unusual for advisors to start their hypothetical performance starting in 1975, which eliminated the horrible losses of 1973 and 1974.

Here’s what I won’t accept.  If someone tries to sell you the performance of a handful of actively managed funds that have out performed the market, you should start by asking if these were the funds they were recommending 10 years ago.  If they say yes, ask them to put that in writing.  Anyone can tell you which funds had the best performance over a period of time.  Unfortunately there is very low correlation with that past performance and the future.  But it’s a great sales pitch because everyone would like to invest in yesteryears best performers, if they would reproduce the past. 

Never forget, there is no risk in the past.  Everyone in the industry knows what he/she should have done.  And if you ignored your spouse’s suggestion to buy Microsoft in 1986, it’s possible he/she is still reminding you how your life would be different if you had just listeneda to them.

Also, I suggest you ask them about their commitment to low expenses, low turnover and high tax efficiency.  All of those forces that will have an impact on your future results.