Improve your Investment Returns by Using a Losing Decade to Your Advantage

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Let me ask you a question: Would you invest with a money manager or mutual fund with no track record and no real-time results to judge them by? Would your financial planner do so? I have asked this question dozens of times and the answer is always the same: Investors say “no” and planners say “of course not.” Nevertheless, the financial community is full of people ready to offer you a “hypothetical portfolio” with no track record at all. I will bet 90% of the investors reading this have come across this, and those looking for a new advisor will receive one as well.

In fact, most investors will receive an obligatory “custom” asset allocation plan when they hire a new advisor. This plan shows how this “custom” mix of assets would have done in the past. It also shows how this will perform in the future. The predicted future is almost always a very rosy one with the client’s goals and risk tolerance taken in account. After these presentations, everyone is left with a warm-and-fuzzy feeling.

However, the real truth is pigs will fly before most of these plans come true. In fact, the magnitude of error for plans generated in the 1990s and 2000s is nothing short of amazing.

Your advisor will likely give you a plan he generated using a form of asset allocation or modern portfolio theory. It is optimized to fit history so that it looks like these recommendations or portfolios as a whole did pretty well in the past.

The first problem is optimization of portfolios. Optimizing allows the computer to try thousands of mixes of assets, and percentages of those assets in the portfolio, in just a few seconds. This gives anyone with a mouse the ability to look like a genius—based on past performance. Of course, you don’t know how optimized the asset allocation plan is or how well it will hold

up in the future. The plan is dependent on the future looking just like the past. It is also dependent on past correlations between asset classes staying consistent.

Unfortunately for the investor, advisors and planners can use the “custom” asset allocation plan excuse to avoid providing a verifiable track record of how these plans have fared for other investors.

Just look at the list of excuses:

• “This new portfolio can’t be judged against any others because this one is customized for this investor.” 
• “If we had to produce a track record, then we wouldn’t be sensitive to the clients’ needs.”
• “We are not hired to beat or even keep up with the market, so this is a non-issue.”

I think this is just about as wrong as it gets. Having worked at large firms and seeing literally hundreds of portfolios like this over the years, I can tell you a few facts:

• If the same investor goes to ten different firms, he will get ten different portfolios. All show they are correct—using perfect 20/20 hindsight. The process is incredibly subjective with no real constraints or quality control methods.
• Bad decisions or investments for other clients can never be seen and don’t have to be disclosed. Every other investor could have lost 50% but without a track record you have no way of knowing what really happened to other investors.

The big boys, such as hedge funds, intuitional money managers, private money managers and commodity trading advisors, are required to have track records so the potential investor can have some guide to performance, skill and risk control. They have pages upon pages of rules to consider when reporting performance numbers that are released to the public. Failure to meet these disclosure and reporting rules has very dire consequences for these firms.

Yet financial planners, stock brokers, financial advisors and such  have no such required disclosure, and on top of that, they sell hypothetical futures. They get to sell fairy tales every day while saying they don’t believe in them. Hopefully, this practice will change in the future and anyone who charges a fee to manage assets or money will be required to produce a legitimate track record.

You should require a verifiable track record if you pay for asset or money management. It is your only defense against all the hype and fairy tales disguised as investment certainties.  You are much better off buying the Vanguard Asset Allocation

or Balanced funds, or other no-load funds, if that is the path you decide to go. You can see what these funds have done and they have a real track record.  Besides, who do you think has better a handle on risk and investment performance: a company like Vanguard or the guy at your country club or church with a laptop?  It is almost comical when you think about it this way.

In fact, the internet and two bear markets in ten years has made it the best time in history for investors who will take the time to look at track records and see how managers reacted when every advantage was taken away. That is how you can use the second worst decade in history to your advantage.

Your new mantra should be: “no real-time track record, no money from me.” It’s a simple rule that could keep you out of real trouble.

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