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TOOLS OF THE TRADE-Using the Right Lens

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When it comes to providing a successful investment experience for your clients, one piece of advice I learned early on as an advisor is this: Play defense. If you can block the many incoming threats to your clients’ financial futures, you’ll give them a much better shot at achieving their goals than if you spend your time trying to play offense and make all the right moves.

The best way to play defense for your clients–and achieve maximum profitability for your firm in the process–is to keep them from making costly mistakes that can rob them of the money they’ll earn by simply letting the capital markets generate wealth for them. For example, if you had invested $1 million in a diversified portfolio 30 years ago and stayed with that portfolio, you’d have gained 16% annually and earned $85 million by the end of last year. But make just a few screwups, like timing the market poorly or concentrating the portfolio, and you easily could have cut that return in half.

I believe successful investing is like filling a bucket to the brim with water. As long as that bucket sits on a firm foundation, all the water stays in place and you get to keep every drop. As soon as you pick up the bucket and move it around, however, water starts sloshing out, resulting in the loss of a portion of what you had. The lesson is simple: The less “hands-on” you are with your clients’ portfolios, the better off they’ll be over time.

Two Ways to View Investing

This concept of doing less to achieve more is difficult to accept. After all, as human beings we’re constantly taught that to win we must always take action, show initiative, and get ahead of the game.

So how can you convince clients that making fewer moves with their money is the right thing to do? Just as important, how can you stay committed to that idea? So much attention is devoted to keeping clients on track that we sometimes forget that advisors face the same pressure to act as individual investors when it comes to making decisions on what to do with clients’ portfolios.

The key is to use the correct time unit of measurement or, as I like to say, “use the right lens.” You can choose to view the investment landscape in one of two ways: through an investor’s lens or a speculator’s lens. If you use an investor’s lens, you see that true investing is a process that occurs over time periods of 10, 20, 30, or more, years. Therefore, your opinions about the markets and portfolio management will be shaped by this long-term viewpoint. Of course, the vast majority of your clients have goals that require a long-term perspective, such as not outliving their retirement savings. An investor’s lens therefore allows you and your clients to make decisions that reflect their needs over several decades.

Unfortunately, the think-fast mentality of daily life discourages us from making decisions with a 20- or 30-year timeframe. As a result, most investors are much more likely to view the world through a speculator’s lens, which emphasizes extremely short units of time such as a single month, quarter, or year. Clients who see the world through the short-term speculator’s lens will believe it makes sense to frequently shift in and out of various markets and asset classes. They’ll want to take action with their portfolios every time a big political or market event occurs. Some may even want to avoid equities altogether because of the wide swings in performance that stocks often demonstrate over very short periods, such as one year.

The Wages of the

Short Term Focus

The repercussions of taking a short-term speculator’s focus instead of the long-term view of a true investor can be enormous. Consider the following results:

Performance Chasing. A short-term view encourages behavior such as changing investment strategy based on the annual returns of asset classes–in other words, chasing after hot sectors of the market and avoiding unpopular ones. We’ve all seen the numbers showing how buying the best-performing investments and selling the poorest performers is a recipe for below-market returns. Yet that lesson is easily forgotten during trying times. I remember talking to a group of advisors about emerging markets during a period when that asset class was underperforming. Sure enough, one advisor complained that he’d taken on the risk of investing in emerging markets in his clients’ portfolios, but hadn’t received a commensurate return over the past 12 months. The past 12 months! Clearly this advisor, and his clients, were viewing investing through a speculator’s lens.

By contrast, the investor’s lens will focus your attention where it should be–on the long-term risk/return characteristics of an asset class and how those properties might affect a portfolio over several decades. With this focus, your clients won’t be tempted to add or throw out any investment due to its recent results. What’s more, they’ll see the value of owning many different asset classes once they understand that longer holding periods mean more predictable returns–even for seemingly “risky” areas such as emerging markets (see Best of Times, Worst of Times chart below).

There are two other consequences of taking a short-term focus:

High costs. The frequent trading associated with jumping into and out of the market also results in greater costs, including bigger annual tax bills from short-term gains and higher transaction costs, that eat away at investors’ bottom lines. An investor’s lens that focuses on the long term doesn’t magnify the present or the recent past, thereby discouraging trading and helping to keep costs as low as possible. The end result, of course, is that you help clients retain more of their wealth.

Business erosion. Advisors who see the world through the speculator’s lens do more than hurt their clients’ prospects–they damage their own businesses as well. Think about it: If you’re always moving money around based on short-term developments, you send a message to clients that you’re capable of doing so successfully. Your perceived value is based entirely on the performance you deliver to clients. That’s fine if you never make mistakes. But as soon as you make a bad call, your perceived value will plummet and your clients will start jumping ship. Get it wrong often enough, and you’ll end up having to peddle financial products instead of acting as a true investment advisor.

It’s Your Call

It’s in your best interest, therefore, to view the investment landscape through a long-term investor’s lens. It’s also your duty as a trusted advisor to encourage your clients to do the same.

The great news is that you’re uniquely qualified to teach them. Let’s face it, they’re not going to get the message from the big brokerage firms or asset managers, most of which are publicly traded companies run by people whose compensation is dictated by the firms’ stock prices. These companies can’t help but make decisions based on the short term. What’s more, those decisions frequently conflict with investors’ goals. For example, as brokerage firms’ stock prices fell during the downturn, they scrambled for some fast revenue to boost their image with Wall Street. Often that meant raising fees, which were passed along to investors. Why would anyone want to invest money with a firm that’s willing to boost its own short-term performance at the expense of the very investors it claims to serve?

Here’s the upshot. As an advisor, you have a tremendous opportunity to teach your clients the best way to view the investment process–as long-term investors, not short-term speculators. If you do, your clients will reward you with more assets, more referrals, and a stronger, more profitable business in the years ahead. As I always say, do your job and the numbers will take care of themselves.

Dan Wheeler is director of global financial advisor services at Dimensional Fund Advisors in Santa Monica, California. He can be reached at [email protected].