TOOLS OF THE TRADE-Using the Right Lens

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].