I often get this question the first time I meet with a prospective client. This tends to be a question asked from someone who has never worked with an advisor before, or maybe didn’t have the best experience the first go around.
I think it’s absolutely a fair question! Any good financial advisor should be able to easily articulate their value. This could be anything from financial coaching, helping with behavior, or just putting a client at ease with the second set of eyes monitoring their financial plan. There are tons of reasons, but with this article, I want to look at some hard data. I think it is important to get away from the subjective and look at some facts.
First, let’s look at a study/chart from Fidelity:
This is a pretty simple chart but let’s dive in a little bit. Based on the study Fidelity conducted from 1998-2017 the chart shows that stocks returned 7.2%, bonds returned 4.6% and asset allocation returned 5.9%. Those are all solid returns in my opinion. They are all well above historical inflation and from a long-term investment, standpoint has done their job. The problem is the average investor didn’t get anywhere close to these numbers. There was a GAP of 1.91%, 4.16%, and 3.32% in the different categories. There is a pretty easy explanation for the deviations. It all comes down to investor behavior.
The second chart we are going to look at is routinely referred to as the “Quilt Chart” in the financial services industry. The purpose of the chart is to look at the performance of different asset classes from 2000 -2020.
By looking at this chart we can identify that over the last 20 years there isn’t a single asset class that has “won” for a meaningful amount of time. Now back to investor behavior. Typically, what happens, is from year-to-year individual investors will run from lower returning asset classes and move to higher returning asset classes. So, what is the result?
Take 2008 for example. A typical investor may decide to move out of international (worst performer of 2008) and move to government bonds (best performer of 2008). What happened in 2009? International went from the worst-performing asset to best reforming asset and government bonds went from best to the worst performer. We see the same situation occur in 2018 -2019 with treasury bills (first in 2018 to last in 2019). What we can see from the chart, replacing individual asset classes with a diversified portfolio may help reduce volatility.
In the chart, you can see that historically a diversified portfolio is never the top-performing asset, but more importantly, is never the lowest performer.
This brings me to my final point. The power and the absolute need to stay invested as much as possible even in turbulent markets. The chart below illustrates this extremely well.
From January 2000 through December of 2020 there were exactly 5,036 trading days in the market. If you stayed invested for the full 5,036 days, the annualized return was 7.4%. Again, this is a very solid return that beats historical inflation. But look at what happened if you missed out on just the 10 best days of the total 5,036 days! That is .2% of the total trading days and the return is sliced by more than half! If you miss the 20 best days, your return is flat, and you don’t even beat historical inflation.
The reality is the topics I just discussed are not inherently difficult to understand. The most difficult thing is controlling your behavior. Working with an advisor can help in this regard. Have you been structured appropriately to weather the storm? How did you feel during the dot-com bubble, how about the great recession, or more recently market volatility at the beginning of COVID? Did you lose sleep, make a poor decision, or do something you wish you hadn’t? Would working with a financial advisor have prevented it?
Please reach out with any questions, I would be happy to help. Remember, consistency and education are the keys to a great financial plan.