Reprinted courtesy of the National Post
by Tom Bradley
When markets are good, advisers and portfolio managers get too much credit for investment returns. Clients are happy that their nest egg is growing and attribute their good fortune to their provider.
Conversely, when markets are bad, investment professionals take the heat. Whether it’s fair or not, it happens a lot.
I’ve been thinking about this because we started our firm in 2007. I know, it wasn’t great timing, but the good thing is that most of our clients joined us after 2008. They’ve had an uninterrupted string of positive returns since they joined and many have credited us with undue brilliance.
My point is, before you praise or criticize, it’s useful to understand where your portfolio returns are coming from. Below, I’ll lay out the basic sources of return in the order of importance.
How bonds and stocks are doing is the single most important determinant of how well you’re doing. No matter if you have an indexed portfolio or are pursuing active strategies, the direction and magnitude of your returns will be driven by the markets. Your stocks and equity funds won’t be up when the markets are down (and vice versa) except in rare and temporary circumstances. Similarly, your fixed-income holdings won’t buck the trends in interest rates and credit spreads, no matter how unique your approach is.
You can’t control the markets, but there are things you can control. The biggest lever you have for balancing return and risk is your asset mix. Your portfolio’s blend of asset types — cash and GICs; bonds; stocks; and real estate — should fit your goals, time frame, risk tolerance and personality.
The cost of investing is always important. Research has repeatedly shown that the most consistent differentiator between investment approaches is cost, with low fees being the winner. In the 2 per cent interest rate world we find ourselves today, the impact of fees, commissions and administrative charges is magnified.
Being an old stock analyst, it kills me to say this, but security selection, whether it’s done by a professional manager or yourself, comes in a distant fourth on the list. The latest hot stock gets all the attention, but in the grand scheme of things, its impact is limited.
This lower placement assumes that the portfolio is reasonably diversified across geographies and industries. If, on the other hand, it’s characterized by a limited number of large, thematic bets (i.e. precious metals; Canadian banks; REITs; technology; or cannabis), then the stock picks increase in importance, for better or worse.
At this stage, my nice, tidy list gets messier. That’s because the fifth source of return can be slotted in anywhere. It depends on you. Your behaviour can be an important swing factor. If your actions show discipline, patience and courage (when needed), this item is at the bottom of the list. Your returns will come from markets, asset mix, cost and to a small extent, the securities you select.
Conversely, if you don’t have a plan, are inclined to make frequent changes and ignore the cost side, your conduct moves to the top of the list, usually with negative implications. The size, frequency and timing of your moves could overwhelm the other factors.
I started by saying that investors give their investment professionals too much credit, both good and bad. That’s true, although the industry has contributed greatly to the situation. We get too much credit because we take too much credit. You’ve heard it said many times, “Your good results are because of me. The bad ones? Oh, it was the market.”
In assessing your provider, it’s important to go beyond your initial reaction — Am I up or down this year? You must look at your results in relation to the market environment and your asset mix. Service and responsiveness should be factored in, as well as cost. And finally, the biggie — is your adviser or portfolio manager helping you to be a better investor — informed, disciplined, patient and courageous?
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