Inept Advisors

Inept advisors are those who may be perfectly well meaning, but are simply unable to give good advice because they are in over their heads. In other words, they’re incompetent. They may not understand how financial markets operate or they may not understand investing well enough to provide good advice. Inept advisors aren’t breaking any laws or game rules, but fail to make the best choices for your long-term prosperity.

Just as sports scouts evaluate young athletes, some advisors are supposed to examine the landscape of fund managers and identify the best ones for you. In reality, however, many of them don’t do a good job.

The following quote was taken from the abstract (summary) of an academic article. This information is somewhat dense and written in academic-speak. Don’t worry! I provide an “English” translation below.

“We study broker-sold and direct-sold funds from 1996 to 2004, and fail to find that brokers deliver substantial tangible benefits. Relative to direct-sold funds, broker-sold funds deliver lower risk-adjusted returns, even before subtracting distribution costs.”

- Bergstresser, Daniel B., Chalmers, John, M.R., and Tufano, Peter, September 26, 2007.

As promised, here’s the English version:

“There doesn’t seem to be any evidence that brokers who direct investors to particular mutual funds are providing any benefits. In other words, their advice doesn’t appear to add any meaningful value.”

This section doesn’t imply that all advisors or brokers are a waste of your time and money. Many are very hard working, well-meaning and utterly trustworthy. It is the case, however, that advisors and brokers have to make a living and, naturally, they make a living off of you. They provide a service that you ultimately pay for. If they provide a very good service, their fees may be justified. If, on the other hand, the service is not commensurate with the fees charged, you are losing out.

In his book, The Big Investment Lie, Michael Edesess states the following:

“…professional investment help is a good deal worse than useless,” and “…Nobel-prize winning theories show that an investment strategy skirting the professionals entirely is the best policy.”

Some asset managers point to annual rankings of their funds as proof of their ability to add value. Scientific evidence, however, shows that very few money managers are able to consistently perform above average. The evidence indicates that even those who do string together a few winning quarters, or years, are hard pressed to prove they are benefiting from skill rather than luck. In almost all cases, their good performance is followed by declines and losses, leading to mediocre or average long-term performance.

Like investment advisors, asset managers also can cause non-malicious losses. They may make poor security selection choices in the funds they manage or fail to utilize simple hedges or other risk management techniques to protect your principal. None of these failures is malicious, but all lead to losses. Adding insult to injury, you still have to pay their asset management fees, further undermining your nest egg value over time.

In principle, to the extent that asset managers do a great job, yielding very high returns, high fees may be justified. Empirical evidence, however, indicates that asset managers are rarely if ever able to consistently deliver high returns after including their fees. This leaves the average player worse off than she’d have been without “help.”

Because the fees we pay advisors can so dramatically undermine our nest eggs, I’m in favor of avoiding intermediaries wherever possible. For some investors a good advisor represents a good investment, but we must all fully understand the limitations of these professionals, which ensures that they get their fees the old fashioned way—by earning them. The good advisors understand and agree with this; in fact, they recognize that removing the inept advisors from the scene is ultimately good for everyone.

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