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Money

Why Your Financial Advisor Doesn’t Deserve Credit For Your Gains

Last week, I ate lunch at a vegan restaurant with my friend, Bill. As the server poured us drinks Bill said, “We met a financial advisor last week. Our friends recommended him because has made them a lot of money over the past few years.”I said, “Bill, even if that advisor were a total fool, your friends would have still made buckets of money.” Bill hadn’t heard the expression, “A rising tide raises all boats…even the crappy ones.” The S&P 500 isn’t among those shoddy boats. But it shows how far the tides have lifted. The S&P 500 includes 500 of America’s largest stocks. Nobody trades the stocks within it. If you buy an S&P 500 index, you’ll own a sliver of every stock: the good, the bad and the downright ugly.I’ve listed the annual returns for the S&P 500 over the past 1-year, 3-year, 5-year and 10-year periods. For example, over the ten-year period ending December 31, 2019, a $10,000 investment in the index soared to $35,166. That’s a compound annual return of 13.40 percent. That’s why financial advisors don’t deserve credit for investment gains. Everything has risen…a lot. <br /> American Stocks Have Soared <br /> How $10,000 Would Have Grown In The S&P 500 <br /><br /> <br /> <br /> Duration<br /> Compound Annual Gain<br /> $10,000 Would Have Grown To….<br /> <br /> <br /> <br /> <br /> Past 1 Year<br /> 31.33%<br /> $13,133<br /> <br /> <br /> Past 3 Years<br /> 15.12%<br /> $15,256<br /> <br /> <br /> Past 5 Years<br /> 11.55%<br /> $17,297<br /> <br /> <br /> Past 10 Years<br /> 13.40%<br /> $35,166<br /> <br /> <br /> Source: portfoliovisualizer.com, using Vanguard’s S&P 500 Index (VFINX); Ending December 31, 2019<br /> <br /> <br />Some investors, however, earned total portfolio returns that were higher than the S&P 500. They took bigger risks. That’s not a big deal, as long as investors know they gambled. For example, if an investor loaded up on growth stocks, such as Apple, Alphabet, Netflix or Tesla that would have done the trick. A growth stock market index would have beaten the market too. But if people build portfolios that aren’t diversified, the effort gets judged based on a double standard. A friend of mine likes to say, “When somebody does something crazy, and they live, they look heroic. But if they try that same thing and they die a tragic death, everyone calls them foolish.”If your financial advisor earned you returns that were a lot higher than 13.40 percent annually over the past 10 years, and if you didn’t know you took bigger risks, it might be time to fire your advisor.In contrast, if your advisor earned returns much lower than 6 percent annually over the past ten years, and you considered the portfolio balanced, it’s time to ask some hard questions. Imagine a portfolio with about 50 percent in a U.S. bond market index and 50 percent in a global stock index. The global stock index would have included exposure to the world’s stock markets based on market capitalization. In other words, almost half of its stocks would include international shares. This would represent a conservative, diversified portfolio. According to portfoliovisualizer.com, it would have averaged a compound annual return of 6.47 percent over the ten years ending December 31, 2019.Long-term, stocks beat bonds. That doesn’t happen every decade but it did happen over the past ten years. Stocks provided growth. Bonds provided stability. If a portfolio earned much less than 6 percent over the past ten years, the bond allocation should have been higher than 50 percent of the total. If the bond allocation were lower than that, and if the portfolio earned much less than 6 percent per year, investors should be disappointed. After all, portfolios with lower bond allocations (and higher stock exposure) should have earned much higher returns. For example, assume a portfolio had 20 percent in a bond market index and 80 percent in a global stock index. This adds a level of risk: the bond allocation is low.But in this case, the higher risk would have rewarded the investor. According to portfoliovisualizer.com, this portfolio would have averaged a compound annual return of 8.04 percent over the ten-year period ending December 31, 2019.To earn even higher returns, investors would have needed to shun international shares and bonds, or focus solely on U.S. growth stocks over the past ten years. Focusing on U.S. growth stocks, only, would have been foolish­…much like climbing El Capitan without a rope. When the markets drop, such a portfolio would fall hard upon the rocks. When investors calculate returns, they should compare their returns to a benchmark that fits their portfolio’s allocation. For example, if an investor has a conservative portfolio comprising 50 percent stocks and 50 percent bonds, they should compare their returns to a portfolio of index funds comprising 50 percent stocks and 50 percent bonds. This would allow them to make an apples-to-apples comparison. Investors should also understand the level of risk they took to earn those returns. Below, I’ve listed the ten-year performance of several allocations. They show how lump sums would have performed over the past ten years with each portfolio allocation. I’ve categorized the portfolios from relatively conservative (50 percent bonds) to portfolios that are extremely risky (100 percent U.S. growth stocks). If you have less than 50 percent in bonds, and your advisor earned less than 6 percent per year, it’s time to ask some questions. And if your advisor earned you a compound annual return much greater than 15 percent over the past ten years, don’t celebrate that success, unless you knew, in advance, that you knowingly took risks that could have ended badly.<br /> How Much Money Should You Have Made And What Risks Did You Take? <br /> December 31, 2009-December 31, 2019 <br /><br /> <br /> <br /> <br /> Portfolio Allocation <br /> <br /> <br /> Risk Scale <br /> <br /> <br /> 10-Year Compound Annual Return <br /> <br /> <br /> <br /> <br /> <br /> <br /> 50% Global Stocks (VT)<br /> 50% U.S. Bonds (VBMFX)<br /> <br /> <br /> 3: Balanced<br /> <br /> <br /> 6.47%<br /> <br /> <br /> <br /> <br /> 35% U.S. Stocks (VTSMX)<br /> 15% International Stocks (VGTSX)<br /> 50% U.S. Bonds (VBMFX)<br /> <br /> <br /> 4: Balanced<br /> <br /> <br /> 7.39%<br /> <br /> <br /> <br /> <br /> 60% Global Stocks (VT)<br /> 40% U.S. Bonds (VBMFX)<br /> <br /> <br /> 5: Balanced<br /> <br /> <br /> 7.01%<br /> <br /> <br /> <br /> <br /> 40% U.S. Stocks (VTSMX)<br /> 20% International Stocks (VGTSX)<br /> 40% Bonds (VBMFX)<br /> <br /> <br /> 6: Balanced<br /> <br /> <br /> 7.95%<br /> <br /> <br /> <br /> <br /> 80% Global Stocks (VT)<br /> 20% U.S. Bonds (VBMFX)<br /> <br /> <br /> 7: Assertively Balanced<br /> <br /> <br /> 8.04%<br /> <br /> <br /> <br /> <br /> 55% U.S. Stocks (VTSMX)<br /> 25% International Stocks (VGTSX)<br /> 20% U.S. Bonds (VBMFX)<br /> <br /> <br /> 8: Assertively Balanced<br /> <br /> <br /> 9.44%<br /> <br /> <br /> <br /> <br /> 100% U.S. Stocks (VTSMX)<br /> <br /> <br /> 9: Aggressive (not diversified)<br /> <br /> <br /> 13.30%<br /> <br /> <br /> <br /> <br /> 100% U.S. Growth Stocks (VIGRX)<br /> <br /> <br /> 10: Extremely risky<br /> <br /> <br /> 14.44%<br /> <br /> <br /> <br /> <br /> Note: A global stock index includes about 55% U.S. stocks and 45% international stocks. <br /> *U.S. stocks beat international stocks over the past ten years. But that doesn’t always happen. Sometimes, international stocks win. <br /> <br /> <br /> For Additional Reading <br /> Why Your Fast & Furious Stocks Might Be Putting You At Risk <br />Andrew Hallam is a Digital Nomad. He’s the author of the bestseller Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas

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