Why performance promises and goals are worthless
The other day, I met with a prospective client who told me of a meeting she recently had with a competing advisor at a well-known brokerage firm who suggested that he could consistently generate returns for her on the order of 12% per year. Unfortunately, such shameless hyperbole is still common practice in the financial planning profession, but few things irk me more than misrepresentations about one’s abilities to generate future returns.
Separately, an existing client recently asked me if we could set a return objective of 5% per year for his conservatively invested (50% cash,10% bonds, 40% stocks) portfolio. Although this more modest performance objective would seem to lend itself better to assurances, the purpose of this piece is to make the case that specific return benchmarks – even modest ones – have no place in the advisor-client dialogue.
As the title of this piece suggests, at the heart of the issue is the simple, well established fact that financial advisors have no control over capital markets returns. This point is effectively illustrated in the following table*:
Two obvious conclusions from this table are (1) that there is a wide range of returns across all time periods, and (2) that negative annual returns have occurred for periods as long as ten years. The fact that the 10 year period ending February 2009 produced average losses of 3% per year should be ample fodder to question any advisor who claims the ability to consistently produce double digit returns.
But what about more modest promises, such as the 5% annual return my dear client is seeking? Surely, with a balanced allocation of stocks, bonds, and cash, such a return is well within range of reasonable expectations, yes? Actually, no. In the current investment environment in which cash pays nearly 0% and interest rates on bonds are near historic lows, such a promise from me would be nearly as irresponsible as that made by the less-than-forthright fellow who promised 12% per year. Think about it – with 60% of my client’s portfolio in low-yielding, cash and fixed income investments, the 40% that is invested in equities would need to generate on the order of 12% per year to bring the portfolio average to 5%.
The bottom line is that both investors and their financial advisors have no control over either interest rates or stock market returns. While we can deploy asset allocation strategies and diversification to temper volatility, promising or setting absolute performance measures is a pointless endeavor. The markets will give what the markets give.