One phrase that has become so trite over the years as to be threadbare is the old chestnut that certain people and businesses aim to under-promise and over-deliver. That sounds fine in theory. Most people don’t even question the sentiment. Here’s a way to test the sentiment in the investment management and financial planning world. Ask your advisor: “what sort of return should I expect, net of all fees over the next 20 or more years, on a portfolio that is 60% stocks and alternatives and 40% income and cash?”
Before reading further, see if you can come up with a number in your head. What do you think a reasonable answer might be? Got the number? Think about it first. Don’t read on until you do…
In contemplating this, we could all be asking ourselves a few questions. To my mind, those questions, in sequential order, are:
- Would you prefer the number to be high, low or just right?
- When you hear the advisor’s number, how will you know if it is high, low or just right?
- If the number you hear is close to what you expect, will you think it is credible?
- If it differs substantially from what you expect, will you think It is credible?
- If the advisor answering this provides a relatively high number, isn’t that advisor “over-promising”?
- If you answered ‘yes’ to question 5, check your answer to question 1 and, if necessary, explain yourself.
My sense is that the answer is something like 3%. Here’s my rationale: Expected return on stocks: about 6% (3.6% of the total). Expected return on bonds: about 1% (0.4% of the total). Total expenses: at least 1% (but this will vary depending on who you work with, what the services provided are and how large your account is – among other things). In truth, I expect the number to be a bit below 3% (i.e. expenses to be over 1%), but that’s the ordinal number that is closest to my thinking. I doubt that your initial guess involved a decimal point.
Now, here’s the real exercise. Before you ask a prospective advisor anything, ask yourself if you have biases or motivations that you are reluctant to acknowledge. My experience is that many would-be clients give their business to the first advisor who sets an expectation that is both relatively high, yet somehow plausible in the eyes of the person asking. For example, if you thought 7% was a reasonable answer, you might give your business to someone who said 7% or 8%, but you might think the person suggesting double digits was blowing smoke. Conversely, if you thought 7% was reasonable and the advisor suggested something like 3% or 4%, you might think the advisor wasn’t particularly good at his or her job. People say they want honesty from their advisors, but when that honesty is based on the best evidence and the consensus viewpoints of the best forecasters, my sense is that many people simply work with whoever makes them feel the best. Sometimes, those are the advisors who are the furthest away from being reasonable and measured. Rather than rewarding professionalism, consumers end up rewarding salesmanship.