Four Behaviors That Generate Alpha
Last week we discussed Vanguard’s research showing how an advisor can deliver measurable “alpha” – that is, above average performance. This week we dig deeper with four examples of what that looks like.
Vanguard identified “behavioral coaching” as the area of where advisors can and should add the greatest value. The research pegged the behavior benefit at around 150 basis points a year, but added that when it matters most, the value-add can be far, far greater:
“…the most significant opportunities to add value do not present themselves consistently, but intermittently over the years…during periods of either market duress or euphoria. These opportunities can pique an investor’s fear or greed, tempting him or her to abandon a well-thought-out investment plan. In such circumstances, the advisor may have the opportunity to add tens of percentage points of value-add, rather than mere basis points.” (Vanguard, The Advisor as Alpha)
The benefit described above is very real, but often invisible to investors because it derives not from dramatic actions taken by the advisor, but from dangerous actions not taken. Here are four ways your advisor should help you earn better than average performance:
Not bailing out in a storm. There are few scarier feelings than watching your portfolio balance fall by 10, 20 or 30 percent in a market decline. Instinct tells you to bail out and wait for calmer waters. Unfortunately bailing out of the market (or a lagging asset class) after a big fall typically means buying back in at a higher level – that’s selling low and buying high, the worst case scenario for long-term performance. Your advisor’s counsel to stay the course may be tough to swallow, but it could save you a large portion of your net worth. Remember: The financial crisis of 2008-09 and every bear market before it.
Not following the greedy herd. Just like the fashion world, there’s always something new and exciting in the investment arena. The buzz du jour over dividend stocks, emerging markets, a hot new technology, bitcoin, or financial services companies can be irresistible, especially when market pundits make the latest and greatest sound like absolute sure things. Of course there are no sure things, and what seems white-hot one day can easily end up being nothing more than a blip, a Siren, a desert mirage. Through discipline and allegiance to your long-term plan your advisor can steer you clear of these false idols. Remember: The dot-com bubble. Aggressive growth funds.
Not reacting to headlines. The world is a troubled and troublesome place, awash is bad news somewhere every single day. It’s easy to translate dire headlines into doom and gloom for the markets. Doing so is a mistake as there’s little correlation between headlines and market performance, especially in the long-term. Your advisor can help keep you focused on your business, your family and other interests, without worrying about what the nightly news means for your portfolio. Remember: The fiscal cliff, the debt downgrade, the government shutdown, the tsunami, Cyprus.
Not tinkering for tinkering’s sake. High net worth individuals have a bias for action, probably feeling that through greater diligence and fine-tuning, anything can be improved. This can cause you to make changes to a portfolio when none is needed – selling one large cap fund to buy another, adding a trendy mutual fund that a colleague has mentioned, and so on. Such changes generally cause unwanted deviations from the long-term investment plan and can often lead to unnecessary transaction costs and taxes. Your advisor can add value by not trying to fix with what’ not broken. Remember: Changes you’ve made to your portfolio “just because.”
Not every advisor has the discipline to avoid the behavioral mistakes that average investors make, but that discipline is the backbone of our business model. We’d be pleased to discuss this further, anytime.
John F. Osbon – firstname.lastname@example.org
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