In a recent research report (see below) to be published in The Journal of Wealth Management, Prof. Philip Z. Maymin concludes that the ultimate value of financial advisors is that they can act to stop the emotional impulses of their clients.
The study looked at the number of interactions between clients and their advisors from the boutique asset management firm of Gerstein Fisher which manages over $1 billion. It found that Not surprisingly, the urge to trade increases with market volatility. But surprisingly it arrives immediately after the volatile period has ended. And that can cost clients dearly in performance: up to 4% a year.
So in a way we can think of financial advisors like parents holding the leash taut on a toddler who is about to get into some mischief.
To someone who values contrarian sentiment and trades off that data specifically, attempts to curtail it are disappointing. Where would we be if everyone traded non-emotionally? if everyone made smart trading decisions?
I’m being facetious of course because while we may invent new ways to curtail our impulses we will always have them. They’ll always be with us, nestled deep within our reptilian brains and provide the fight or flight responses that rarely are helpful in a modern world.
As well, let’s now forget that financial advisors are mere mortals. They do not exhibit any real edge over their clients when we look at them in aggregate. As Don Phillips points out in this article at Morningstar, most funds (83%) invested today are overseen by a financial advisor. And yet even with the support of advisors, most retail investors fare poorly in the market.
You may claim that the fault lies in the inability of clients to follow the guidance of advisors. But that doesn’t really explain what’s going on here. Consider, for example, an indicator that tracks the sentiment of financial advisors, the Rydex SGI Advisor Confidence Index:
As you can see, in its relatively short lifespan it exhibits the same tendency to swing from ebullient cheerfulness to despondency that we see in the weekly AAII retail investor’s sentiment metric. If you look closely there may be a few divergences here and there but overall, financial advisors are not really immune to the same emotional forces that buffet their clients.
Part of that is the fact that we are looking at the aggregate data or the crowd as a whole. Individuals can be smart but the crowd is usually too emotional and volatile, especially at the extremes. So we’ll always have contrarianism, no matter how hard we try to root it out. All we can do is get better at measuring it, analysing it and working with it. The indicators and tools may change but the underlying forces here will remain.
Here is the research report from Prof. “Preventing Emotional Investing: An Added Value of an Investment Advisor” (PDF document).