Investment Performance 


Financial advisors, including myself, will often try to make a point by illustrating graphically or numerically the performance of a particular investment.  If that presentation is made without qualification as to the timeframe, it is very likely to be misleading.  Over a long enough period, most investments will go up.  But the truth is, investments go up and investments go down over different periods.  Be skeptical of a glowing presentation and be prepared to ask how performance was over different periods and market conditions.


Modern Portfolio Theory (MPT) 


MPT is the foundation of the approach used by so-called “robo-brokers” (see below) and a many investment advisors, including me.  At the risk of oversimplifying, MPT provides a mechanism to identify investments with the best combination of potential return and risk.  The problem is that MPT is based on a number of theoretical assumptions that are well known to be unrealistic and produce unreliable prospective views of risk and potential return.  Therefore, advisors need to make judgments to adapt its principles to practical use.  Adherence to MPT principles without regard to current economic and market conditions subject a portfolio to significant volatility, including downdrafts from market bubbles, that can destroy investment gains for many years, as happened in 2001 and 2008.


Diversification is Good 


This is an outgrowth of MPT but is true only if the returns on the securities are relatively uncorrelated and remain that way. What is surprising and not often discussed, is that correlation is not constant and there are times when even so-called uncorrelated assets, like stocks and bonds, are highly correlated.   Moreover, diversification, regardless of correlation, needs to be implemented in the context of current market conditions and outlook.


Rebalancing is Good


In general, I agree.  Without rebalancing, investment returns suffer.  It is demonstrable that portfolios that are rebalanced over time or as allocation percentages get out alignment with the long term goal have higher returns over time than portfolios that are not rebalanced.  Keeping in mind that it is impossible to consistently pick the tops and bottoms of markets, rebalancing on autopilot alone (elapsed time or percentages) only accidentally picks the most ideal times to take action at best, and at worst, leaves the portfolio susceptible to market bubbles with longer recovery times.   Also, if the portfolio contains more than, say, 10 distinct securities, an advisor’s ability to implement an effective rebalancing program is impaired. 


Low Expenses are Good 


Again, in general, I agree.  However, what really counts is the expected total return of an investment (and an advisor), regardless of its expenses.  For funds that cover a broad swath of a given market, for example, the S&P 500, returns before fund management fees among different funds are likely to be virtually identical.  In those situations, it’s best to choose the funds with the lowest fees.  On the other hand, when choosing funds with a more narrow focus, the expected total return over the relevant time frame is more important than the fund’s expense ratio.  For example, a recent examination of 5 real estate exchange-traded funds and 5 real estate mutual funds found that the best performing fund over various periods of years was not the one with the lowest expense ratio.


A Long Term Investment Focus is Good


That may be true if you are Warren Buffett with little concern about market fluctuations, but for most of us, that can be a trap.  Yes, over long periods of time, the stock market has gone up and it is reasonable to think it will continue to do so over long periods of time.  Since 1980, however, there have been 5 occasions when a “correction” in the S&P 500 took over a year to recover.  Since 2000, two of those corrections each took over 5 years to recover.  Since we don’t know when the next correction will occur or how long it will last, it’s best to have a plan in place that will preserve portfolio values when, not if, another such correction occurs.




Robo-brokers or robo-advisors are a relatively new phenomenon providing a very low cost, automated investment platform in which the investment choices (typically less than 10 exchange-traded funds) are pre-established based on diversification, low fees and low correlation (MPT-based techniques).  The initial allocation is usually based on an on-line risk assessment questionnaire with little or no human involvement and trading is automated based on periodic, formulaic rebalancing.  The platform can be enticing since the “advisor” fees may be anywhere from zero to, say, 0.25% (more if there is human contact) and funds are chosen to be low fee, as well.  Robo-brokers present a simplified “set it and forget it” approach that can work acceptably well in normal times – if we only knew when times were going to remain normal.  Their lack of attention to emerging macroeconomic and market conditions and their promotion of MPT techniques without reference to the limitations are just two of the reasons why robo-brokers fall short, in my opinion, to meet the needs of most investors.

Smart Beta

Smart Beta is based on the notion that there are characteristics that, if honed in on in the construction of a portfolio, exchange-traded fund or mutual fund to the exclusion of securities that don't match the criteria, that better investment performance can be achieved.   One firm describes Smart Beta this way:  strategies ... designed to add value by systematically selecting, weighting, and rebalancing portfolio holdings on the basis of factors or characteristics other than market capitalization.  The idea is, Smart Beta is promoted as an alternative to broad-based indexing (or some other manner of asset selection).   Who wouldn't want to be associated with a "smarter" investment strategy?

The truth is, while there are always periods of time when certain factors (for example, growth stocks, or small cap stocks, or low P/E stocks, each of which can be found in Smart Beta funds) are in favor, there is no such thing as "factors and characteristics" that consistently, over time, outperform a broad index such as the S&P 500.  There are many reasons for this including mean-reversion and business cycles.  


What counts are an investor's goals and how performance will be measured.  For investors without the time, where-with-all, and/or inclination to make portfolio adjustments based on current market conditions and relative performance, Smart Beta is nothing more than a marketing ploy.

Variable Annuities Are Not For Everyone

There's probably not been a more complex financial product presented more simply to every day investors than variable annuities.  Nothing makes this point more strongly than the admonition by the insurance company that investors should read the prospectus carefully.  That's easier said than done.

With considerable oversimplification, variable annuities promise a guaranteed return over the life of the annuitant, currently around 5% or 6% for a contract issued to a 65 year old.  A death benefit is provided, usually equal to the value of the initial premium reduced by the sum of the annuity payments made.

That return seems attractive as does the insurance guarantee, but whether this is a good investment for an individual depends on a careful analysis of the investor's circumstances and alternative investments available.  Unfortunately, with the generous commissions associated with these products, that analysis is rarely provided by the financial consultant.  For that reason, an independent analysis by a qualified advisor who does not have "skin in the game" is highly recommended. 

The friendly professor is here to emphasize that my goal is to educate readers about some of the more popular notions about investing and how these notions are sometimes used as a marketing tool by investment advisors without the benefit of a full explanation.