Wrong! My Mistakes Over a 20-Year Advisory Career
In the last two decades as an investment advisor, I’ve often been wrong – about markets, products and their providers, investors, the government, and the advisory business. Here are my top 10 items I’ve got wrong.
1. International stocks should do as well as U.S. stocks. Nearly 20 years ago, I had my first meeting with the late Vanguard founder, John C. Bogle. One of the things we discussed was his view that international stocks should either be excluded from the portfolio or be no more than 20% of the stock portion of a portfolio. Bogle believed U.S. stocks doing business abroad had enough exposure to international markets. I pointed out that if U.S. stocks had enough international exposure, we wouldn’t be seeing such different performance between the two.
In a way, I was right (as performance was wildly different going forward). But in the only way that matters, Bogle was right, as international stocks badly lagged U.S. stocks. I still believe that we live in a global economy and capitalism works across the planet. I’m not abandoning international stocks.
2. Factors should best market beta. Early on in my practice, I attended a DFA seminar with Ken French as one of the presenters. It was very enticing, but the work from Fama and French made it clear to me that factors weren’t a free lunch. Rather, they were compensation for taking on more risk. Other than a small experiment with my own money, I embraced "dumb beta,” electing to take more beta risk with lower fees and higher tax-efficiency.
Smart beta became the rage and there were soon hundreds of so-called factors. Before long, there were so many factors that even Research Affiliates’ Rob Arnott was sounding the alarm that smart beta can go horribly wrong. As it happened, just about every factor failed going forward, at least over the past 15 years.
I was right not to use factors but dead wrong in thinking they would outperform the overall market beta based on the long-term compensation for taking on that additional risk.
3. Stock markets eventually react to consequential news. For quite some time, I’ve known that one cannot predict markets. I’ve also known that the daily headlines as to why stocks plunged or surged were foolish as well. I was pretty sure that, in the longer run, the stock market was rational.
I’d call the last two years and seven months a reasonably lengthy period of time. Since the beginning of this decade (2020), we’ve had a continuing global pandemic, political dysfunction, a war in Europe, record debt, and high inflation. The U.S. stock market responded with a 32.7% gain between 12/31/19 and 7/31/22.
The market makes fools of all of us. If I can’t even explain past market performance, I’m not going to delude myself into thinking I can predict the future.
Providers and products
4. Vanguard will always be the low-cost leader focused on individual investors. Bogle’s legacy was to give every investor a fair shake. As indexing caught on, Vanguard benefited from economies of scale. Those economies of scale combined with the fact that Vanguard didn’t have two masters to serve (since Vanguard investors were also owners) made me think that it would always be the low-cost leader focused on smaller investors.
Today, however, competitors have lower cost products, including Fidelity Zero funds with a zero-expense ratio. You can even buy the lowest cost Vanguard ETFs at firms like Schwab and Fidelity for no cost (other than the bid-ask spread of ETFs). Further, Vanguard’s customer service is faltering along with its web and mobile apps.
What I failed to consider was the ability of other firms to cross subsidize between products. Much like HP can sell a printer below cost to have an income stream of selling ink with a huge margin, Vanguard competitors are doing the same. As the most vivid example, Schwab made about 119% of its pretax profit in the first quarter of this year from cash – paying investors little in its sweep account and using that cash to earn a market return.
5. Index funds will always be a small part of the fund industry. U.S. stock index funds now have more assets than active funds. Some predict overall passive indexing will overtake active funds by 2026. When I started my practice, I’d have bet heavily against this ever occurring.
I started indexing in the late 1980s (about 14 years after Jack Bogle launched the first S&P 500 fund) and those few I mentioned the strategy to felt it was awful. As recently as 20 years ago, when I started my practice, I had to explain to clients what an index fund was and why it was superior.
Though indexing goes against every human instinct, it is logically superior. Yet that logic is hard for humans to accept as our instincts usually drive our actions. I’ve never been so happy to be totally wrong.
Government and industry watchdogs
6. Tax rates will increase. You can’t keep printing money forever, I thought. I tell my clients that they have to live within their means and that eventually the U.S. government debt would require a large portion of our GDP to service that debt so taxes would have to increase, along with more controls on spending. Well, the U.S. debt rose five-fold from just over $6 trillion 20 years ago to over $30 trillion today.
Individual and corporate taxes declined while the federal estate tax exemption mushroomed. What was the source of my error? Thinking that logic and politics had anything in common.
7. Regulators protect the public. I thought the role of the regulator was to create a fair playing field between the industry and consumers. When I saw outrageous behavior, I was able to escalate my concerns to very high levels within the SEC and MSRB. Their response was to look the other way. The CFP Board, functioning as a licensor rather than a regulator, was exposed by the Wall Street Journal for its so-called higher standard. The Journal cited 6,300 advisors claiming to be scrubbed by the CFP board though they had regulator disclosures including criminal complaints. Rather than disciplining senior management, the CFP board of directors rewarded management with hefty raises while the organization took in more certificants and increased revenue. Getting regulators and the CFP Board to do what they claimed was their mission was my biggest failure.
Clients and prospects
8. People have a basic understanding of their financial fitness. Some people are savers while others are spenders. I thought it would be the spenders who would be so worried about retirement as they got older. Turns out those people who contacted me optimistic about retirement hardly saved a penny, while those pessimists who said they’d never be able to retire often already had more than enough to do it. In hindsight, my error was obvious; those who worried about running out of money saved, and spender optimists had the misplaced belief that things would take care of themselves.
9. Those who are passionate about rebalancing will follow through. While I don’t use risk-profile questionnaires, I do ask clients behavioral questions such as what they would do if their stock portfolio lost half its value. Almost everyone answers that they would buy more stocks to rebalance. Some are very confident, saying they would definitely buy more during a half-off sale, while others say they know it will be hard and hope they would have the courage to rebalance. In general, the latter did while the former didn’t and sometimes needed to be talked out of panicking and selling the rest. The latter imagined the pain and the consequences of such a bad market and the former didn’t.
10. The hourly model will never catch on. I started my practice as an hourly planner. My logic was that every profession was fee-for-service. I had the luxury of being financially independent when I did so (mostly due to a frugal lifestyle) and I’d likely have used the AUM model if it meant supporting my family. I even thought that hourly was best suited for the mass affluent rather than the very wealthy. I was wrong again.
In a “duh” moment, hourly scales better for wealthy clients. Late last year, Bob Veres wrote about the inescapable future of the hourly model. While he noted that barely more than 2% of advisors surveyed used hourly as their primary fee model, I was surprised it was that high. While I don’t think the percentage will increase to represent a majority in my lifetime, the hourly model is growing.
I’ve been wrong a lot. But I try to embrace my wrongness and learn from it. Though some of the things I’ve been wrong about proved to be a huge disappointment, others were a pleasant surprise.
Allan Roth is the founder of Wealth Logic, LLC, a Colorado-based fee-only registered investment advisory firm. He has been working in the investment world of corporate finance for over 25 years. Allan has served as corporate finance officer of two multi-billion-dollar companies and has consulted with many others while at McKinsey & Company.