Financial advisers can do a lot of good.
They can stop you making stupid decisions. They can stop you panicking. They can pressure you to budget better, get the right insurance, make and stick to longer-term plans, and do important things like keeping an up-to-date will. At their best, they’re both a trusted counselor and a personal trainer. Yes, they can also help you with investing.
But only up to a point.
Earlier in my career I took a series of postgraduate finance courses at several U.S. colleges, of the kind that is standard for most of the qualified financial planners working today. I was partly interested in what I would learn about finance. But I was also interested in what I would learn about planning and about planners. The industry is a key factor in moving markets.
The good news: Financial planners are all taught sound financial theory based roughly upon something called the Efficient Market Hypothesis and something else called the Capital Asset Pricing Model.
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The bad news? They are all taught financial theory based roughly upon the Efficient Market Hypothesis and the Capital Asset Pricing Model.
To put it simplistically, your planner has been taught that it is impossible, or next to impossible, to beat the stock indexes because stock prices are so good at reflecting all the fundamentals. And, also putting it simplistically, he or she has been taught that history tells you the likely returns and risks from each asset class, and that the “riskier” the asset the higher the return.
Sounds good, right?
Well, yes, OK. It’s not crazy and it mostly works most of the time.
But as the Dow Jones Industrial Average DJIA, +0.70% takes a roller coaster ride these last few months, and you dial up your financial adviser for some calming words, here are 10 things he or she didn’t learn in school and may have trouble explaining.
1. If stock prices reflect fundamentals so well, why are they so volatile? Why did the S&P SPX, +0.64% index double between 1995 and 1998, and again between 2010 and 2014, and halve between 2000 and 2002, and again from 2007 to 2009? Did the true, underlying value of U.S. industry really double, halve, double and then halve again during those short periods?
2. U.S. stocks sport a notably higher “average historic return” today than they did nine years ago, as well as notably lower historic volatility. That’s because during that time the S&P 500 has trebled in price. Does this mean stocks today are a more attractive investment, at three times the price, than they were then?
3. If you can’t beat the market, how did Berkshire Hathaway’s BRK.A, -1.92% BRK.B, -1.67% Warren Buffett do it? What about Sir John Templeton? Julian Robertson? George Soros?
4. Does gold have a value? If so, why? If not, why is it trading at $1,200 an ounce?
Also see: How investment apps coach their customers through a volatile market
5. The U.S. accounts for less than a third of the global economy. So why should I have most of my stock portfolio in U.S. stocks? On what basis do you believe stocks in countries like Britain, Germany, Japan, Australia or Singapore are “riskier” than the U.S.?
6. Why are emerging market bonds considered to be “riskier” than, say, high yield U.S. debt, even though U.S. corporations have defaulted at similar or even higher rates?
7. If U.S. Treasury bonds are “low return,” why have they produced much better returns than stocks during several long periods, including from 2000 through 2015? And if they are also are “low risk,” why did their owners actually lose money in real terms during most of the 1960s and 1970s?
8. Should we expect similar annual returns from 10-year Treasuries today, when they yield 3.1%, as people got in the past, when 10-year Treasuries yielded 6% or 10% or even more? If so, how? If not, how useful is their historic return and risk data?
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