Content provided by Case Eichenberger, CIMA, CLS Client Portfolio Manager
As I write this, markets are reaching new highs again in the U.S., which is great news for investors who were able to put emotions aside the last year and stay invested. Easier said than done.
At CLS, we routinely see clients trying to time the market. Unfortunately, it typically does not end well. Preventing this inevitable return gap (known as the behavior gap) and coaching clients to stay put in their portfolios is how financial advisors and CLS earn their fees. That said, advisors need coaching from time-to-time too. Yes, some advisors also like to try to time the market and are prone to the same emotions and behavioral biases as investors. CLS tries to prevent emotion-driven investing through an investment philosophy known as Risk Budgeting (RB).
A study I conducted on a CLS client and a CLS advisor, who we will call “John Smith,” illustrates the pitfalls of the behavior gap. John has the ability to alter Risk Budgets and move to cash for his clients. Recently, after the emotional fallout over Brexit, John moved some clients to cash. One of those clients’ investment experiences is shown below.
As you can see, the blue line (benchmark 70 RB*) ends much higher than the green line (client).
Here’s the experience of another client, who remained in a 70 RB portfolio.
The client (green line) was much better off by staying the course and letting the RB do its thing.
Below are total returns over the time period.
Behavior gap client:
The returns show a difference of approximately 5% that could continue to compound and grow over time.
I can’t stress enough the importance of good advice in the marketplace, and there has been no shortage of studies that show market timing does not add value. Investing is emotional, and we believe the Risk Budget is the best tool we have to enhance the investor experience and keep the client comfortable and invested. After all, isn’t that the goal of the Risk Budget in the first place? A client’s RB number represents a portfolio that he or she is comfortable with in all environments; it should not be used as a timing tool to move from one to the other.
Click here for a study from Envestnet that takes this anecdotal evidence to another level. I’m just showing one CLS account here, Envestnet examined thousands, and the result was the same. Tactical timing to cash and back is harmful to the client’s bottom line performance.
“Try to be more patient” is the best financial advice that no one wants to hear, like the doctor saying “eat better and go for a run.” — Morgan Housel