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Trust Me, Trust is the Key

I pity investors. Especially those looking to start a new relationship with someone to advise them on their wealth. That’s tough.

Any healthy, long-term committed relationship must be built on trust. But how is trust cultivated? Slowly, over time. So right off the bat, when someone begins working with a financial advisor, there is a lack of trust.

Not distrust – that’s not it at all. After all, if there was distrust, the investor would have never decided to work with the advisor in the first place. Instead, it’s more like a weighty hope that their instinct to place trust with the advisor – with their life savings! – was not a foolish decision.

What makes it even harder is that not only does trust take time to develop, but investment strategies can too. I have met clients who thought one year is a sufficient timeframe by which to judge investment skill. It’s not. Neither is three years or even five years. Believe it or not, there have been 10-year timeframes where that could be true.

That may seem like a hedge, especially coming from a financial advisor. I can imagine people thinking, “Sure – of course you would say that. That gives you an out. You just don’t want your feet held to the fire.”

And I appreciate that sentiment. After all, people work with an advisor to help them make money. If the advisor’s strategies and investments yield ho-hum results, then why pay them?

But it’s not always that simple.

Here’s a thought exercise to consider. Pretend you had two investment accounts managed by two different advisors. Over a ten-year timeframe, Account A retuned 12% a year, while Account B returned 11% a year. All else is equal. Everyone would choose Account A, right? But what if Account A lagged Account B for the first five years by 3% a year? Based on my experience, many investors would have bailed on Account A before it ever had a chance to shine. “Account A is a dog, and the advisor is clueless,” you might tell yourself.

When it comes to investing, the eternal question is, “Does the strategy just need more time or was it a bad strategy from the start?”

Investment securities are not trained actors. They do not perform on cue. Sometimes they don’t perform for years at a time. That’s more normal than people realize.

For example, small publicly traded companies in the U.S. have returned more than large publicly traded companies in the U.S. Here are the figures: From 1929 through 2019, small companies have returned an average of 11.9% a year and large companies 10.2%. But the outperformance of small companies didn’t happen every year. Small company stocks underperformed large company stocks in 44% of all one-year periods since 1929, 38% of all five-year periods, and 28% of all ten-year periods.

So while small companies outperformed large companies by 1.7 percentage points since 1929, they failed to do so on a good number of rolling 10-year timeframes. If your advisor tilted your portfolio towards small company stocks during those periods of underperformance, they may have looked like a dud of an investment advisor. In fairness, your window of judging performance may have simply been too narrow.

The investment fund company Vanguard conducted a study recently on how long certain investment strategies can underperform. Their findings compelled them to draw the following conclusion.

“As with most things in life, success in investing requires patience; investing, in fact, probably requires more patience than most endeavors. You need patience when what you are invested in is performing poorly — and you need it when what you haven’t invested in is performing well.”

Nothing tests trust like an investment strategy underperforming for 10 years. But sometimes that’s what it takes. Trust is the key.

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