The Best Defense

It has been said that the best defense is a good offense, but that usually applies to sports, not investing. I thought about that after hearing about a broker’s pitch to her client. The saleswoman recommended that one way to claw back from the depths of losses is to buy more of the stuff that has dropped the most, which in this case was the financial sector. There was only one problem: the broker had suggested the same strategy starting last summer and every quarter since then.

The net result of the strategy was a decimated portfolio---a drop from $3,000,000 at the top to $1,000,000 as of June 30th. The client was distraught and needed to understand how the broker could have made advocated such a terrible strategy. (Note to all of the brokers out there: if the strategy had worked, the client would not have known just how bad the strategy really was---proving once again that it stinks to be wrong!)

I hate these stories—they are oddly reminiscent of the dot-com flame-out, when throughout 2000 and 2001, some brokers advocated “doubling down,” “taking advantage of sale prices,” or my least favorite, “just hanging in there.” These comments and the subsequent action or inaction taken simply compounded the original sin of advocating portfolios that were highly concentrated in risky assets or asset classes.

Yet after doing this for some time, I have come to believe that most of the brokers then or now are not actively trying to harm their clients. Sure, they may be trying to scratch out a living by selling a loaded mutual fund, but I think that they really do believe the strategies that they advocate. It’s just that they are a tad bit hopeful and succumb to the age-old problem of many in the retail investment business: they are overly optimistic because they really want to believe that all will be better. If conditions improve, clients stop calling and complaining and it’s easier to sell more stuff.

So what is a good defense when markets start to turn? The same exact core strategy that is created for a good offense when markets are rising: a diversified portfolio that is structured to be shifted as conditions change in the economy and the marketplace. By its very definition, this type of portfolio is better suited to a fee based on assets under management, rather than on commission. The reason is that as you shift the asset allocation here and there, you do not want to pay a commission.

Beyond the actual fees that you pay, there is a more important message here: nobody wants a salesperson to be a cheerleader for the market—we have CNBC and Jim Cramer for that. Retail investors are not asking their brokers to tell them what they want to hear, rather they are hoping for unbiased guidance that will allow them to earn money when the market rises and mitigate losses when it falls. When the industry wakes up to this fact, it just might stop getting caught up in market cycles. Interestingly enough, this might actually smooth out earnings for the big firms and make for happier clients over the long term. Imagine that? A win-win in an industry plagued by “heads we win, tails you lose.”