Do Financial Advisors beat the Market ?

The short answer is, no, Financial Advisors can’t beat the market and in fact, you have a much higher probability at beating the market (and almost all professional advisors, not just financial advisors) if you learn How to Invest in the Stock Market. However, This is the wrong question to ask. It is common for people to confuse Financial Advisors with other professionals in the financial world who are actually in the job of managing a client’s investment portfolio. Let’s see what The Financial Industry Regulatory Authority (FINRA) says on their website about Financial Advisors:

The term financial advisor is a generic term that usually refers to a broker (or, to use the technical term, a registered representative)”.

So that begs two questions, what is a Broker and what is a Registered Representative? Again, from FINRA:

A broker-dealer is a person or company that is in the business of buying and selling securities […] on behalf of its customers (as broker), for its own account (as dealer), or both. Individuals who work for broker-dealers—the sales personnel whom most people call brokers—are technically known as registered representatives.”

In other words, a Financial Advisor is a salesperson who works for the Broker. What are they selling to people? Stocks, Mutual Funds, Bonds, etc.

Therefore, asking the question “Do Financial Advisors beat the Market” is the wrong question to ask because a Financial Advisor’s job function is that of a salesperson and not the job function of investing and managing/monitoring the investments for each of their clients. A person with those functions would be an Investment manager.

If an investor buys a Security (i.e. Stock, Mutual Fund, Bond, etc) from a Financial Advisor, the financial advisor would recommend a type of security to the investor that is suitable for the investor at that time. The investor would then pay a commission to the Financial Advisor (for example, he may pay 4% commission when buying a mutual fund). Then, it is up to the investor to determine when to sell those securities. Sometimes the Financial Advisor would suggest the investor buy other securities (and pay another commission) which by default would require the investor to sell his other holdings to have the cash available for the new investment.

A better question to Ask

Actually, a better question to ask would need to be asked with two separate questions:

  • Do Investment Managers Beat the Stock Market?

An investment manager would determine what to buy/sell, when to buy/sell, how much to buy/sell, and price to buy/sell, on behalf of the client. So there wouldn’t be the need for the investor to call the Investment Manager to tell him what to sell or buy because the manager would be in charge of making those decisions. Obviously, the investor is not really qualified to make decisions on when/what to buy/sell so it makes sense that job function would be delegated to an investment manager. If you’re an investor who knows what you’re doing, then there’s no need to be looking at investment managers or mutual funds for that matter.

As always, the client can still call and ask for portfolio positions to be liquidated. The Investment Manager doesn’t get commissions for selling any products because his job is Only to manage the portfolio and his compensation is a fee based on annual percentage of assets under management. Some believe that because the investment manager doesn’t get commissions then he is more likely to be free of the conflict of interest that could exist if he were to receive commissions (for example, he might be inclined to sell products, such as mutual funds, that pay the highest commissions).

So now to the question, do Investment Managers Beat the market? The answer is Yes and No. That takes us to answering question number 2.

  • Which Investment Managers Beat the Stock Market?

One thing to realize is that investment managers are people. Think about any professional athlete, say professional football players: most are very Good compared to the general public but within the NFL there are Great, good, and terrible players. The same can be said about investment managers or any other person within their profession so one cannot make blanket statements.

Since the knowledge and skills of investment managers is superior to that of the retail investor then in theory, many investment managers should be able to beat the market but we believe because of the nature of certain portfolios they manage the odds are against them and sometimes their hands are tied.

The biggest example of inability to beat the market is investment managers of Mutual Funds. While some mutual fund managers are successful, the vast majority does worst than the general market. The table above shows that it doesn’t really matter if the investment strategy is large cap, small cap, mid cap, etc. The vast majority of the mutual funds will not even reach the performance of the market. The market is an average of all stocks within a index so, not even reaching the performance of the overall market means the performance is below average.

For example let’s look at All-Large Cap funds, which benchmark is the S&P 500. Almost 87% in the last 5 years did Worse than the Market. Imagine investing money into a fund and realizing there’s only a 13% chance of having a performance that is better than average.

There are various reasons why Mutual Funds have such a hard time beating the market, these reasons are further discussed in our article entitle Mutual Funds: Double Edged Swords.

Another problem is picking too few stocks without proper diversification; We are of the opinion that having anything less than 15 stocks in one or two sectors of the economy almost guarantees you will consistently Not beat the market. This problem might happen if the manager is managing a portfolio that is too small.

And finally, there’s one more reason in our opinion that an investor might still not do better than the market even when employing a fully able and capable investment Manager, and that is because of Client (investor) suitability. An investor must be willing to take on more risk over the short period to be able to beat the market over the long term. Most investors are Risk averse thus preventing them to maximize profits. An excellent article is How To lose Money in the Stock Market: Top 6 ways investors sabotage their Investments.

If an investment manager has more flexibility, that is, if he’s not limited by the points discussed above, then he will have a better chance of beating the market or at least do just as good, and doing just as good, would put him ahead of roughly 80-90% of all mutual funds.

Senator, You’re No Jack Kennedy

Everybody knows World Famous Investor Warren Buffett has made Billions of Dollars in the Stock market, putting him consistently among the top 5 Wealthiest men in the World. Almost Nobody, including us, can claim to be “Warren Buffets” unless we have the Billions to prove it. Fair enough.

But learning from the Maestro, we see that Mr. Buffett is a passive investor most of the time and, the few times he’s active, it’s usually the times that make him even richer. If you follow his investments and the things he says, you’ll see he consistently invests in relation with the Economic Cycle. In 1974, when the market had lost a ton of value, he famously said:

Now is the time to invest and get rich.

In 2008, once again, deep into a Recession, when the market had tanked so low people had lost all hope and “everybody” was getting out of the market, he said:

You want to be greedy when others are fearful. You want to be fearful when others are greedy. It’s that simple

In other words, he believes in a philosophy that we also believe in, which is, be passive, but at the right time, you’re going to have to be active either in a defensive way (“fearful”) or offensive way (“Greedy”), depending on the situation. For more on this, please visit our page When is a Good time to be in the Stock Market.

Beating the market is difficult and cannot be done year after year. But, in the long term, with patience, the right suitability, discipline, and consistency, matching or beating the overall market returns is possible.

This website contains only general information, which must not be construed as specific advice or recommendations

Leave a Reply

Your email address will not be published.