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Choose wisely with use of investment advisor vs doing it yourself
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This is the first of a three-part series on how an orthopedic surgeon will get investment advice during his or her lifetime. This article focuses on the decision to use a professional advisor. In the second installment, we will discuss the one fundamental issue orthopedic surgeons must understand when choosing an investment advisor. The final article will outline the various types of financial advisors and describe the pros and cons of each type.
Young orthopedic surgeons will wonder whether they need an investment advisor. The answer differs based on the individual and his or her situation. While some orthopedists are capable and savvy with their own investing, data show most investors are often better off using the services of an investment advisor as opposed to managing their investments alone.
Why do investors, including orthopedic surgeons, sometimes do so poorly on their own? You may have heard of the impact of greed and fear on investing — getting overly optimistic when the market goes up, assuming it will continue to do so and wanting to be in on the action (greed) and then becoming pessimistic during downturns and wanting out before losing everything (fear).
Investing mistakes affect performance
A 2010 report that the Securities and Exchange Commission Office of Investor Education and Advocacy requested that The United States Library of Congress Federal Research Division prepare on the behavioral traits of U.S. retail investors identified nine common investing mistakes that affect investment performance were identified. They were active trading, disposition effect, paying more attention to the past returns of funds than to fees, familiarity bias, mania/panic, noise trading, momentum investing, under-diversification and naïve diversification.
Active trading is the practice of engaging in regular, ongoing buying and selling of investments while monitoring pricing in hopes of timing the activity to take advantage of market conditions.
Disposition effect is the tendency of retail investors to hold losing investments too long and subsequently sell winning investments too soon.
Paying more attention to the past returns of funds than to fees is when investors, including physicians, give too much credence to the past performance of funds and virtually ignore the funds’ transactional costs, expense ratios and fees.
Familiarity bias is the tendency of investors to gravitate toward investment opportunities that are familiar to them.
Mania is the sudden increase in value of a “hot” investment wherein the masses rush to get in on the action. Panic is the inverse, where investors try to abandon an investment which is performing poorly in the short term.
Noise trading may occur when the investor decides to take action without engaging in fundamental analysis. When investors follow the daily headlines too closely and succumb to false signals and short-term volatility, their portfolios suffer.
Momentum investing is the practice of buying securities with recent high returns and selling securities with low recent returns, which assumes past trends and performance will continue.
Under-diversification occurs when the investor becomes too heavily concentrated in a specific type of investment.
Naïve diversification is when an investor decides to diversify between several investments in equal proportions rather than in strategic proportions.
By the numbers
Studies demonstrate the degree to which retail investors underperform indices. According to one such study, DALBAR’s 2018 Quantitative Analysis of Investor Behavior, the average equity mutual fund investor underperformed the Standard & Poor’s 500 index by a margin of 5.04%. While the broader market experienced losses of -4.38%, the average equity investor was down -9.42%. In 2018, the 20-year annualized S&P 500 return was 5.62% while the 20-year annualized return for the average equity investor was only 3.88%, which was a gap of 1.74% annualized.
Other studies show retail investors underperform the very funds they have chosen because of greed and fear behavior. For example, Morningstar monitored mutual fund investors’ cash flow for 10 years. It used investor returns to determine how the average investor fared during the decade. From 2000 to 2009, the total return for the average investor in all funds was 1.68% compared with 3.18% for the average fund itself. Morningstar determined most investors read too much into recent performance (bias) and let fear and greed influence their decisions, making bad situations worse.
Use of a professional advisor
How and why do investment advisors make a difference? Theoretically, no one has a greater interest than you in protecting and looking after your investments. However, this same interest in protecting and looking after your investments may be the single greatest factor working against your investment performance, per the aforementioned studies. The reasoning is the same as what prompted Abraham Lincoln to declare about attorneys, “He who represents himself has a fool for a client.”
Several studies quantify the value professional advisors bring to their clients. Two such studies, from Vanguard and Morningstar, examined the financial management of clients with vs. without professional advice and looked at a myriad of planning factors. The Vanguard study estimated advisors can potentially add 3% in net returns, calculated retroactively on an annual basis. The Morningstar study concluded an investor could expect an annual return increase of 1.59% by using an advisor.
Beyond these studies, the important point for orthopedic surgeons to consider is advisors do not exist strictly to pick the best stock, mutual fund or exchange traded fund or to simply forecast economic conditions and make tactical decisions in a portfolio. Although those activities and others are important components of investment advice, an advisor should also act as a buffer who puts space between you and your investments to take some of the emotion out of investment decisions. For most orthopedists, this component alone will prove valuable during a lifetime of investing, especially in the most stressful times.
Conclusion
Although some orthopedists may have the acumen, discipline and time to invest their hard-earned savings without the help of a professional, data show many orthopedists, especially those with limited time, will benefit from consulting an advisor. In the next article, we will explore the number one issue orthopedic surgeons should understand when choosing an investment professional.
- References:
- http://corporate.morningstar.com/ib/documents/PublishedResearch/AlphaBetaandNowGamma.pdf. Morningstar Investment Management. Accessed June 29, 2019.
- Wealth Protection Planning for Orthopaedic Surgeons or Wealth Management Made Simple are available free in print or by e-book download by texting OT19 to 555-888 or at www.ojmbookstore.com. Enter code OT19 at checkout.
- www.morningstar.com/articles/325664/bad-timing-eats-away -at-investor returns.html. Accessed July 8, 2019.
- www.QAIB.com.
- www.vangulard.com/pdf/ISGQVAA.pdf. Putting a value on your value: Quantifying Vanguard Advisor’s Alpha; (September 2016) Vanguard Research. Accessed June 28, 2019.
- For more information:
- Sanjeev Bhatia, MD, is an orthopedic sports medicine surgeon at Northwestern Medicine in Warrenville, Illinois. He can be reached at email: sanjeevbhatia1@gmail.com.
- David B. Mandell, JD, MBA, is an attorney and founder of the wealth management firm OJM Group www.ojmgroup.com. You should seek professional tax and legal advice before implementing any strategy discussed herein. He can be reached at mandell@ojmgroup.com or 877-656-4362.
Disclosures: Bhatia and Mandell report no relevant financial disclosures.