THE EVIDENCE PRESENTED IN Chapters 10 and 11 teaches two lessons: (1) Selecting winning equity funds over the long term offers all the potential success of finding a needle in a haystack. (2) Selecting winning funds based on their performance over relatively short-term periods in the past is all too likely to lead, if not to disaster, at least to disappointment.

So why not abandon these “do-it-yourself” approaches, and rely on professional advice? Pick a financial consultant (the designation usually given to the stockbrokers of Wall Street, and indeed brokers everywhere); or a registered investment adviser (RIA, the designation usually applied to nonbrokers, who often—but not always—work on a “fee-only” basis rather than on a commission basis); or even an insurance agent offering investment “products” such as variable annuities. (Beware!)

Registered investment advisers (RIAs) can play a vital role in providing investors with assistance.

In this chapter, I’ll attempt to answer the question about the value of investment consultants. You’ll note that I’m skeptical of the ability of advisers as a group to help you select equity funds that can produce superior returns for your portfolio. (Some do. Most do not.)

Professional investment advisers are best at providing other valuable services, including asset allocation guidance, information on tax considerations, and advice on how much to save while you work and how much to spend when you retire. Further, most advisers are always there to consult with you about the financial markets.

Advisers can encourage you to prepare for the future. They can help you deal with many extra-investment decisions that have investment implications (for example, when you want to build a fund for your children’s college education or need to raise cash for the purchase of a home). Experienced advisers can help you avoid the potholes along the investment highway. (Put more grossly, they can help you to avoid making such dumb mistakes as chasing past performance, or trying to time the market, or ignoring fund costs.) At their best, these important services can enhance the implementation of your investment program and improve your returns.

A large majority of investors rely on brokers or advisers for help in penetrating the dense fog of complexity that, for better or worse, permeates our financial system. If the generally accepted estimate that some 70 percent of the 55 million American families who invest in mutual funds do so through intermediaries is correct, then about 15 million families choose the “do-it-yourself” road. The remaining 40 million families rely on professional helpers for investment decision making. (That’s essentially the unsuccessful strategy described in my opening parable about the Gotrocks family’s Helpers.)

Helpers—adding value or subtracting value?

We’ll never know exactly how much value is added—or subtracted—by these Helpers in selecting mutual funds for your portfolio. But it’s hard for me to imagine that as a group they are other than, well, average (before their fees are taken into account). That is, their advice on equity fund selection produces returns for their clients that are probably not measurably different from those of the average fund, and therefore several percentage points per year behind the stock market, as measured by the S&P 500 Index. (See Chapter 4.)

However, I’m willing to consider the possibility that the fund selections recommended by investment advisers (RIAs and brokers) may be better than average. As I explained in Chapter 5, if they merely select funds with the lowest all-in costs—hardly rocket science—they’ll do better for you. If they’re savvy enough to realize that high-turnover funds are tax-inefficient, they’ll pick up important additional savings for you in transaction costs and taxes. If you put those two policies together and emphasize low-cost index funds—as so many advisers do—so much the better for the client.

If you can avoid jumping on the bandwagon . . .

And if professional investment consultants are wise enough—or lucky enough—to keep their clients from jumping on the latest and hottest bandwagon (for example, the tech-stock craze of the late 1990s, reflected in the mania for funds investing in “new economy” stocks), their clients may earn returns that easily surpass the disappointing returns achieved by fund investors as a group. Remember the additional shortfall of about one and one-half percentage points per year relative to the average equity fund that we estimated in Chapter 7? To remind you, the average nominal investor return came to just 6.3 percent per year during 1991–2016, despite a strong stock market in which a simple S&P 500 Index fund earned an annual return of 9.1 percent.

Alas (from the standpoint of the advisers), there is simply no evidence that the fund selection advice RIAs and brokers provide has produced any better returns than those achieved by fund investors on average. In fact, the evidence goes the other way. A study by a research team led by two Harvard Business School professors concluded that between 1996 and 2002, “the underperformance of broker-channel funds (funds managed by the salesman’s employer) relative to funds sold through the direct channel (purchased directly by investors) cost investors approximately $9 billion per year.”

Average annual return of funds recommended by advisers: 2.9 percent. For equity funds purchased directly: 6.6 percent.

Specifically, the study found that broker and adviser asset allocations were no better, that they chased market trends, and that the investors they advised paid higher up-front charges. The study’s conclusion: The weighted average return of equity funds held by investors who relied on advisers (excluding all charges paid up front or at the time of redemption) averaged just 2.9 percent per year, compared with 6.6 percent earned by investors who took charge of their own affairs.

This powerful evidence, however, does not bring the researchers to the clear conclusion that advice in its totality has negative value: “We remain,” the report states, “open to the possibility that substantial intangible benefits exist, and will undertake more research to identify these intangible benefits and explore the elite group of advisers who do improve the welfare of households who trust them.”

The Merrill Lynch debacle: a case study.

There is even more powerful evidence that the use of stockbrokers (as distinct from RIAs) has a strong negative impact on the returns earned by fund investors. In a study prepared for Fidelity Investments covering the 10-year period 1994 to 2003 inclusive, broker-managed funds had the lowest ratings relative to their peers of any group of funds. (The other groups included funds operated by privately owned managers, by publicly owned managers, by managers owned by financial conglomerates, and by bank managers.)

In the Fidelity study, the Merrill Lynch funds were 18 percentage points (!) below the fund industry average. The Goldman Sachs and Morgan Stanley funds were 9 percentage points below average. Both the Wells Fargo and Smith Barney funds were 8 percentage points behind in terms of 10-year returns.

Part of the reason for this performance failure may arise from the nature of the job. The brokerage firm and its brokers/financial consultants must sell something every single day. If they don’t they won’t survive. When a brokerage firm introduces a new fund, the brokers have to sell it to someone. (Imagine a day when nobody sold anything, and the stock market lay fallow, silent all day long.)

Two terrible ideas: the Focus Twenty fund and the Internet Strategies fund.

This powerful example illustrates the Merrill Lynch debacle, a shocking example of the destructive challenges that may be faced by investors who rely on stockbrokers. In March 2000, just as the bubble created by the Internet stock craze reached its peak, Merrill Lynch, the world’s largest stock brokerage firm, jumped on the bandwagon with two new funds to sell. One was a “Focus Twenty” fund (based on the then-popular theory that if a manager’s 100 favorite stocks were good, surely his 20 favorites would be even better). The other was an “Internet Strategies” fund.

The public offering of the two funds was an incredible success. Merrill’s brokers pulled in $2.0 billion from their trusting (or was it performance chasing?) clients, $0.9 billion in Focus Twenty, and $1.1 billion in Internet Strategies.

A marketing success for Merrill Lynch, an investment failure for its clients.

The subsequent returns of the funds, however, were an incredible failure. (This was not surprising. The best time to sell a new fund to investors—when it’s hot—is often the worst time to buy it.) Internet Strategies tanked almost immediately. Its asset value dropped 61 percent during the remainder of 2000 and another 62 percent by October 2001. The total loss for the period was a cool 86 percent.

Most of the fund’s investors cashed out their shares at staggering losses. When the fund’s original $1.1 billion of assets had plummeted to just $128 million, Merrill decided to kill Internet Strategies and give it a decent burial, merging it with another Merrill fund. (Keeping a record like that alive would have been a continuing embarrassment to the firm.)

Investment disaster: Clients lose 80 percent of their assets.

For what it’s worth, the losses in Focus Twenty were less severe. Its asset value declined 28 percent in the remainder of 2000, another 70 percent in 2001, and another 39 percent in 2002, before finally posting positive returns in the three years that followed. On balance, its cumulative lifetime return through late 2006 came to minus 79 percent. Investors have regularly withdrawn their capital, and the fund’s assets, which had reached almost $1.5 billion in 2000, currently languish at $82 million, a 95 percent decline. Unlike its Internet Strategies cousin, Focus Twenty soldiers on, now known as BlackRock Focus Growth. The lesson remains: The $2 billion marketing success of the Merrill Lynch Internet Strategies fund and Focus Twenty fund resulted in an investment disaster for Merrill’s clients, who lost some 80 percent of their hard-earned savings.

The value of financial consultants.

Despite their disappointing results (as a group) and that example of colossal failure by brokerage firm Merrill Lynch, RIAs can add value to investors in many other ways. I endorse the idea that for many—indeed, most—investors, financial advisers may provide valuable services in helping to give you peace of mind; in helping you establish a sensible portfolio that matches your appetite for reward and your tolerance for risk; in helping you deal with the complexities, nuances, and tax implications of investing in mutual funds; and in helping you stay the course in troubled seas. But the evidence I’ve presented so far strongly confirms my original hypothesis that, as vital as those services may be, advisers as a group cannot be credibly relied upon to add value by selecting funds that will beat the market.

The rise of the robo-adviser.

In recent years, a new method of providing advice to investors has developed. A number of new firms have taken advantage of record-keeping technology and offered computerized “robo-advice” directly to investors, often with little or no face-to-face interaction.

These firms claim the advantage of tax-loss harvesting, but otherwise generally have recommended buy-and-hold portfolios with asset allocation among bond and stock index funds. They typically focus on exchange-traded index funds, with their ready liquidity and absence of limits on frequent transactions often imposed by fund managers.

The growth of robo-advisers has been rapid. In 2017, the two pioneering robo-advisers report about $10 billion of client assets under management. But so far robo-advisers represent only a tiny fraction of total investor assets served by RIAs. With annual fees that are extremely low (often around 0.25 percent), they may well become a significant participant in the field of advice going forward.

Simplicity beats complexity.

Despite being dated or anecdotal, the evidence in this chapter is an eye-opener to the challenge faced by complex investment strategies. In all, this evidence suggests that, yet again, the simplicity of a broad-market, low-cost index fund, bought and then held forever, is likely to be the optimal strategy for the vast majority of investors.

If you are considering the selection of an RIA, a stockbroker, or an insurance agent to provide you with investment advice, please take heed of these findings. If you decide to go ahead, make sure you are paying a fair fee, for fees paid to advisers result in a significant deduction from whatever rate of return your fund portfolio earns. Since most investment advisory fees tend to begin in the range of 1 percent per year and then scale down, be sure to balance the worth of the peripheral services that advisers provide against the reduction in your returns that those fees are likely to represent over time. Finally—and this will hardly surprise you—look with particular favor on advisers who recommend stock and bond index funds in their model portfolios.

The fiduciary standard.

I close this chapter with good news for clients who rely on professional advice in selecting and managing their mutual fund portfolios. There is a developing trend toward establishing a federal standard of fiduciary duty for advisers. This means, simply put, that advisers are required to place your interests first. The standard approved in 2016 by the Department of Labor would apply only to firms and persons offering retirement plans to investors, such as individual retirement accounts (IRAs), 401(k) thrift plans, and 403(b) thrift plans. RIAs are already held to a fiduciary standard for all of their clients under existing law, but the application of the standard to stockbrokers and insurance agents represents a major extension to the principle, “put the client first.”

Ultimately the new standard must be expanded to encompass not only retirement plans but all accounts of all clients. Yet even now, a partisan political move is afoot to dilute or eliminate the existing standard, set to become effective in 2017. But the reality is that, even if the present proposal ultimately fails, the principle of fiduciary duty—of putting the client first—will prevail. The arc of investment is long, but it bends toward fiduciary duty.