The Obvious Follow-Up Question

In the wake of the 2008-2009 mega-crisis, one of the most common responses on the part of all financial advisors and investors – myself included – was to take a great interest in strategies, products and managers that managed to avoid the drawdown. This is rational behavior. Something terrible happened, surely there must have been a solution that would have helped you avoid it – or could help you avoid it down the road.

All manner of money then poured into hedge funds, “black swan” funds, managed futures funds and all other manner of alternatives. Massive fees and relatively short track records were overlooked in the pursuit of perceived “safety” – again, this is also natural, normal behavior. After something traumatic takes place, you’ll pay almost any price to be protected from it again and you’ll ignore a lot of flaws when your savior arrives.

And now, I’ll share with you a ridiculous quote from a new Investment News feature on alternatives that illustrates one of the biggest traps that investors fall into. Here’s a financial advisor who says that his typical client portfolio includes a 30-35% allocation to alternatives:

“In 2008, when the S&P 500 lost 38%, my average portfolio went down 4% because I had alternatives in there,” he added. “It is mathematically impossible to have a properly allocated portfolio without using alternatives.”

Sounds great on the surface (regardless of the fact that it’s pretty odd to see a registered person making a performance claim like this in a public forum – hope that’s audited, pal).

But then there’s the obvious follow-up question, the question that should always be asked in the presence of a claim like this:

“Okay, minus 4% in 2008 sounds great – how did things go in the following year?” How about over the next 36 months? How much of the S&P 500’s incredible double, and subsequent triple, did you then leave on the table, as a consequence of this?”

Believe it or not, most investors aren’t equipped with the knowledge in order to come up with this follow-up question, in my experience. The realization that there is a price to pay is a painful one, and it comes on slowly as markets recover without you.

Unfortunately, many people rushed whole-hog out of the frying pan and into the fire. The solutions they ran toward carried pitfalls of their own. Insult has been added to injury – losses were compounded by lack of gains as alternatives have failed spectacularly to enable their shareholders to benefit from the market’s comeback.

The lessons:

Sometimes the cure can be just as bad as the sickness

Insurance has a cost, sometimes a higher cost than seems apparent upon purchase

Arranging an entire portfolio for once-in-a-lifetime market events, as though they are a commonplace occurrence, is severely detrimental

The continuing conflation of “risk” with “volatility” will claim new victims during every bear market

Investors without an overarching investment philosophy will be most susceptible

After the next big negative event for stocks or bonds, will you be keeping these lessons in mind?

 

 

This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment.

The commentary in this “post” (including any related blog, podcasts, videos, and social media) reflects the personal opinions, viewpoints, and analyses of the Ritholtz Wealth Management employees providing such comments, and should not be regarded the views of Ritholtz Wealth Management LLC. or its respective affiliates or as a description of advisory services provided by Ritholtz Wealth Management or performance returns of any Ritholtz Wealth Management Investments client.

References to any securities or digital assets, or performance data, are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

Wealthcast Media, an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. Investments in securities involve the risk of loss. For additional advertisement disclaimers see here: https://www.ritholtzwealth.com/advertising-disclaimers

Please see disclosures here.

What's been said:

Discussions found on the web
  1. scotiabank online banking login commented on Jan 17

    … [Trackback]

    […] Read More to that Topic: thereformedbroker.com/2016/10/10/the-obvious-follow-up-question/ […]

  2. Milescraft 12130713 manuals commented on Jan 19

    … [Trackback]

    […] Find More Info here to that Topic: thereformedbroker.com/2016/10/10/the-obvious-follow-up-question/ […]

  3. Epson TW100 manuals commented on Jan 22

    … [Trackback]

    […] Information on that Topic: thereformedbroker.com/2016/10/10/the-obvious-follow-up-question/ […]