Barry Ritholtz: Building trust and coping with uncertainty
Through his columns, blog posts, and podcasts, Barry Ritholtz has the attention of thousands of investors and advisors, as well as access to some of the most notable names in business and finance. Ritholtz, the cofounder and chief investment officer of Ritholtz Wealth Management, a financial planning and asset management firm, is a columnist for Bloomberg and The Washington Post, hosts Bloomberg’s Masters in Business podcast, and blogs daily at The Big Picture. He’s also the author of the 2009 book Bailout Nation.
In a recent interview with Vanguard, Ritholtz discussed uncertainty in the markets, building trust with clients, and the biggest worry for retirees, among other topics.
In a world beset by uncertainty, how do we cope? How do we help ourselves sleep at night?
I love this question, because it’s so important. First, you’re right, the world is beset by terrible uncertainty today. However, it always has been and always will be that way. That’s the default setting. You have to start at that point, start by recognizing that simple truth, which can be very humbling.
Given this uncertainty, what do we tell ourselves, to allow us to sleep at night? Well, there are a few things. First, we really need to understand what is and is not within our control. Stressing out about the things that are out of your control is a total waste of time, effort and energy. Its psychologically denilitating, and is not how we should be using our finite amount of intellectual capacity and brain power. So, look, we can’t control if it’s going to rain tomorrow, but we can get up each morning, check the weather report, and decide whether to take an umbrella or not. That’s a better approach than stressing about the weather. It’s a simple form of risk manasgement.
The questions we hear all the time goes back to that uncertainty issue: What’s the Federal Reserve going to do? How many rate hikes this year? Where’s the Dow going to be in 12 months? What’s your favorite stock pick?
All those questions are things that you as an investor simply are not going to be able to answer with any degree of accuracy — its really a crapshoot. And so, rather than guessing, wasting a whole lot of psychological emotion and energy on it, why not just recognize—and, again, it’s with great humility—recognize what we do know and what we can’t know, what we cant know – and try to adjust accordingly. This leads quite naturally to a portfolio that is balanced and robust enough to withstand the regular market turmoil.
Over the past 20 years, how many market booms and busts have we seen? There was the dot-com boom and bust; the 2008–2009 financial crisis. There have been several 20% pullbacks over the past few years. That is simply the normal state of affairs for U.S. markets. Investors must understand that volatility is part of investing; if you leanr that truth about markets, it won’t surprise you when it finally arrives and it shouldn’t disrupt your sleep too much.
What would you say to a prospective client who asks about what an advisor can do, what the value proposition of an advisor is?
I would say three things: behavior, discipline, and education. Those are the three aspects that I think the average advisor can bring to the client. As we’ve seen over and over again, investors can be their own worst enemies. A number of studies show that not only do most investors underperform the market, they actually underperform their own investments. The only explanation for that is the behavioral aspect of what people are doing. Very often, a lot of that traces back to a lack of planning and a lack of discipline, which are really two sides to the same coin.
The second thing I think that advisors bring to the table for investors is a plan that helps them reach their various goals – and the discipline to follow through on it. If you’re saving for retirement, then what happens in 2017 is irrelevant to 10, 20, 30 years from now.
The third issue is education and the correction of misinformation. We live in an era of fake news, and we constantly hear questions from investors. There are pundits out there who every year make dire predictions about an imminent stock market crash. At a certain point, you have to say these guys are just jumping up and down for attention, and serious investors should ignore them.
There’s really a fourth thing: In our office, we call it organizational alpha. It’s all the little things you do that improve returns over time. It’s identifying the lowest cost holdings for each slot in your portfolio, it’s doing regular rebalancing, it’s doing tax-loss harvesting. All those little things add up. They’re not 10% a year, but they’re dozens of basis points. Compounded over time, that has a substantial impact on net returns.
All told, a good advisor doing all of these things more than makes up for whatever their fee structure is. And on the behavioral side, it is often by 100s of basis points – thats not a rounding error.
What do you think trust means to an investor, and how do you build trust as an advisor?
To an investor, trust means that they can rely on what you say, that you’re speaking about things you know about and have experience and a deep knowledge base from which to draw upon. That you’re not merely opining on subjects, which is an all too human tendency amongst people who have a perceived expertise, including the fear of saying “I don’t know.” Sharing hard-won wisdom and experience that others have found useful is a very good way to build trust.
Trust has to be earned and built up over time, and it’s a function of reputation and of experience. We never promise people we’re going to get everything exactly perfect, especially when we’re talking about the future. Part of it is understanding your own skill set, working within those skills, and not overpromising or trying to answer questions that you can’t. But, ultimately, it’s the nature of a relationship in which you’ve earned and demonstrated that you’re a trusted fiduciary, that you’re an important part of this person’s financial life, and that you’re worthy of their trust.
You build trust by providing value, by always making sure that you give the right information to people, that you never try to offer information that you can’t possibly know or will either be right or wrong.
I love the famous J.P. Morgan quote when he was in front of Congress. One of the senators asked him, “So where will the market be a year from now?” And his response was, “Markets will fluctuate.” That’s a fantastic answer as opposed to, “We’re looking for an 8% to 10% gain over the next 12 months,” which is either right or wrong. I would argue it’s wrong even if it’s right because you’re rolling the dice on something that you honestly have no answer to. Avoiding that sort of faux expertise is how you build trust.
What’s the biggest worry for people near retirement or in retirement?
The biggest issue we hear from clients the past few years is a concern with outliving their money. By the time many of our clients retire – we have a huge age range among clients but I would guess the median is mid-50s – by the time these folks retire, human life spans will be closer to 90 than to 70. People have to plan for much longer retirements. Some folks are having trouble wrapping their heads around it, but that’s the overall trend.
What’s a potential answer? Although the traditional 60/40 portfolio is lagging somewhat because of the ultra-low rate environment we’ve been in for the past decade, maintaining a fairly robust equity exposure that is global and intelligent in its construction really seems to be the best choice for most people. A conservative 50/50 model when you retire no longer makes a lot of sense.
We’ve seen active managers face a lot of questions and challenges in recent years. How do you think active management is going to evolve?
In any one year, 30%, 40%, even 50% of managers might beat their benchmark, but doing so consistently over time has proved quite elusive. That said, some people have demonstrated an ability, which is obvious after the fact, to select stocks or sectors or asset classes that have outperformed their benchmark.
If people want to take a percentage of their portfolio and put it in some form of active management, we don’t tell people that’s the worst idea, but we do want people to recognize the uphill challenge. Active managers tend to have much higher fees than passively managed index funds. Be aware of the effect of fees, the drag they put on returns.
I think the entire active space wildly overexpanded in the post war period. They pay big salaries, charge big fees, attract a lot of the best and brightest, and suddenly it’s really hard to beat the market because 10,000 other people are doing exactly what you’re doing. There just isn’t that much outperformance to go around.
Bottom line, the shift to indexing is far from over, but I also don’t think active management is going away.
Originally published at Vanguard, July 12, 2017