I've been talking with some other advisers lately and getting into the weeds on best practices, hopefully, practices that serve both the business and the client. The two shouldn't be at odds, an adviser can't have a business without clients and they aren't doing their clients any favors by going out of business. And if an adviser is doing his clients a favor by going out of business, then he shouldn't be in business anyway.
During these talks, the subject of change has come up, and this can be a big problem for both advisers and investors. At the end of the day, people are people and a lot of the axioms of investing are pretty rock solid throughout the decades. But, also, the democracy of data and speed at which we have access to it has certainly made its mark. Some strategies that worked for prior generations don't work as well now. Or it could be that the strategy is undergoing a typical period of poor performance, which is pretty much inevitable. So, during the down periods, investors are constantly wondering if they should just right the storm out, or if something about the markets has permanently changed. Or maybe, the markets haven't changed, but the investor is simply wondering if his initial assumptions had any merit at all.
The question is "when should we change our minds?" As this blog says, "the graveyard of investors is filled with people who refused to change their mind." True, we may know the guy who is still waiting for the whole internet fad to play itself out, but we also probably know someone who sold in 2008, who may well mostly still be in cash, missing out in very real gains. Flexibility is great, spinelessness is not.
Maybe one of the better ways to think about this is to look at one of the lions of modern finance, Eugene Fama. He made his hay off of the Efficient Markets Hypothesis, which basically said that stocks are all priced correctly, so don't bother trying to beat the market. He later modified his views into the Three Factor Model (developed with colleague Kenneth French), which said that a stocks return could be attributed to overall market return, the size of company, and price-to-book ratio (or value, as in "is this stock cheap?"). It was later expanded to the Five Factor Model by adding profitability and what they call an "investment factor". Defining those isn't important right now. The fact that they modified their opinion is. Also, in the midst of this, Fama and French also came to the uncomfortable (for them) conclusion that momentum (a stock's recent movement) exists, as well. Although, how much merit they place in it is still up for debate.
It's also important to note that to Fama, this isn't merely an academic.question. He also serves as consultant, board member and thought leader for Dimensional Fund Advisers, so real money is on the line here. What he does and says has consequences. He's got every reason to remain entrenched in a position, but he still is curious and intellectually honest enough to modify his beliefs. Furthermore, the fact that he has made past adjustments isn't getting in the way of his acting on his current ideas, and making money for himself and others in the process.
Part of the difference between what people like Fama and French are doing and what the average investor is doing is familiarity with the data. For most, the only feedback they get with regard to investing is their current return. Not to sound like Johnny Cochran, but, if it's bad, they get mad. Then, they change things up at the worst possible time, a fool's errand when investing virtually assures that even the best strategies will give us a pretense to be dissatisfied at one point or another.
Performance alone, or lack of it, isn't a good enough reason to change course. Investors need to look for the reasons behind the performance-the explanatory factors-in order to determine whether a change is warranted. Results are important, but they don't tell the whole story. At any given time, investing results could be bad. That's life. That isn't a reason for massive change any more than a passing mood is. In the same vein, the 2-3 days a month we generally spend in a depressed state isn't a reason sell the house, quit the job and follow Widespread Panic on the road.
Advisers need to be on guard for this as well. My general rule has been to make changes slowly, although I hope this doesn't prevent me from someday making a quick change if the facts are overwhelmingly obvious. That's where judgement comes in, and that comes with experience and knowledge. If you have these things yourself, you very well might not need an adviser. If you don't, that's where one can help. For all the knowledge that advisers like to think they have, with the proliferation of data and robo-advisers, their best service might merely be serving as a firewall between a client and a bad decision.