Morningstar Advisor - December/January 2010 - 80

Phillips Curve I Read the News Today, Oh Boy By Don Phillips There are two very different types of people in finance: Those who make headlines and those who make money. I learned that lesson as a junior fund analyst covering the Templeton World Fund. It was early 1988, and the investment world was reeling from the October 1987 crash. One of the most prominent market commentators of the time was claiming that the crash was just the start of a meltdown that would see the Dow go to 400 and the mutual fund industry cease to exist. Those were scary sentiments to a young man who had hitched his financial future to an embryonic fund research company. Fortunately, John Templeton offered a contrasting view. In researching Templeton World’s post-crash purchases, I noticed that Sir John was aggressively buying stock in nearly every publicly traded asset-management company. He saw that asset management was an intrinsically strong business backed by very powerful demographic trends. He wisely saw the crash as a time to buy, not to panic. The market commentator’s views got the headlines, but Templeton’s actions made money. I think of this lesson in the wake of the current crisis. Today’s headlines scream that buy-andhold is dead, that it’s time to retire the 401(k), that asset allocation and diversification failed. Yet amid this hyperbole, a small article in The Wall Street Journal reported that the median 401(k) account at Vanguard is up 7% over the past two years. Think about that. In the worst financial storm any of us can recall, investors who stuck with their investment plan emerged with modest gains. They weren’t wiped out. They made progress toward their goals. How did these investors survive? For one, 401(k) plans, especially in the days of default target-date options, encourage intelligent asset allocation and rebalancing. Second, 401(k) plans encourage a long-term horizon, and automatic contributions make abandoning ship less likely. Third, Vanguard runs a conservative, low-cost shop, so its investors weren’t subject to debilitating losses from bond funds playing too close to the edge in 2008. The clear takeaways from this example are that if you’re broadly diversified with reasonable asset allocation, low costs, a bias for quality, and you stay the course, you can weather almost any storm. These results confirm the merits of the financial-planning community’s collective investment learning and should be cause for relief, if not celebration—not the pessimism that pervades today’s investment debate. Unfortunately, negativity is creeping into the financial-planning profession. It’s alarming to see veteran planners question their beliefs. I never thought I’d see FPA sessions promoting market-timing, yet we’ve seen them recently and they’ve been well attended. In one such session, the presenter acknowledged markettiming’s bad reputation before launching his pitch as to why advisors should embrace it. He neglected to mention why timing has a bad rep—quite simply, no firm has ever produced a credible track record in a real-world mutual fund setting using market-timing as a primary investment tool, despite numerous attempts. Remember the Lowry Market Timing Fund? FlexFunds Muirfield? There’s a reason you don’t. Sure, there are timing schemes that look good on paper, but if timing hasn’t been deployed effectively in a mutual fund, why should any advisor think he can do it with his client’s money? Moreover, if there’s one lesson to be had from this crisis, it’s that timing doesn’t work. As seen in Vanguard’s example, investors who stayed the course lived to fight another day. The main way investors irreparably hurt their portfolios in the meltdown was by entering the crisis heavily invested and then going to cash at the bottom. Sadly, that happened to many who tried to time the market. I spoke recently with the head of the ultrahigh-net-worth practice at a big trust company. His firm advocated staying the course, but many well-to-do clients panicked and insisted on moving to cash. Its clients’ average cash position last September was 11%, by March it was 46%! They got all of the downturn but only half of the rebound. These supposedly sophisticated clients found the surest way to lose: They fell prey to the emotions that make market-timing dangerous. Once again, we see the difference between headlines and wealth creation. Today’s headlines say buy-and-hold is dead; the facts say that market-timing is as foolish as ever. Today’s headlines say asset allocation and 401(k) plans failed. The numbers say they worked. The question isn’t which path will be proved right, it’s how much damage will be done to advisors and clients who abandon years of training and accumulated wisdom and succumb to hyperbole. As ever, don’t confuse headlines with real investment insight. K Don Phillips is Morningstar’s managing director, corporate strategy, research, and communications. 80 Morningstar Advisor December/January 2010

Morningstar Advisor - December/January 2010

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