Is Your Advisor Starting to Use Active Management?

(MoneyWatch)  According to an article in Investment News, some advisors are turning away from buy-and-hold principles for their clients and moving toward strategies such as "tactical investing," which is just a fancy word for market timing. If your advisor is one of those, run.

To quote from the article: "More professionals are questioning the value of buy-and-hold strategies." Robert Levitt, president of Levitt Capital Management, LLC, stated "It's time for the industry to wake up and realize retail investors don't have a long-term risk tolerance, and I would think if you were a buy-and-hold firm last year, you don't have many clients left."

Perhaps it's Mr. Levitt who needs to wake up. My firm, Buckingham Asset Management, has been advising individuals and institutional investors since 1994. Since day one, we've based our investment philosophy on academic evidence from highly regarded peer-reviewed journals, which has shown that the strategy most likely to allow you to achieve your financial goals was a passive buy, hold and rebalance strategy. We now manage approximately $1.9 billion -- almost identical to the amount of assets we had under management before the crisis. Our sister firm, BAM Advisor Services, acts as a provider of services and intellectual capital to more than 100 other RIA firms with about $8 billion under management. And they too have about the same amount of assets under management as they had before the crisis.

Given that the equity markets haven't fully recovered their losses, it's obvious that these firms (mine included) have been adding to their client base.

Our clients stayed disciplined because they were educated on the failure of active management, the inability of prognosticators to forecast better than chimps, and the inevitability of bear markets. Thus, they took the amount of risk appropriate for them. While a few clients learned they were overconfident of their ability to withstand the stress of a severe bear market, even the majority of them were able to avoid panicked selling because we helped them stay true to the principles of prudent investing and reminded them that market timing was a loser's game.

The results of 2008 and 2009 have only added to the body of evidence on the failure of active management. The majority of active funds underperform in all market conditions, and studies show there's no persistence in outperformance beyond the randomly expected. This is true whether we look at individual investors, mutual funds, hedge funds or pension plans.

The article quoted another advisor: "It's fair to say that in this market, there is a need for more active management. One of the most frequent comments we have been getting from prospective clients is that their adviser just sat there last year as the market went down." My response is that good advisors don't sit there and do nothing. Good advisors harvest tax losses and rebalance their clients' portfolios to stick to the plan tailored to their ability, willingness and need to take risk to achieve their financial goals.

Warren Buffett is one of the greatest investors of all time. So who should you take advice from, some advisor who espouses market timing or Buffett who states "We continue to make more money when snoring than when active"?

While we all would like to believe there's someone who can predict where the market is going, there's no such person. You're best served by focusing on the things you can control -- the amount of risk you take, costs, tax efficiency and broad global diversification.