In April, the Department of Labor expanded its definition of which investment professionals will be considered to be fiduciaries. Those with fiduciary responsibilities are legally responsible for making the welfare of clients the paramount consideration when making an investment recommendations.

As we discuss in our IOI 100-Series course, the average mutual fund investor’s account performs significantly worse than the mutual funds in which they invest – even before taking fees into account. The problem, lawmakers and administrators figured, must be related to the “Agent-Principal” issue: professionals recommend clients invest in a way that increases advisory fees rather than in a way that increases investor wealth.

However, recent research from academics at the University of Chicago, Northwestern University, and the University of Texas at Austin find that a sample of 5,000 Canadian financial advisors who oversaw a total of 500,000 accounts from 1999-2013 advise clients poorly because they themselves can be misguided about what makes an effective investment. The study finds that when investing as principals (i.e., for their own accounts) the majority of financial advisors trade too frequently, chase returns, and invest in high-cost actively managed funds that underperform low-cost passive funds. What’s more, advisors’ misguided investment strategies continue even after they leave the business.

Some investment advisors fought hard to oppose the Department of Labor fiduciary duty rule, arguing that adherence would increase costs to clients. However, if the findings in this paper (embedded below) are true, advisors are already following the fiduciary rule in practice — by advising clients to invest the way they themselves are investing. The problem arises not because advisors are not willing to eat there own cooking, but rather because their cooking is simply not very tasty.

People are surprised when IOI suggests that the lion’s share of one’s investment assets should be kept in as low a cost passive index fund or index-like fund as possible. We believe it is possible to beat the market over the long term by combining the efficiency of a passive approach with making selective, prudent investments in companies whose value we can estimate and whose market price is significantly different from our calculated value.  And in reality, some successful advisors invest in much the same fashion.

IOI knows the value of having a process.  Look at the successful investors around us, Buffet (and his lieutenants), Weitz, Prabai, Greenblatt, Berkowitz, Paulson, Musk and even Soros – they all share “PROCESS”.  They have different ones for sure (most are “value-based”), but the “salad bar” approach to investing, taking a little from this model and that strategy flat out doesn’t work.  However, our cognitive biases as humans send us down that path repeatedly.  We want our members to avoid that outcome.  To have successful investment results based on a proven process that doesn’t get shifted by the shiftiness of Mr. Market – No matter if they are agents, principal investors or both.

Frequent trading and investment in “hot” funds run by celebrity managers, on the other hand, is a perfect way to underperform, whether you are an advisor or are an advisor’s client.

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