Lies, Darn Lies, and Benchmarking for Financial Advisors

Pay attention; you’ll learn why benchmarking is important in the mutual fund industry and how you’ll fare better if you truly understand how to invest rather than simply following the crowd.

Why do financial advisors and the mutual fund industry engage in benchmarking? The reason is as follows: If you’re a fund manager or a broker, you won’t be chastised if you stick with the crowd, which means staying close to the benchmark. As a result, you will not only not be criticized, but you will also not be fired.

This applies the following principle: “Failing conventionally is safer than succeeding unconventionally” – John Maynard Keynes.

People’s careers are jeopardized if they deviate too far from the standard. Those in the mutual fund industry will not put their careers at risk. Everything is based on performance in comparison to the benchmark, not on the performance of your money. Independent rating agencies, in particular, help to perpetuate this. They will show if Fund XYZ deviated significantly from the benchmark fund, which means fund advisors and brokers will not buy that fund because the rating company will deduct a couple of stars. This is a standard that is enforced by the practice. This is insane. It’s like saying you can win the race if you stay in the middle of the pack and don’t try to get ahead. And winning, in this case, would be protecting and growing your money. To know more about coaching, visit Business Coaching London.

This also implies that rating agencies will penalize the fund manager who believes they should be in cash rather than stocks. As a result, if the benchmarked index rises without them for a quarter or two, they are chastised by rating agencies for doing the right thing. Thus, the entire system is a massive negative feedback loop. Even if a fund manager says, “Wow, things are dropping like crazy; I’m in the aggressive growth telecom fund, and I think we should have more money in cash,” they are effectively pressured not to do so because the goal is to stay close to the benchmark, even if it is falling, even if it is not best for the investors’ money.

A mutual fund investment manager would have to be insane to jeopardize their career, so they stay close to the benchmark by trading in and out of stocks. This is intriguing but ineffective because you could purchase an index that tracks the aggressive growth telecommunications benchmark. So you don’t even need an active-managing mutual fund.

So, what are you paying for: some fund manager’s career stability or investment results? What you pay for with mutual funds is not what it appears to be. The point of discussing benchmarking is that it is very costly to your wealth because it reduces your returns. I call them relative returns because your money grows only about the benchmark.

The job of a great, prudent financial advisor is to protect and grow their clients’ money using absolute returns rather than benchmarked or relative returns. When working with an advisor, money manager, or broker, look for someone who charges based on performance so that if your money doesn’t grow, you don’t get charged, similar to how mutual funds worked from the 1920s to the 1960s.

The Wall Street mantra of “buy and hold” is riddled with flaws. There are long periods when being in the market is dangerous to your future. Knowing the difference is one of the most important aspects of safeguarding your future.

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