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The Value of Following IFA's Advice

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What has been the value of following or not following the advice of Index Fund Advisors (IFA), regardless of what happens in the financial markets? A similar question was addressed by Vanguard Research in their Advisor’s Alpha article, where they estimated additional annual return values of about 3%, including 1.50% for behavioral coaching and 0.35% for disciplined rebalancing. But IFA wanted to do our own internal study to see if we could determine the success our clients experienced in capturing the Benchmark IFA Index Portfolio returns.

IFA analyzed the performance of actual clients who have been with IFA for at least six full calendar years from 1/1/2008 to 12/31/2013. This period includes the global financial crisis of 2008 and early 2009, as well as the subsequent recovery period. For each of the 100 Benchmark IFA Index Portfolios, IFA maintains monthly historical returns data that can be used to benchmark our clients' time-weighted returns. The Benchmark IFA Index Portfolio returns are net of a 0.9% advisory fee, which is the highest fee paid by any IFA client. The returns shown throughout the IFA Website and the benchmark returns shown on client performance reports are also net of a 0.9% advisory fee. The IFA fee schedule includes a declining percentage fee for larger assets under management, so those clients with larger assets benefited even more relative to the IFA benchmarks.  For each portfolio, we can determine what percentage of the Benchmark IFA Index Portfolio return was received from 1/1/2008 through 12/31/2013. Even though many clients had inception dates prior to 1/1/2008, we chose to hold the time period constant so that every client would have experienced the exact same market conditions during the period analysed.

The full data set consisted of 680 client portfolios1, which were divided into three groups, as delineated below:

Group #1 - 414 client portfolios that did not decrease their stock index allocation by more than 9% or increase by more than 9% compared to IFA's original recommendation. We consider this group to be clients that stayed the course through the Global Financial Crisis and the recovery period.

Group #2 - 161 client portfolios that decreased their stock index allocation by 10% to 25% compared to IFA's original recommendation. We consider this group to be clients that recalibrated their portfolios in response to the Global Financial Crisis.

Group #3 – 105 client portfolios that either decreased their stock index allocation by more than 25% or increased it by at least 10% compared to IFA’s original recommendation. We consider this group to be clients that did not follow IFA’s advice.

Groups #1 and #2 can be said to consist primarily of clients that actedwithin the parameters of IFA’s advice, and Group #3 can be said to consist of clients who did not follow3 IFA's advice. The results are summarized in the chart below. The clients who stayed put in their portfolio (Group #1) captured 36.4% more of the available benchmark portfolio return than clients who drastically changed their risk level (Group #3). The clients who changed their risk level within a reasonable range, as dictated by the drop experienced during the Global Financial Crisis (Group #2) captured 15.4% more of the available return than clients who drastically changed their risk level (Group #3).

Under normal circumstances, IFA considers a reasonable range to be within 9 of the portfolio's original risk level. However, the Global Financial Crisis of 2008-9 presented us with circumstances that caused us to change our limits of a reasonable range. Specifically, Group #2 includes clients who elected not to rebalance their portfolio, and therefore lowered their risk level during the Global Financial Crisis because the drop in their portfolio value exceeded the maximum percentage decline they selected in the IFA Risk Capacity Survey prior to the crisis. During that decline, client portfolios that were not rebalanced declined by about 25 index portfolios, and if they elected to keep the pre-crisis limit of percentage losses in a 12-month period, they declined to rebalance and were simply reclassified to their new index portfolio number. IFA considered this to be consistent with following our advice, as further explained in this article.

Since the time period studied (1/1/2008 - 12/31/2013) was a difficult one for maintaining a constant asset allocation, we decided to evaluate a second group of portfolios that were invested at IFA from 1/1/2011 to 12/31/2013. These portfolios belonged to clients that started with IFA during 2010, so all the clients would have been given the same choices for maximum tolerable loss in IFA's Risk Capacity Survey.

The full data set consisted of 140 index portfolios4 of IFA clients, which were divided into two groups:

Group #1 - 119 client portfolios who followed IFA's advice, defined as clients that did not increase or decrease their risk level by more than 9 compared to IFA's original recommendation.

Group #2 - 21 client portfolios who did not follow IFA's advice, defined as clients that increased or decreased their risk level by 10 or more compared to IFA's original recommendation.

The bar chart below summarizes the results:

Group #1 got 100% of the benchmark return, which is not surprising. The observation that Group #2 got 94.4% of the return is somewhat unexpected. It can be understood by breaking up this group into the clients that increased their risk level and clients that decreased their risk level. The clients that increased their risk level got over 100% of their original benchmark return, and the ones who decreased got only 73.1%.

For all of this data, it is important to understand that there are many reasons why a client's time-weighted return may be different than the return shown for the corresponding IFA Index Portfolio.

  • The Benchmark IFA Index Portfolio returns are calculated on a monthly basis and interpolated for mid-month returns, so a portfolio that starts in the middle of the month usually has a different return for that month. 
  • The funds used to implement client portfolios vary with client situations and may be different than the funds included at the end of the time-series construction for the IFA Index Portfolios. For example, taxable accounts would have tax-managed funds, which may have different returns than the non-tax-managed funds used in the IFA Index Portfolios.
  • Actual client rebalancing will differ from the January 1st assumption incorporated into the IFA Index Portfolios. This could have made an especially large difference for portfolios that were not rebalanced near 1/1/2009.
  • Client returns are net of transaction costs while the IFA Index Portfolios do not include them.
  • Client returns are affected by allocations to cash for fees and withdrawals and client behaviors such as not authorizing the investment of cash immediately when it is deposited or asking IFA to raise cash and then not removing it from the account. They can also be affected by client preferences such as not reinvesting dividends.
  • The IFA Index Portfolio returns are based on a 0.9% advisory fee, and with a tiered fee schedule, clients with larger accounts have lower fees. The benchmark IFA Index Portfolio returns assume that the fee is taken on a monthly basis, but for clients, fees are paid on a quarterly basis.
  • Other factors that may have affected client's returns for portfolios that include taxable accounts are the use of asset location, tax-loss harvesting, and the use of tax-managed funds. 

Also consider that there are millions of investors who were not clients of IFA and we would guess that they had even lower returns than those in our study. Unfortunately, we have not seen any comparable studies of actual client accounts during this highly volatile time period. In addition, we are not aware of any other firm that could even do such a study, because it is unlikely that they would have kept accurate records of 100 benchmark index portfolios, all the clients who invested in those same portfolios and the original recommendations for each client.

To summarize, IFA has provided a real value to our clients who have followed our advice and stayed in their index portfolio that matched their risk capacity as determined while working with an advisor. There are two data points that we believe highlight the value of IFA's advice. The first one is the substantial penalty clients paid for not following IFA's advice during the Global Financial Crisis, with that group of clients giving up about 43% of the return of their index portfolio (compared to the 7% given up by clients who stayed the course). The other important number is the clients who closely followed IFA's advice in the 2011-2013 period, capturing about 100% of the Benchmark Index Portfolio Returns. 

The message is clear. If you want to capture the returns the global stock and bond markets have to offer, stick to IFA's investment strategy that is based on over 60 years of peer-reviewed research.

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1The 680 client portfolios consisted of those that were active for the entire period from 1/1/2008 to 12/31/2013, were not custom portfolios or special allocations such as sustainable or socially responsible, and had at least $100,000 by the end of the period. Portfolios using tax-managed funds were included.

2Group #1 and Group #2 would still include exceptions to following IFA's advice such as failing to invest cash when available or transferring in non-IFA-advised securities and not immediately selling them or not agreeing to rebalance when IFA recommended it. The impact of these deviations varied over time and clients.

3Group #3 would still include clients that may have had legitimate reasons to drastically change their risk and thus actually were following IFA's advice.

4The 140 client portfolios consisted of those that began in 2010 and were active for the entire period from 1/1/2011 to 12/31/2013, were not custom portfolios or special allocations such as sustainable or socially responsible, and had at least $100,000 by the end of the period. Portfolios using tax-managed funds were included.