The Best Investment Question I Never Answer

I was chatting with a prospective client last week and he asked “Adam, I see you manage about $195 million. What has been your clients’ rate of return over the last 3 years.”

This question (or iterations of this question) is worth asking an advisor — it can tell you a lot about who you’re considering working with.

But what I think is the “right” answer is predetermined to leave the inquirer wildly unsatisfied. Let me explain.

But before I get to the right answer, here are some responses to this question which I think are generally bad:

Bad Answer #1: Anything referencing a percentage

Whoa whoa whoa, Adam. Returns are, in fact, percentages…. How could this be a bad answer?

Look, if an advisor starts jumping right into “Well, [Mrs. Client], our 100% equity strategy produced 8%, 15%, and 22% annual returns over the last three years…” You can be partially sure they’re full of shit (regardless of what the numbers are).

This isn’t to say their baseline recommendations didn’t produce those returns. It’s simply to point out that no actual person — no real life, breathing, walking, talking, actual person really bought those investments at the beginning of the three year period, made no contributions or withdrawals (which would have affected rate of return), and received those rates of returns. So if no actual person received that return, is that a reasonable response?

Of course not. Investments aren’t made in some frictionless vacuum. They’re made in the real world (more on this below).

Bad Answer #2: Anything which considers all clients similarly

If an advisor starts talking about how their clients are doing without acknowledging how heterogenous their client base is, that’s a red flag.

Let’s pretend for a minute that Harding Wealth only works with 65 year old retirees in the Phoenix area who play pickleball three times a week, have three grandchildren, a dog, and they take a family vacation twice a year. Every one of them has $1,943,267.87 in their portfolio and a dog named “Spot”.

Surely it would be easy to reference average client performance given how similar everyone is, right?

Wrong.

One client hates Trump and wanted to get conservative when he got elected.
Another loves Trump and wanted the opposite.

One client is expecting an inheritance from their 97 year old mother.
Another takes care of their 97 year old mother.

One client artfully points out that “the men in our family have never lived above 75” while another client’s genetics suggest they may be the first human to live to 130.

…My point is this: There are a hundred factors which determine an appropriate investment strategy for an individual. These factors include mathematical certainties like Cost of Housing or Medicare Premiums, but it also includes enormously consequential and impossible-to-predict factors like Life Expectancy. Not to mention the most critical driver of strategy: client objectives.

Bad Answer #3: Anything which relies heavily on past performance as a reliable indicator of future performance.

I love fun facts. Here are a few that aren’t related to investing:

Bananas are berries, but strawberries are not.
Antarctica is the only continent without any reptiles or snakes.
Your nose can remember 50,000 different scents.

Okay, now here’s a fun fact about investment performance.

Did you know that, on average, only 22% of stock funds which were in the top 25% of performers for 5 years only remained in the top 25% for the next 5 years? Here’s the data:

Source: 2024 Mutual Fund Landscape. Dimensional Fund Advisors.

Here’s what this means:

If you’re making an investment and plan to hold onto it for the next 5 years, should you care what happened the last 5 years? After all, only about 1 in 5 of the best performers from the last 5 years has historically remained a top performer for the next 5.

Remember, the returns which happened before you hired your advisor are purely hypothetical. What matters is what happens from today going forward…. And to help ensure this goes well, the focus needs to be on investment selection process rather than recent historical returns.

Finally, A Good Answer

When someone asks, “What has your performance been?” I think some follow up clarification is needed.

A good response includes something like this:

That’s a great question.

The biggest factor in driving performance is an investor’s asset allocation, or their mix of stocks, bonds, and cash. We think client objectives are the most important driver of investment selection —and those objectives (along with other things like risk tolerance) are what helps us land on a mix everyone is happy with. In short, we don’t have one single number across all clients because all clients are not the same.

With that said, I’d be glad to provide you with the list of funds we currently favor, along with their past performance (even though past performance isn’t a particularly good indicator of future performance).

It’s also worth noting that we won’t simply liquidate holdings in a taxable account (joint, individual, trust, etc.) to buy our preferred funds without evaluating the potential capital gains taxes which may arise.

Your actual investment portfolio with us would reflect not only your investment objectives and risk appetite, but also the holdings which got you here in the first place.

One last thing…

While we recognize low-cost, tax-efficient diversification is important, so is believing in what you’re doing and having an ironclad commitment to it. If there’s a stock or segment of the market you simply love, let’s talk about it. We can accommodate these preferences to build something you believe in and can stick with.

So, that’s it. That’s the answer I think is best. A wishy-washy, vague, specifics-dodging answer a politician would give. But it’s ethical, realistic, and doesn’t set us up for disappointment down the road.

And you know the real killer? We’d love to brag about how our clients are doing… But that doesn’t tell you the story of how you might do in the future.

So, I’ll leave you with one last question to put into your back pocket. Ask your advisor:

”What has been your firm’s growth over the last 5 years in terms of both assets and clients added or lost?”

If they’re getting fired a lot, then their process isn’t very good. If they’re growing a lot, then they’re likely getting referred new clients by their existing (happy) clients.

Best,

Adam Harding

Ps… If you want an exhaustive list of the questions we think you should ask an advisor, let us know and we’ll send it to you.