What Should Investors Look For?

04/12/2012 11:15 am EST

Focus: STRATEGIES

Mark Hulbert

Senior Columnist, MarketWatch

Mark Hulbert has some unique advice for investors who are looking to choose an advisor or newsletter writer, and he shares a window of performance that he thinks is most valid.

I’m here with Mark Hulbert, and we’re talking about the value of perspective. Hi, Mark, how are you?

I’m great, thanks.

Great. I think this is a good time. We’re looking at almost 12 years since the tech bubble burst, and we’re looking at a time when the new bull market has come into play that’s almost about three years old. What does this mean for average investors? What should they take away from some of these landmarks that are showing up?

Well, my general recommendation to my clients is that they need to pick whatever period of time for judging an advisor that they think the future will look like. Now, let me say what that means. If, for example, you look at a three-year ranking now, that, of course, doesn’t include any of the prior bear market. Three years now only includes a bull market period.

If you think the future will only be a bull market—and of course saying it that way, everyone knows it’s not going to be—but let’s say you believe everything is going to be a bull market. Great. Using the last three years as a basis for choosing your advisor may not be a bad idea.

But if you think there’s going to be a possibility at least of a bear market, then you ought to include a longer period of time than the last three years in order to encompass a down period. So, it’s a simple point, but unfortunately, people try to come up with some magic formula. They say, well, three years is enough to judge.

We have debates in the mutual fund world as well as in the advisor world about how long of a track record is long enough. I think the rule of thumb simply is, what do you think the future may look like? “May,” means doesn’t have to know for sure, but what kind of environment do you think the future will include?

If you think it includes at least the possibility of a severe bear market as well as a very bullish period, and I think that includes most of us, then you want to go far enough in time to include both a spectacular bull market as well as a punishing bear market.

If I go back and look, I think that right now means probably 15 years. The reason is that even ten years does not include a period in which the stock market has produced an annualized return that’s close to its long-term average. So, even the last ten years is going to bias your analysis in favor of picking more bearishly oriented services.

But if you go back for the last 15 years, the market is up more or less right in line with long-term averages, and I think that provides the perspective that we all desperately wanted.

It also gives the newsletter editors the value of the time that they need to show what the performance is. The flash in the pan, one-year, three-year performance doesn’t necessarily connote that they’re nailing it every time.

Absolutely. It’s very difficult for all us, because you know somebody that’s had even a three- or a five-year record…all of a sudden, here’s Mark Hulbert saying only look at a 15-year record, and they say, “Look, I have a great five-year record. That can’t be due to chance.”

Unfortunately, the lesson, and it sounds very difficult—and if I were in that advisor’s shoes, I’d be frustrated as all get out to be told that—but it turns out that even at a five-year period of time, the role of luck is sufficiently great, that you can’t be sure that you’re dealing instead of the next Warren Buffett, the next person is going to lose all your money.

There are plenty of people I can tell you who have had great five-year records, and even at the end of that five-year period, they’re about to go over a cliff.

Yeah, because it’s that sixth year that will kill you at that point. Right?

Very right. So, there are no guarantees, but if you go over a long enough period of time, over a period of time that includes all the different kinds of market environments, at least you have the chance or a better chance of not finding somebody who’s going to crash and burn with your portfolio.

Related Reading:

Related Articles on STRATEGIES