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Should Financial Advisors Follow Conventional Wisdom?

Being human, we have the tendency to follow crowds and stick to what everyone else is doing.  This helped us survive over the years, and gave us numerous advantages.  However, in the market, whether it is the stock market, real estate market, Dutch tulip market, or any other market throughout history, following the crowd especially when the euphoria gets to an extreme level has numerous disadvantages.  In bubbles, the conventional wisdom and crowd behavior will be wrong with the common belief being "this time is different".  For the hundreds of years of recorded history,  it has never been different.  The only thing different is the name of the bubble.

But herein lies the challenge for the financial advisor.  If a financial advisor lost money for the client, but the advisor followed conventional wisdom, then it is somewhat excuseable.  Reasons given such as who could have known...nobody could have seen it must have a long term horizon...or any other excuse of the decade will usually be acceptable.  If on the other hand the advisor lost money by going against conventional wisdom, then he likely has some explaining to do.  So it looks like financial advisors will put their practice at risk by going against conventional wisdom.  So then maybe turning to portfolio managers offers a solution.  Nope.  Most portfolio managers operate under the premise that they are paid to buy stocks, and how much an investor allocates to stocks via the portfolio manager's fund is the investor's responsibility -- which basically puts risk management back in the investor's lap.  Worse, many times the investor is not even aware he is responsible for the risk management so nobody ends up covering it.  Furthermore, most portfolio managers are only ranked by how well they follow their benchmark.  I read somewhere that Morningstar's Manager of the Year was down 20% last year.

So what does one do?  Bubbles will always exist.  Most financial advisors will follow conventional wisdom to conform with the regulatory "prudent person" mandate.  It doesn't make it any easier that going against conventional wisdom and trying to go against the crowd will feel awkward at the time as well.  The best time to get out of the market will be when euphoria is at an all time high, and the best time to go long will be when bearishness is extreme.  However, clients will soon start demanding some downside protection and start questioning why are they paying a fee for an advisor and not getting any protection in return.  Financial advisors that are capable of going against conventional wisdom to save their clients from losses will find they attract more clients and their practice will flourish.  Whereas those that are stuck following following conventional wisdom will not be so lucky as clients will refuse to hire them.  These clients will decide that they are better off investing in a low cost index fund, preferable an ETF.  Maybe one day an actively managed ETF will exist that does everything a financial advisor wishes to do but can't for one reason or another...but that may be a topic for a future post.