Investors in index funds will fail in a bear market if they fail to pass this test

Perhaps we should not judge investment advisors depending on whether they can beat the market or not.

It's an incredible admission from someone like me who has dedicated his career to judges as consultants just like that. Nonetheless, I have explored this possibility more and more in recent years. I was pushed to do so by a comment that Benjamin Graham, the father of fundamental analysis, has realized in his investment classic "The Intelligent Investor": "The best way to measure the success of the investment is not if You're beating the market, "he wrote," but if you've put in place a financial plan and a behavioral discipline that will take you where you want to go. "

Graham's commentary puts the funds indexed in a completely different light. Their desirability becomes less statistical if the purchase and holding of such funds exceeds those devoted to active management. That statistical question was solved long ago, of course, with index funds that win hands down.

But buying and holding an equity fund is not at a height if few investors are willing to follow the strategy in a thick way. And, indeed, it seems that they are few.

In contrast, most of those who claim to believe in a long-term buy-and-hold strategy end up discovering – or at the bottom of the bear market – that I do not have what it takes. This means that they bear most or all losses in the bear market and only benefit from a portion of the subsequent market rebound.

By comparison, a consultant whose record seems less statistically could be a better bet than the indexed fund. The key is if an investor finds the consultant's approach sufficiently convincing to keep him in a bear market. Since the key to long-term success is actually following the long-term strategy, such an investor could actually make more money over time than the buy-and-hold investor who throws in the towel in the last stages of a market bearish.

This alternative way of seeing investment success focuses on what an investor should look for when choosing a consultant. The key question is if you are willing to follow a consultant on the dark days of a bear market. Although obviously there is no way to know with certainty in advance, there are several key questions that investors should ask to get detailed information:

• Are you following the consultant due to his track record alone? This is a sign of danger, because no consultant earns continuously. There will inevitably be a time when the consultant is not in sync with the market. And if your only loyalty to that consultant is based on performance, then it is very likely to download it to its first misstep.

• The arguments and rationalizations of investments provided by the consultant satisfy an olfactory plausibility test? This seems a low obstacle to asking a consultant to skip, but you will be surprised that few investors ask their adviser to cancel it. Particularly revealing is when a consultant contradicts himself from one communication to another. For example, if it says it is bullish due to a particular indicator – for example, the S & P 500 index

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is above its 200-day moving average – so see if it becomes bearish when the market falls below it. If he thinks so little about his own arguments not to follow them, then he is unlikely to be loyal when the game gets tough.

You are looking for someone who can persuade you to stay the course when this is the last thing you want to do.

• Do you respect the consultant? This is an amorphous and ill-defined question, to be sure. But it is a crucial part of the puzzle. You're looking for someone who can persuade you to stay the course when it's the last thing you want to do.

The bottom line? When focusing on consultants in these ways, there is no right or wrong answer, but rather a question of better or worse adaptation. A consultant that an investor believes to be convincing could be considered inappropriate by another.

The key to satisfying a consultant is to keep asking the right questions. Whether your consultant beats an indexed fund or not is not the only question – or the most important.

For more information, including descriptions of the Hulbert Sentiment Indices, go to The Hulbert Financial Digest or e-mail [email protected] .Create an alert e-mail for Mark Hulbert's MarketWatch columns here (requires access).

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