In a world where you can get trade execution for $7.99 or buy an index fund virtually for free, why should investors seek out the aid of a financial advisor and pay the additional fees that go along with that?
Well, a certain firm set out to quantify the potential value added by working with a skilled advisor. They found what they believe to be a meaningful improvement to long-term investor performance when they utilize the services of a professional. It might sound like a self-serving study until you realize that the firm in question is in fact Vanguard (see the Vanguard research paper Putting a Value on Your Value: Quantifying Vanguard Advisor's Alpha , Kinniry, Jaconetti, DiJoseph, and Zilbering, March 2014). Yes, the Vanguard that is so famous for their do-it-yourself, ultra-low-cost philosophy.
Below I will lay out the factors that Vanguard listed as the 'value adds', along with how much Vanguard believes they can add, on average, to client returns and why each factor is important.
Suitable Asset Allocation Using Broadly Diversified Funds = > 0%
(This one is listed as worth 'something more than zero'. Vanguard states that the value is significant but too unique to each investor to quantify.)
Making sure that your portfolio's asset allocation is in-line with your financial goals is extremely important. If you don't have a financial plan in place and an asset allocation that matches your plan, how can you know if you're set up to meet your retirement goals? More importantly, how can you possibly stick to your investment strategy during the most turbulent bear markets?
Cost-effective Implementation = .45% annually
Today's investors are becoming increasingly sensitive to costs. This is a good thing. If you're paying for a service, you want to be sure you are getting something of value for it. When it comes to investment selection, my philosophy is that if a more expensive active fund is consistently providing my clients with above-benchmark returns (after fees), then great. If not, I have no qualms with using an index fund that could give me market returns with almost no internal expenses.
Rebalancing = .35% annually
Periodic rebalancing of a portfolio helps ensure that over time you don't drift away from your ideal allocation (according to your financial plan). If over time you end up with too much stock exposure, you may have way more risk than you bargained for. If your stock exposure drops too low, you might not achieve the returns you need to reach your eventual goals. You might choose to rebalance after any large market moves, or you can simply do it on a set schedule. My belief is that as long as you rebalance once a year, you're on-track.
Behavioral Coaching = 1.5% annually
I'll just quote Vanguard here, as they really hit the mark (emphasis mine).
"Based on a Vanguard study of actual client behavior, we found that investors who deviated from their initial retirement fund investment trailed the target-date fund benchmark by 150bps (1.5%). This suggests that the discipline and guidance that an advisor might provide through behavioral coaching could be the largest potential value-add of the tools available to advisors. In addition, Vanguard research and other academic studies have concluded that behavioral coaching can add 1% to 2% in net return."
Asset Location = .75% annually
Basically what this means is that you ensure that investments are strategically placed when an investor has both tax-advantaged and taxable accounts. You want to place investments in a way that minimizes taxes in the taxable account. Perhaps you substitute tax-free municipal bonds for taxable corporate bonds. You might also consider 'tax-managed' funds; funds that attempt to keep turn-over (and the resultant taxes) as low as possible.
Withdrawal Order During the Spend-Down Phase = .70%
This can be complicated and really needs to be worked in tandem with your tax professional (we have a dedicated tax department at Brighton Securities). Deciding where you pull money from each year during retirement (taxable, tax-deferred and tax-free accounts) in order to properly manage your tax liability can keep more of your money in your pocket, instead of sending it off to the IRS. Having your financial advisor team up with your tax advisor can be a powerful tool; one that can save you money over the long-term.
Total-Return vs. Income Investing = > 0%
(This one is also listed as worth 'something more than zero'. Vanguard states that the value is significant but too unique to each investor to quantify.)
This is a bit harder to explain. What Vanguard says here is that an advisor can help their clients to decide whether they should lean towards investments that generate a higher level of income (dividends and interest), or if they should focus more on total return (both growth and income together). This decision will be unique to each client, and figuring out the best strategy based on each client's situation is where the value is added.
So what's this all worth? If we add up the numbers above, we get 3.75% per year. However, this doesn't include the added value for the two factors that Vanguard had trouble quantifying. It also doesn't account for the advisor's fee. Vanguard nets this out and says, using best practices for wealth management, advisors can potentially add "about 3%" in net returns. As Vanguard notes, the extent of the value will vary based on each client's unique circumstances and the way the assets are actually managed, versus how they could have been managed.
There are also other valuable services that an advisor can help clients with that Vanguard didn't consider. This includes, but is not limited to: Medicare planning, college savings, charitable giving, estate planning (in tandem with an attorney), services for business owners, pension benefit analysis, and much more.
The point is that not everybody needs an advisor and the fees that come along with that service. But if after reading this you feel that you could benefit from many of the factors listed above, it wouldn't hurt to speak with someone from a reputable firm to see if they can help you achieve your financial goals.
The projections regarding likelihood of investment returns are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. All investments, including a portfolio's current and future holdings, are subject to risk, including the possible loss of the money you invest. Past performance is no guarantee of future returns.
Sam DiNorma, Financial Advisor
(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp. The author's opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).