As technology has improved and it has become increasingly easier to open accounts and invest money in a diversified portfolio, people are often asking whether financial advice is worth paying for. Or, more specifically, what is the value of financial advice? The answer ultimately depends on what type of advisor you are considering hiring and what level of advice they can give. Still, we believe it’s an important question and one that should be answered thoughtfully. Quantifying Value The decision to hire any professional involves two factors: cost and value. Cost is usually straightforward and objectively stated in the price being charged. Value is harder to ascertain. It tends to be subjective and hard to measure. Nonetheless, there is a growing body of research into this topic. In a research paper titled, “Advisor’s Alpha,” Vanguard estimated that a competent advisor could add approximately 3% per year, although the manner in which that value is added tends to be very “lumpy”. The bulk of the value is added during times of profound fear and greed, as the advisor acts as a behavioral coach more than an asset manager. Below is a summary of the results of Vanguard’s extensive research: Morningstar, the renowned investment research firm in Chicago, published its own research paper that attempted to quantify the value of financial advice. Morningstar attempted to quantify the potential benefits from “good” financial planning decisions, particularly for those living off a portfolio in retirement. Morningstar named this potential value “Gamma” and included five different factors:
Asset location & withdrawal sourcing
Total wealth asset allocation
Dynamic withdrawal strategy
The findings of this study estimated that a retiree can be expected to generate 22.6% more income utilizing a strategy involving these five factors as compared to a base scenario. This additional income translated into the equivalent impact of an annual return increase of 1.59%, which Morningstar concluded was a “significant improvement in portfolio efficiency for a retiree.” The following table summarizes the results of their research. When Advice Matters MostResearch conducted by Aon Hewitt and managed accounts provider Financial Engines provided similar results that reinforced the value of good financial advice. Their initial research was conducted from 2006-2008 and compared those receiving some form of advice to those who did it themselves. Their finding during this particular time frame was that those who received advice outperformed those who did not by 1.86% per year (net of fees). 2009-2010 was a period of even greater volatility and, when they measured this time period, they found that those receiving advice outperformed by 2.92% per year (net of fees). These results are consistent with the conclusion from Vanguard’s study that the benefits of advice are “lumpy,” meaning they are disproportionately experienced during turbulent market cycles when investors are most prone to emotional decision-making. Their findings are broken out in the chart below which compares – per age group – those who received some financial help as compared with those who did not. These various studies, along with others like them, are making a consistent case for the cumulative value of sound financial advice. And, though the findings range from 1.5% to 3.0% depending on the research and the factors involved, good financial advice does appear to have a substantial, quantifiable benefit. The components of this benefit include rebalancing, behavioral coaching, asset location, withdrawal strategy, and asset allocation, among other factors. Problem Spotting In addition to these quantifiable aspects of wealth advice is a more qualitative benefit which we’ll call the “financial well-being”. A separate study released by the Financial Planning Standards Council set out to determine the level of personal financial preparedness of respondents who had a comprehensive financial plan as opposed to those who had either light planning or no financial plan. They discovered that 50% of those who had engaged in comprehensive financial planning were confident in their plans to retire compared to just 22% of their peers with no financial plan. Additionally, 60% of those with a plan felt prepared to deal with unexpected financial emergencies as compared with only 28% of those without a plan. Financial well-being comes from knowing you are working with a wealth advisory team who is asking questions no one else is asking to help insulate you against problems you may not have even considered. The main reason people lie awake at night worrying about stuff is fear of the unknown. To the extent that an advisor surfaces the unknowns ahead of time and considers the implications of all the various components of clients’ plans, (s)he is providing financial confidence. Good advisors are like detectives, looking for things that may endanger your financial situation. Having expertise in a wide range of financial planning topics as well as a solid understanding of your goals allows the wealth advisory team to “stress test” your current plan in order to spot potential gaps, find problems, or uncover opportunities. Benefits that Cannot Be Measured Consider the health care industry… If the goal is not just to treat sick people but to avoid sickness as much as possible – in other words, to be healthy – then it is increasingly about prevention. Likewise, at Brown and Company, we work with successful clients whose need is not to treat financial sickness but to preserve their financial health. In other words, it is preventative. Being preventative means we’re anticipating bad things that could happen by considering all the different ‘what-if’ scenarios and planning for those. This is what we call our Plan BTM. None of the research we cited addresses this aspect since it really can’t be quantified, but this “financial well-being factor” is often the most important value provided to clients. Wealth advisors are expected to deliver value to their clients, and clients need to understand what they can expect for the amount they pay for advice. We hope this provided you with a better understanding of the value of comprehensive wealth advice in general and, more specifically, the type of advice that we believe is worth paying for.