You know you incur fees to buy and own investments. You also know you’ll pay a separate fee when you hire an investment advisor to help you.
But is the investment advisor’s fee worthwhile? Or, stated differently, will the advisor’s services potentially enable you to earn more (net of all fees) than if you avoided the advisor and invested on your own?
Yes, according to Vanguard1, whose mutual funds manage about $5.1 trillion for investors worldwide. Even though the company is well-known for catering to “do-it-yourself” investors, its study has concluded that financial advisors may help increase their clients’ investment returns by about three percentage points.
How an Investment Advisor Can Help Produce Better Returns
Vanguard identifies several factors that contribute to these increased returns. The first and most significant pertains to behavioral finance: Keeping clients focused on the long term and urging them to stick to a regular investing plan can add up to 1.5 percent, the report says.
Indeed, two key behavioral factors that often hurt DIY investors’ performance are “the allure of market-timing and the temptation to chase performance,” Vanguard says. “Advisors, as behavioral coaches, can act as emotional circuit-breakers by circumventing clients’ tendencies to chase returns or run for cover in emotionally charged markets.”
This reminds me of the coaching — I might call it hand-holding — that many people received from their financial planners during the 2008 credit crisis. When some clients grew upset, they didn’t panic and sell. Instead, they were panicked and called, giving their planners the opportunity to reassure them that their investment strategy would get them through the crisis. Over long periods, Vanguard says, this is worth as much as 1.5 percent in returns.
Advisors may also increase returns by up to 0.75 percent by providing “thoughtful allocation of assets.” That refers to diversification — advising clients on how much to invest in stocks vs. bonds, gold, real estate, oil and gas, foreign securities and other assets. The right asset allocation may help increase returns, and Vanguard says professional advisors are better at this than consumers.
Another 0.40 percent can be generated in returns when advisors help clients keep fees low. In addition, rebalancing adds another 0.35 percent of value. We know very well how valuable rebalancing can be in portfolio management. Unfortunately, few investors rebalance regularly — if at all — on their own.
In addition, by carefully evaluating their mix of tax-free, tax-deferred and taxable accounts, advisors can help clients minimize the total taxes2 they pay over the course of their retirement through withdrawals, thereby increasing their wealth and the longevity of their investments.
The Hidden Value of an Investment Advisor
All told, that’s how financial advisors can add about three percentage points or more in net returns, according to Vanguard. We have two observations about the study.
First, those three percentage points are worth even more than they seem. If we take into consideration working with an advisor over the long term, you can see how this additional value can be impactful over time.
Second, Vanguard’s study was limited to investment results. It did not consider the additional services and advice that we offer. How much additional value do we generate for our clients through the advice we provide regarding their mortgages, employee benefits, credit and debt, taxes, insurance and estate planning?
How much time do we save our clients thanks to the record-keeping and tax-reporting chores we perform so that they don’t have to?
Stated another way, might it be said that the advice pays for itself? You’ll decide, of course. But if this wasn’t the case, few people would hire financial advisors.
If you’ve been uncertain about the value of an advisor, Vanguard has just quantified it for you.
1 Source: Vanguard Research – Putting a value on your value: Quantifying Vanguard Advisor’s Alpha – September 2016. Like any approximation, the actual amount of value added may vary significantly depending on clients’ circumstances.
2 Neither Edelman Financial Engines, a division of Financial Engines Advisors L.L.C., nor its affiliates offer tax or legal advice. Interested parties are strongly encouraged to seek advice from qualified tax and/or legal experts regarding the best options for your particular circumstances.