The marketplace for financial advice is changing if recent research is any guide. Simply stated, there are other (and better) measures past portfolio return to determine whether your financial advisor is performing well. In financial terms, does your advisor generate “alpha” or results that are better than those you could achieve on your own?[i] As the marketplace for financial advice evolves there are valuable services beyond portfolio investment returns that your financial advisor should provide to you as part of the relationship.
Financial research revealed some time ago that few “active” fund managers consistently beat broad market averages. Many active managers beat market performance by sheer luck or by taking risk they fail to disclose to clients. Moreover, many managers will trade frequently, seeking in vain to “time the market.” This raises costs, generates unwanted taxes and diminishes your returns.
But don’t sack your financial advisor just yet. Complex financial markets and the intricacies of life argue more than ever for good investment advice. One study identified that asset allocation — the alignment of stock and bond categories to your risk tolerance — explains two thirds of your portfolio returns. Asset selection – the choice of specific stocks, bonds or funds to include in your portfolio explains the remaining third.[ii] A good advisor will tailor your portfolio to meet your specific needs, which gives you control, flexibility, and transparency as you maximize returns and minimize costs.
But your advisor should deliver more value. First, good advisor will be a fiduciary — they will act in your best interest and they will submit to the oversight that keeps your interests front and center.
Next, your financial advisor will listen to you and understand your goals. They should show you where you are today and provide you a roadmap to take you where you want to be. They will bring research, experience, and consult specialized expertise where your circumstances require. The roadmap will be tailored to your unique goals, risk tolerance, and needs such as investment, cash, estate planning and timing. A very skilled advisor will understand your most important financial asset — your ability to generate income — and will incorporate education and career decisions into the picture. The advisor will review the plan with you as necessary and will watch for changes in conditions and your circumstances that call for adjustments.
Third, a good advisor will help you pay the taxes you must and no more. For many individuals, this is a high return area. They will remember that taxes are a feature, not the center of the plan. They will focus on goals, minimize your total tax bill and defer payments where possible so your assets can generate returns for as long as possible.
Fourth, your advisor will identify and help you mitigate risks in your plan. A good financial advisor will help you avoid costly mistakes along the path and help protect you against the ones you can’t avoid.
Fifth, your advisor will make sure you always have some spare cash — “dry powder” — to seize opportunities that arise. These will often come from rebalancing that keeps risk in line with your goals or from periods where other more fearful investors sell assets at “fire sale” prices. Spotting and taking opportunities consistent with your goals helps you to buy low and sell high.
Finally, perhaps the most important role the advisor can play is that of the “financial coach” who keeps you on the road to success. Much as a personal trainer who encourages good nutrition and exercise so you can have the health you want; a good financial advisor will keep you on the financial road that will help you achieve your goals.
How valuable is a good advisor? Research indicates that these five things done well can yield up to three percent of returns above what you could achieve by going it alone. Perhaps more significant, the most valuable elements require judgement, discretion and encouragement — things that a “robo advisor” will not do for you.
On your own, suppose you could secure a 3% return after taxes and fees. An advisor who could find that extra 3% for you would turn $10M into almost $18M in ten years compared with the $13.5M you would achieve on your own. Work with an advisor to find more returns, stick with it for a few decades and the additional returns compound. You and your advisor will multiply your initial investment many times over, your goals will arrive faster than you think, and you’ll have room for more. ■
[i] Donald G. Bennyhoff and Francis M. Kinniry, Vanguard Advisor’s Alpha®, Vanguard Research, 2018 also Capital Sigma: The Return on Advice, Envestnet, 2016
[ii] Renato Staub and Brian D. Singer, CFA, “Asset Allocation vs. Security Selection: Their Relative Importance,” Journal of Performance Measurement, vol. 16, no. 3, p. 10.