The value or ‘alpha’ a financial planner provides to their clients is a challenging metric to measure and goes far beyond investment returns . Financial advice should be unique to every client’s personal situation and goals and the timing, nature and outcomes of advice may be monetary or non-monetary. Given these quantitative and qualitative aspects to the planner / client relationship, is it even possible to measure the impact of advice and what is the value a planner adds?
Forbes published an article in 2015 looking at the value of financial advice and focused on studies completed by Vanguard and Morningstar. Some key points from these studies are summarized below:
Vanguard’s Advisor Alpha
Vanguard developed their Advisor Alpha concept in 2001. The info graphic below shows their overall estimate for Advisor Alpha is 3% on a net basis (4% less an assumed 1% fee). Vanguard explain their objective is to shift the focus away from “traditional beat-the-market objectives” (i.e. traditional alpha) toward what they view as the “best practices of wealth management.” These best practices are separated into several categories that focus on tax efficiency, costs, risk management, and making good investment decisions:
(1) Build a customized investment plan aimed at achieving goals and meeting constraints for risk tolerance and risk capacity
| > 0% | suitable asset allocation with broadly diversified investments |
| 0.45% | focus on low-cost investments (low expense ratios) |
| 0 – 0.75% | locating assets properly in taxable and tax-advantaged accounts |
| >0% | focusing on total returns investment instead of income investing |
(2) Minimize risks and tax impacts
| 0.35% | rebalancing to the strategic asset allocation |
| 0 – 0.70% | deciding where to draw assets from (tax-deferred or taxable) to meet spending |
(3) Behavioral coaching
| > 1.5% | providing support to stay the course in times of market stress |
Overall net impact of good advice: about 3%
Morningstar’s Gamma
Morningstar created a similar study about the value of good decision making and their research is more directly focused on how retirees can achieve higher income, which they call gamma. Morningstar left out issues like behavioral coaching, and included other matters like dynamic retirement spending. The dimensions for improving financial decisions considered in their paper are broken down into several issues, along with how a naïve investor might approach each issue and how an improved outcome could be achieved with the guidance of a professional. Working with an adviser, a client may make improved financial decisions resulting in an increased retirement income. The improved outcome scenario comes out 22.6% ahead of the naïve investor.*
By it’s very nature, value is subjective, however, where the client is at the centre of a relationship, they should experience value from a collaborative relationship with a financial planner, acting in their interests. Whether this advice results in improved investment returns, objective decision making or both, working with a trusted planner in a long term relationship should result in a beneficial outcome.
*Source: Forbes ‘Value of Financial Advice’ July 21, 2015