You are most likely paying for an investment advisor. The fees can be in the form of commissions if you’re working with a broker, be a percentage of your assets, and less commonly charged on an hourly basis or a flat annual fee. But how do you know you’re getting your money’s worth when working with a financial advisor? Certainly peace of mind is a big part of the value proposition for most clients. One colleague is in the habit of saying that “we sell sleep.” But how do you quantify the value of psychological well-being because you’re working with a competent financial planner? You can’t.
In a report issued last month, mutual fund behemoth Vanguard weighs in on the value of an investment advisor. While it acknowledges the importance of peace of mind, the report does a rigorous job of delving into the more measurable aspects of working with a wealth manager. Calling it “Advisor’s Alpha,” Vanguard describes the particular strategies that most help clients.
Now keep in mind that the folks at Vanguard are notorious cheapskates – and I say that with complete admiration. Their fees are rock bottom and they are well known as the all-around lowest cost investment company. So when this do-it-yourselfer company looks at the value of an advisor, my suspicion is that they would see little at all.
Vanguard’s surprising conclusion is that a quality wealth manager could add 3 percent annually of value to a portfolio. Luckily for us, they broke these value components down so you can see whether your current or future advisor uses these techniques.
Behavioral Coaching. Providing a whopping 1.5 percent of extra return a year, having your advisor work with you to stick to a strategy in good and bad markets is vital. In good markets, this can take the form of encouraging and educating you to not invest everything in stocks while the markets are rallying. In poor markets such as 2008, a good advisor can work to keep you invested even when global financial calamity seems to be at the door.
Asset location. This can add up to 0.75 percent a year to returns, depending on your situation. Asset location is the concept that there are different types of investment accounts: taxable, tax-deferred (IRAs and 401ks), and tax-free (Roth IRAs), plus some hybrids such as annuities and cash value life insurance. You should seek to optimize your tax situation by ensuring the right type of investment is in the right type of account. Do you hold a REIT Fund or a US small cap stock fund? Those could be great options in a Roth, an account where you’re never taxed on its gains as long as you follow the rules. Bonds and other interest generating options are good fits for tax-deferred accounts. By optimizing the asset location, your wealth manager can keep your tax bill down for years to come.
Spending strategy. While in retirement, you have a choice of different accounts to draw from when generating cash for your living expenses. Through prudent decisions on IRA distributions and drawing from other accounts, Vanguard estimates that up to 0.7 percent annually can be added to returns.
Rebalancing. A systematic method of selling your winners and investing the proceeds in your losers can add 0.35 percent a year to overall returns. Rebalancing sounds very simple when first considered, but care must be taken to do this on a regular basis and in a manner that minimizes taxes.
Cost-effective investing. Clearly Vanguard has a stake in this question, but they conclude that that careful selection of low-cost funds and other investments can mean 0.45 percent per year in value-add.
Asset allocation. Vanguard didn’t estimate the value of a prudent investment allocation – the percentage of portfolio in stocks and bonds – and portfolio diversity. Nevertheless, they state it’s the most important component of overall returns and portfolio risk.
What should we take from the Vanguard study? That there are many ways for a qualified wealth manager to help you in a way that exceeds their fee, but they must be diligent in using these elements in order for it to be worthwhile. The study can be found at http://bit.ly/1r5nRcn.