The value of using a Financial Advisor

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It's difficult to quantify the value of financial advice.  Historically, financial advisors have been paid commissions on the products they sell and many of these fees have been largely hidden.  In Canada over the next few years this appears to be changing where more and further disclosures will bring those fees front and center for the consumer and the question will no longer be "what am I paying for advice?" and instead it will turn to "what am I getting for that fee?" This is a critical question for consumers and advisors alike.  Vanguard has completed a study on exactly this topic, and the results are very interesting. 

 

The paper was written by Donald G. Bennyhof CFA and Francis M. Kinniry CFA in 2012, and it breaks down the "alpha" for advisors into a few points.  First I should note for readers who are unfamiliar that the term "alpha" in the world of finance is often used to represent the amount over and above the market return (which is called beta).  The summary of this paper is that advisors have a better chance of adding alpha for their clients by "... through relationship-oriented services, such as providing cogent wealth management and financial planning strategies, discipline and guidance, rather than by attempting to outperform the market."  An interesting start to quantify the value of financial advice. but not an actual quantification per se. It concludes by saying that advisors should  

 

"...consider a new value proposition based on alternative skills and expertise: acting as a wealth manager and behavioral investing coach, providing discipline and experience to investors who need it. On their own, investors often lack both understanding and discipline, allowing themselves to be swayed by headlines and advertisements surrounding the “investment du jour”—and thus often achieving wealth destruction rather than creation. In the advisor’s alpha framework we’ve described, the advisor becomes an even more important factor in the client-advisor relationship, because the greatest obstacle to clients’ long-term investment success is likely themselves. " 

 

Here I think we get a good sense of the qualitative value that an advisor can provide, but nothing qualitative. Vanguard has completed another research paper this spring though, and this goes a little further in trying to put some numbers to that earlier paper.  You can see a link to their PDF here which explains the value added by a financial advisor and how they come to those figures.  The overall impression they leave is that financial advisors add about 3% per year to their clients portfolios, and that is achieved in a number of ways.  Let's be clear here; a boost of 3% per year to a portfolio is enormous!  So how does that happen?  Some of these factors are purely relationship based, and have little to do with actual investment returns and portfolio management as you can see below: 

 

 

 

Of course there are other things that an advisor does for their clients that are closer to investment management, particularly in the areas of behavioral finance and investment behavior in general.  This could be anything from initially suggesting that investment in a particular area or sector could be prudent to helping you find the courage to stick with an investment in times you might otherwise want to pull the plug.  As you can see from the graph below, many investors have mastered buy high and selling low: 

 

 

Advisors are definitely not always right; I certainly wouldn't want to imply that or give that impression at all. The important thing to realize here though is that an advisor reviewing your situation and going through things with you is not emotionally invested, and that is the significant difference.  So while you might feel some sense of urgency to make a particular move the advisor with a good temperament will be able to slow things down and help you take a reasoned and rational approach.  That is very difficult to put a value on consistently, but it certainly adds some peace of mind as well as potentially adding to your longer term financial performance.