The Value of a Financial Advisor

| September 4, 2013 | 0 Comments

We Americans tend to be a very optimistic bunch. It’s part of our national character and some might even say part of our DNA. Perhaps that’s why casinos are so popular despite certain knowledge that the odds are against us. How else could you explain spending $1 for a lottery ticket with odds against us of more than 175,000,000 to 1? (By the way, in investment terms, that means you’re investing $1 for an asset with an expected value of $0.0000000057.)

There is a fairly consistent body of research which suggests that the odds of finding an investment manager to ‘beat the market’ aren’t much better. If that’s the case, does working with an investment advisor improve your odds? If an advisor’s fees make it that much harder to beat “the market,” is there enough value added to justify the extra costs?

A 2012 study by mutual fund research company Morningstar approached the question from a holistic perspective, attempting to quantify the value of making better decisions about multiple financial topics like portfolio allocation and rebalancing, spending strategies, asset location and so-on. According to their research, making better financial decisions could add about 1.8 percent per year to a retiree’s potential income.

For example, one of the things that Morningstar looked at was portfolio asset location – the combined choice of which accounts to use to own certain kinds of assets, and which accounts to withdraw first, based on a person’s circumstances. By working with an advisor to optimize asset location, they estimated that a retiree could add about 0.5 percent per year to their retirement income. Morningstar also estimated that better asset selection (e.g.: more stocks, less bonds) could also add about 0.5 percent per year. Other factors accounted for the remaining 0.8 percent.

Financial Alternatives, an advisory firm in La Jolla, also surveyed research on the value added by investment advisors. They found that:

• Lower cost institutional investments, exchange traded funds and active tax loss harvesting could save up to 1.25 percent per year.
• Better diversification could add value by adding higher return for taking the same risks, or providing less risk for the same returns.
• Disciplined rebalancing can add up to 0.8 percent per year over simple buy-and-hold strategies.
• Purchasing undervalued securities rather than chasing the herd can add significant value. On average, buying stocks when P/E ratios are high can result in very poor future returns.
• Emotional mistakes (“get me out, I can’t take this anymore!”) can subtract up to 1.5 percent per year from investment returns. Just consider those who went completely to cash in 2008 or 2009 and missed even some of the recovery.

All told, they estimated that good decisions made with the help of a fiduciary advisor could add up to 4.5 percent per year to the investment returns an individual might achieve on their own. And that was just dealing with one single facet of financial planning: investments. Their review didn’t even consider the value you can receive on insurance, estate, tax or cash flow planning.

At the end of the day, it’s nearly impossible to quantify the value of financial planning advice because individual needs will be different and the amount or type of help received will vary from person to person.Keeping costs down is important, but looking only at the cost of advice can be shortsighted, too. Doing something yourself can save you money. But as any plumber or attorney can tell you, it’s usually a lot cheaper to get professional help the first time around than it is to pay someone to clean up the mess afterwards.

This column is prepared by Rick Brooks, CFA, CFP®. Rick is Vice President for Investment Management with Blankinship & Foster, LLC, a wealth advisory firm specializing in comprehensive financial planning and investment management. Rick can be reached at (858) 755-5166, or by email at Rick and his family live in Mission Hills.

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