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What is the Value of a Financial Advisor?

Is getting your finances in order one of your New Year's resolutions? Great! But your work may just be getting started. 

Getting to work on that resolution means diving into a lot of topics that many are unfamiliar with. From tax codes to mutual fund or ETF prospectuses, there is a lot to read and understand. Worst yet, wrong moves now can compound over time and end up costing you tens of thousands of dollars in the future. And for that reason, many turn to a financial advisor when looking to create their financial plan. 

Because the benefits of having a financial advisor are different for everyone, it has always been hard to quantify the help a financial adviser can provide. But thankfully Vanguard has a whitepaper out to help explain and asses what a financial advisor is really worth. 

 

Calculating the Value of a Financial Advisor

Vanguard's key finding? Financial advisors can add 3% "alpha" (or extra performance) per year. We'll look at exactly how in a second, but first - What would 3% mean to you? We can use our Compound Interest Calculator to find out:

Let's say you are still just getting started to really save and invest. You have $25,000 and put away $5,000. Too little to need the help of a financial advisor? Think again: 

 It is important to note that the performance in this graph is in no way indicative of expected or guaranteed performance with Hylland Capital Management. This is only an example, and is not intended as investment advice. 

It is important to note that the performance in this graph is in no way indicative of expected or guaranteed performance with Hylland Capital Management. This is only an example, and is not intended as investment advice. 

For even someone just getting started saving and investing, a 3% difference performance could mean a $100,000 difference over the next 20 years. 

Thanks to compounding interest, the effects are even more dramatic if you have larger amounts of savings:

 

 Again, it is important to note that the performance in this graph is in no way indicative of expected or guaranteed performance with Hylland Capital Management. This is only an example, and is not intended as investment advice. 

Again, it is important to note that the performance in this graph is in no way indicative of expected or guaranteed performance with Hylland Capital Management. This is only an example, and is not intended as investment advice. 

 

How Does A Financial Advisor Create Value?

Vanguard's paper finds 7 practices of advisors that add value:

  1. Cost Effective Investment Plan Implementation
  2. Disciplined Account Rebalancing
  3. Behaviors Coaching
  4. Asset Location
  5. Withdrawal and Spending Strategy
  6. Total Return Vs. Income Investing
  7. Suitable Asset Allocation 

 

1. Cost Effective Investment Plan Implementation

Vanguard says:

"Cost-effective implementation is a critical component of every advisor’s tool kit and is based on simple math: Gross return minus costs (expense ratios, trading or frictional costs, and taxes) equals net return. Every dollar paid for management fees, trading costs, and taxes is a dollar less of potential return for clients. And, for fee-based advisors, this equates to lower growth for their assets under management, the base from which their fee revenues are calculated. As a result, cost-effective implementation is a “win-win” for clients and advisors alike. If low costs are associated with better investment performance (and research has repeatedly shown this to be true), then costs should play a role in an advisor’s investment selection process. With the recent expansion of the ETF marketplace, advisors now have many more investments to choose from—and ETF costs tend to be among the lowest in the mutual fund industry."

Vanguard estimates that this practice alone would save the average investor 40 basis points, or 0.40%. 

For prospective clients of Hylland Capital, one of our first planning meetings entails looking at your current investment portfolio and analyzing what could be done better. 

portfolio-before.png
 This is just a made up example and is not a recommendation for your investment portfolio. 

This is just a made up example and is not a recommendation for your investment portfolio. 

That is just one example of how we can save clients money and improve their long term investing returns.

 

2. Disciplined Account Rebalancing

Rebalancing your investment account is both a way to manage risk and a way to help with long term performance. 

Investors typically set a specific asset allocation in their investment portfolios to control risk and achieve their needed returns. For example, a risk adverse individual may be 50% in stocks and 50% in bonds. 

But as time goes by, the outperformance of one asset class over another causes that weighting to get out of balance. After 10+ years of high stock market returns, like we have seen since 2009, that 50/50 portfolio may be 60/40 or 70/30. 

By regularly rebalancing investors can ensure that they are; reducing risk in their portfolio by preventing too high of an allocation to a certain investment, and reinvesting into assets at lower prices while taking gains in investments that have appreciated. 

Vanguard shows these effects in their paper:

 

rebalancing_effects.png

Vanguard finds that disciplined investing could boost performance by 35 basis points, or 0.35% on average, annually.

 

3. Behaviors Coaching 

Vanguard says:

"Based on a Vanguard study of actual client behavior, we found that investors who deviated from their initial retirement fund investment trailed the target-date fund benchmark by 150 bps. This suggests that the discipline and guidance that an advisor might provide through behavioral coaching could be the largest potential value-add of the tools available to advisors. In addition, Vanguard research and other academic studies have concluded that behavioral coaching can add 1% to 2% in net return."

Investors have historically been their own worst enemies when managing their portfolios. Buying heavily at market tops, in risky sectors, or getting scared of the the market at the wrong times. 

By providing support, an advisor can keep clients invested and in line with their long term plan.

 

4. Asset Location

Asset location refers to having investments in the right type of retirement and investment accounts. Investors will hold many types of investments, with many different characteristics and tax treatments. An investor with bonds, growth stocks, dividend stocks, MLPs, and foreign stocks in their portfolio has a lot to consider about how to allocate these investments. What securities should go into an IRA, or a ROTH IRA? What investments should be held in a taxable account, what investments produce special tax consequences even in a tax sheltered IRA? 

The answer to all these questions will vary depending on the investor. Vanguard estimates that the average investor could save 75 basis points, or 0.75% by properly allocating their investments. 

asset_location.png

 

5. Withdrawal and Spending Strategy

Vanguard explains:

"With the retiree population on the rise, an increasing number of clients are facing important decisions about how to spend from their portfolios. Complicating matters is the fact that many clients hold multiple account types, including taxable, tax-deferred (such as a traditional 401(k) or IRA), and/or tax-free (such as a Roth 401(k) or IRA) accounts. Advisors who implement informed withdrawal order strategies can minimize the total taxes paid over the course of their clients’ retirement, thereby increasing their clients’ wealth and the longevity of their portfolios. This process alone could represent the entire value proposition for the fee-based advisor."

Taking money out of an IRA vs. a ROTH IRA vs. a taxable account can make a big difference when you are retired. Not only are taxes a concern, but desiring to leave assets for heirs can effect this decision as well. 

We can help you optimize retirement withdrawal strategies. With our financial planning software, we can simulate many different withdrawal scenarios and see how your net worth is effected over time. 

withdrawal_strategies.png

And we can even use this information to pre-populate future tax forms, so you can see the effect your actions today will have on taxes a decade from now:

 

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Vanguard estimates that the average investor could benefit by 110 basis points, or 1.10% annually with a proper withdrawal strategy.

 

5 and 6: Suitable Asset Allocation and Total Return vs Income Investing

The last two practices will vary widely from client to client, but both center around constructing an appropriate investment portfolio for the client. 

First, many investors expose themselves too much to risky investments creating income-based portfolios for retirement. They also miss out on higher total returns by focusing on an investment's income potential instead of an investments capital gain potential.

incomevstotalreturn.png

With asset allocation, investors typically either fail to take enough risk in their investments (making it harder to achieve long term goals) or take too much risk (jeopardizing future financial independence). Vanguard says:

"It is widely accepted that a portfolio’s asset allocation— the percentage of a portfolio invested in various asset classes such as stocks, bonds, and cash investments, according to the investor’s financial situation, risk tolerance, and time horizon—is the most important determinant of the return variability and long-term performance of a broadly diversified portfolio that engages in limited market-timing"

And they conclude:

"The value-add from asset allocation and diversification may be difficult to quantify, but is real and important, nonetheless."

 

In Summary

Hiring a financial advisor costs money, 0.175% of your invest-able assets per quarter (0.7% per year) for Hylland Capital Management. But for many investors, getting help from a financial advisor is well worth the costs. 

Best yet, we charge nothing for our introductory meetings. Contact us today and set up a meeting to see what we can do for you:

For those interested, the Vanguard paper cited can be found here:

Quantifying Advisor "Alpha"

Matt Hylland