The Value of a Financial Advisor

More and more people are realizing they want to work with financial advisors who are Fee-Only (as opposed to Fee-Based), Independent, and act as a Fiduciary at all times.  These advisors are literally only paid for advice instead of receiving commissions for selling products.

As the demand for these types of advisors increases, it becomes vitally important to demonstrate the value of this advice.  Respected companies such as Vanguard and Morningstar have attempted to quantify the value of an advisor.

Vanguard first tackled this with Advisor’s Alpha.  It focused primarily on investment management and determined an advisor adds about 3% of value to a portfolio.  Importantly, half of this is due to behavioral coaching, such as not trying to time the markets. This is in line with the famous (and much criticized) Dalbar study which identified the behavior gap.  The so-called behavior gap exists when an investor’s returns are lower than the investment’s returns. Unsurprisingly, this behavior gap widens as volatility increases.

Morningstar did a similar study focused more on retirement called Alpha, Beta and Now…GammaTheir findings indicated the value of an advisor was around 1.82% by determining how much extra income a planner could get the retiree and solving for the increased rate of return that would have been necessary to match this higher income.

Most recently Vanguard attempted to expand on their earlier research and published Assessing the Value of Advice.  This finally expanded beyond simple portfolio management and included financial outcomes, such as increasing the probability of achieving a secure retirement.  The study also included emotional outcomes, such as increasing trust and confidence.

Vanguard found that 45% of the perceived value of working with a financial advisor came from emotional outcomes.  Not surprisingly, it is very difficult to measure some of these things. I believe this proves something I’ve long suspected.

The decision to hire an advisor is ultimately an individual one, even for two people who seem the same from a quantitative standpoint.  

As you contemplate whether or not to hire an advisor, or evaluate whether or not you are currently with the right advisor for you, you have to determine how much value you put on the services you receive, and this will be different for each person.

Broadly speaking, I think there are three areas you need to evaluate the value you would receive.  The first is the pure time savings to you. To manage your finances properly, how many hours would you need to spend per year?  This may be different from the amount of hours you are spending per year, which may be its own indication that working with an advisor may be right for you.  Now compare this to how many hours you would spend if you worked with an advisor and you can get a pretty good idea of this component of value.

The second area is the actual advice you receive.  This one is a little trickier to value but you can still approximate it.  By working with an advisor, would you save money on insurance? Pay off debt sooner or for less money?  Lower your tax bill? In short, would you make better financial decisions as a result of working with an advisor?  Will you avoid some costly mistakes?

The third component involves this pesky to quantify emotional outcome section.  Will you be more confident that you aren’t missing something you didn’t even know about?  Will you have less fear of market fluctuations? Will you have less stress about money? 45% of the value you receive from an advisor falls in the section according to Vanguard. 

Only you can determine if you will receive enough value in these areas for the cost you are paying.  If you will, then you should work with an advisor. If you will not, then maybe working with an advisor is not for you, or maybe you are working with the wrong advisor.