Investment Advisor as Personal Trainer
A good personal trainer helps you choose exercises that are appropriate to your level of fitness. The trainer encourages you to work a little bit harder, which can accelerate your path to fitness. A personal trainer also helps you avoid exercises that are likely to cause injury.
A financial advisor provides similar benefits. A financial advisor helps you invest in areas that are best for your level of financial fitness, including areas you might not think about. A financial advisor can help you avoid decisions that could injure you, such as overreacting to swings in the market, or buying and selling in ways that increase your tax liability.
Fund Returns vs. Investor Returns. Most people assume that an investor who invests in a fund will receive the same returns as the fund. Surprisingly, that is not the case. Investors tend to sell when the market drops, and then buy back in as the market rises. This amounts to an unintentional strategy of “sell low, buy high.”
A Vanguard analysis found that for all types of equity funds, average investor returns were lower than the returns of the funds they invested in by an average of 0.81% per year over a 10-year period, and the results varied from year to year. For 2021, the last year of the analysis, investors averaged 1.32% lower returns than the funds they were invested in.
When Will You See the Benefit of Working with an Investment Advisor? The behavioral coaching value of a financial advisor is not something you will see every month or even every year. Over a period of years, Vanguard reports that an advisor’s behavioral coaching can add as much as 2% per year, and they emphasize that the benefit is likely to be provided irregularly, over time.
Sources: Vanguard, “Putting a value on your value: Quantifying Vanguard Advisor’s Alpha,” Advisor’s Alpha Perspectives, July 2022; Russell Investments, Value of an Advisor / 2022.
How Valuable is Working with an Investment Advisor?
A good advisor can add value in each of the areas of Empathy, Evidence, and Equations.
Vanguard reports that a good advisor can add 3% or more to your annual returns through behavioral coaching plus a combination of lower cost investments, tax-smart asset location, withdrawal strategy, and rebalancing. (This means, for example, an annual return of 4% could be increased to an annual return of 7%.)
Morningstar reports that “gamma” (the value added by making better investment decisions) can be as high as 22.6% through a combination of holistic asset allocation, dynamic withdrawal strategy, tax efficiency, and focus on funding liabilities. (This means, for example, an annual return of 4% could be increased to an annual return of 4.9%.)
A Canadian study by Claude Montmarquette and Alexandre Prud’Homme found that households that used financial advisors had asset values anywhere from 50% to 290% higher than comparable households without a financial advisor. The study found that, in general, the longer the households had worked with an advisor, the greater the differences became. The study also found that advisor benefit was especially high in periods that included financial crises.
Sources: Vanguard, “Putting a value on your value: Quantifying Vanguard Advisor’s Alpha,” Advisor’s Alpha Perspectives, July 2022; David Blanchett and Paul Kaplan, “Alpha, Beta, and Now … Gamma,” Morningstar Investment Management, August 28, 2013; Russell Investments, Value of an Advisor / 2022; Claude Montmarquette and Alexandre Prud’homme, “More on the Value of Financial Advisors,” Cirano, 2020RP-04.
