Hannah Boundy, CFA®, CFP®
How Having a Good Advisor Can Improve Your Bottom Line
In 2001, Vanguard began studying what they call Advisor’s Alpha. Put simply, if alpha is a measure of outperformance, then Advisor’s Alpha offers us insight into the additional outperformance generated by having a financial advisor. As the study points out, the traditional value proposition for financial advisors has been outperformance of a benchmark – typically a stock market index. Over time, the difficulty of outperforming the market has become clearer. Not only do actively managed funds struggle to consistently outperform a passive index, but the fees and expenses that come with managing a portfolio present a high obstacle. In contrast to this performance-based proposition, the Advisor’s Alpha study has offered a different proposition based on the services received from an advisor and their impact on an individual’s greater financial picture.
As the wealth management industry has evolved, we’ve discovered that while pursuing outperformance through actively managed portfolios may inefficient, there are tangible returns to be had through good financial planning and behavioral coaching. With regards to the latter, we see the potential for improved returns simply by offering clients access to a well-diversified portfolio that allocates risk based on the client’s situational and emotional ability to tolerate risk. This allows us to aid the client in weathering the ups and downs of the market, thereby reducing underperformance resulting from excessive trading and buying the highs and selling the lows. Smart portfolio management in combination with thoughtful tax-planning also allows us to generate additional returns simply by reducing the amount of wealth subtracted from a client’s net worth as a result of taxes. Finally, the advisor model offers what Vanguard refers to as “time, willingness, and ability” or what might also be described as specialization. There is value to be had from delegating something that may have taken you ten hours to figure out to someone who may only need two hours in order to confidently come up with a solution. When time is a precious and finite resource, there is worth to be had from being able to spend more of it doing what you care about and are good at.
“Rather than placing its major focus on investment capabilities, the advisor’s alpha model relies on the experience and stewardship that the advisor can provide in the relationship.” - Vanguard's Advisor Alpha Study
A similar study by Russell Investments posits that the value derived from having an advisor can be attributed to five major categories: annual rebalancing, avoiding behavioral mistakes, minimizing the cost of investing, utilizing financial planning, and being tax efficient. In 2017, they suggested that additional returns derived from having help in these categories could be quantified at roughly 4%. Another study by the financial technology firm Envestnet, concluded that a similar set of categories would generate roughly 3% of added value. Furthermore, a study from researchers at Morningstar concluded that the value added from making better financial planning decisions, something they've termed as "Gamma," was about 1.5%. While there's certainly still more to be learned regarding the benefits of professional financial advice and how best to quantify them, there is a growing body of evidence that suggests that there is true, quantifiable value to be had.
Whether it’s working with your CPA to help make sure you’re using the most efficient investment vehicles to increase your after-tax returns or reviewing your employment benefits to make sure that you’re getting the most out of your job, you deserve a financial advisor that is worth their fee and more. At Sherwood FP, we believe that having a good financial advisor can have a legitimate impact on your bottom line and we seek to be a firm constantly searching for ways to increase our Advisor Alpha – both tangibly and intangibly. Wherever you’re at in your journey, we’d love to partner with you to help you find lasting peace when it comes to your finances.
Bennyhoff, Donald G., and Francis M. Kinnery, Jr. "Vanguard Advisor’s Alpha®." Vanguard, July 2018. Accessed June 26, 2019. https://personal.vanguard.com/pdf/ISGAA.pdf.
Blanchett, David, and Paul Kaplan. "Alpha, Beta, and Now…Gamma." Morningstar, August 28, 2013. Accessed June 26, 2019. https://www.morningstar.com/content/dam/marketing/shared/research/foundational/677796-AlphaBetaGamma.pdf.
"Capital Sigma: The Advisor Advantage." Envestnet PMC, 2019. Accessed June 26, 2019. https://www.investpmc.com/sites/default/files/documents/PMC-CAP-SIGMA.pdf.
"WHY ADVISORS HAVE NEVER BEEN SO VALUABLE." Russell Investments, September 2017. Accessed June 26, 2019. https://russellinvestments.com/Publications/US/Document/2017_Value_of_Advisor_study.pdf.