During a recent meeting with one of our advisors, the principal of a RIA firm that we serve, the topic of an advisor’s value came up. He offered to share the article with me. Over the years, there have been numerous articles written on the topic, and many that I have seen tend to center on the ability of advisors to help prevent clients from making emotional decisions about their investments, and stay consistent to an agreed upon plan. Without a doubt, this is an area that advisors can add considerable value for their clients.
The article shared by the firm principal was produced by Russell Investments just shy of three years ago, and I believe just a relevant today as when it was released. The title of the report is, “Value of an advisor is still more than 1%”. The report breaks down four components for estimating an advisor’s value. I will cover them briefly below, and provide a link to the original document at the bottom of this post.
The author of the post presents quantifying the value of an advisor with an equation:
A + B + C + P > Advisor’s Fee
I will review each briefly and explain my perspective on each. For a more in-depth review, you can view the original post below.
A – stands for Annual rebalancing of investment portfolios. The author equates that advisors provide 0.93% in additional potential portfolio return by having a structured annual rebalancing process. They cite a study by Russell Investments between July 1996 and September 2011 comparing; Buy & Hold, Annual Rebalancing, Quarterly Rebalancing, and Monthly Rebalancing. In short, all three rebalancing strategies outpaced the Buy and Hold strategy for Annualized Return, and Annualized Standard Deviation.
B – stands for Behavior mistakes by individual investors. For this factor, Russell cited an internal study of how the “average individual equity investor’s portfolio performed” over a 29-year period. The study demonstrated that the “average equity investor” underperformed the Russell 3000® Index by 2.2% annually. The activity that takes most of the blame for this is the tendency for individual investor to act on emotion, and relative to what is occurring in the “market”. Most notably, buying high when the market is moving up, and selling low when the market has gone down over a short period.
C – stands for Cost of investment-only management. The author estimates the value of investment-only advice at 0.35%. Since the writing of this original post, this is the area that has seen compression, and it could be argued that the current figure is even less than 0.35% now. The advisors feeling the most pressure on this factor are those who offer investment-only advice.
P – stands for Planning costs or the costs of providing a financial plan. The author of the post provides details about a 2011 Financial Planning Association study about financial plans. The author points out that in order to help clients meet their financial goals, a financial plan is a must. In short, the author estimates that the value of this factor is 0.85% (0.60% for annual planning, and 0.25% for other planning-related services).
To add that all up, 0.93% + 2.2% + 0.35% + 0.85% = 4.33% > Advisor’s Fee
It is important to understand the services your advisor provides, and how they are compensated. It is also important to note that not all advisors will provide all of the services outlined above. Be sure to confirm what services they provide.
Here is a link to the original post: Advisor’s Value More Than 1%