When it comes to managing finances and investments, there are two main options to choose from — DIY (or do-it-yourself) and hiring a financial advisor. The question you must ask yourself is simple: Which option is best for you and your family?
Research conducted by Vanguard could help answer this question. In a report titled “Assessing the Value of Advice,” Vanguard assigns an objective value to working with a financial advisor. According to the research, working with a financial advisor and receiving professional investment advice can result in a net portfolio return that’s approximately 3% higher than DIY financial and investment planning.
Of course, there’s a cost to working with a financial advisor that should be subtracted from this higher return to arrive at the net potential added by an advisor. Average fees charged by financial advisors are around 1% of assets under management for accounts with $1 million or less in assets, according to AdvisoryHQ, though there are many different types of fee arrangements and associated costs.
Three Value Dimensions
Vanguard compared self-managed investor accounts to an advisor model to arrive at this conclusion. They defined value “in the broadest sense, going beyond portfolio outcomes to include both financial outcomes and emotional well-being.”
The framework of the research defines the following three value dimensions as they relate to the services provided by a financial advisor:
- Portfolio value — This relates to an advisor’s ability to help clients devise optimal portfolio construction (including proper asset allocation) and assume the appropriate level of investment risk. It includes such factors as portfolio risk and return characteristics, tax efficiency, investment fees, and rebalancing and trade activity.
The researchers studied changes in portfolio diversification of a sample of Vanguard self-directed investors who switched to an advisor to determine the value of professional advice on portfolio outcomes. Advice led to “meaningful outcomes” for most investors, materially altering equity risk-taking for two-thirds of them and reducing cash holdings for about one-third of them.
- Financial value — This relates to an advisor’s ability to help clients attain financial goals related to saving and spending, managing debt, retirement planning (e.g., cash flow, income and healthcare costs), insurance and risk management, and legacy and estate planning.
The researchers calculated the forecast success rates of a sample of Vanguard self-directed investors who have set a retirement goal. Eight out of 10 of these investors have an 80 percent or greater probability of achieving a financially secure retirement while just two out of 10 are at risk of not achieving a financially secure retirement.
- Emotional value — This relates to an advisor’s ability to help clients achieve financial peace of mind. It includes such factors as trust in an advisor and the financial markets; financial success, confidence and a sense of accomplishment; and behavioral coaching.
The researchers estimated the fraction of value arising from emotional elements like a personal connection with and trust in a financial advisor. They determined that emotional outcomes account for 45 percent of total perceived value. The remaining 55 percent of perceived value is associated with functional aspects of the relationship with an advisor, such as financial planning, portfolio management and similar services provided by advisors.
Value Dimensions Broken Down
According to the research, the portfolio value added by working with a financial advisor could result in 1.2% in additional annual returns, the financial value could result in 1.0% in additional annual returns, and the emotional value could result in 1.5% in additional annual returns. For example, advisors can guide clients away from making emotional investing decisions like selling in a panic when markets drop or chasing after the latest “hot” stocks, mutual funds or ETFs.
There are other areas where financial advisors can add value beyond these three dimensions. For example, advisors can help clients implement wealth protection strategies to safeguard their assets from loss, as well as estate planning strategies to ensure the continuation of their legacy and tax avoidance strategies to minimize current taxes.
Different Kinds of Financial Advisors
Keep in mind that not all financial advisors are the same. Some advisors are classified as Registered Investment Advisors, or RIAs, while others are classified as broker-dealers. RIAs are held to a higher professional standard than broker-dealers when it comes to offering unbiased advice.
Specifically, RIAs are held to what’s referred to as a fiduciary standard. This means RIAs are required by law to offer financial and investment advice that’s best for the client, not for their firm.
Broker-dealers are held to what’s referred to as a suitability standard when offering financial and investment advice — this means that their advice must be “suitable” for the client’s needs at that particular time. The suitability standard is less stringent than the fiduciary standard in terms of the advisor’s obligation to make recommendations that are in the client’s best interest.
In addition, RIAs and broker-dealers are compensated differently. RIAs charge either a percentage of assets under management or a fixed or hourly fee. Broker-dealers receive most of their compensation through commissions based on the investment products they recommend and sell. Therefore, their advice could be influenced, at least in part, by how much money they will make based on their recommendations.
The only way to ensure that the recommendations you receive from your financial advisor are completely unbiased is to work with an RIA who must offer advice that is based on your best interest. Your interests will always take precedence over the advisor’s interests when you choose a Registered Investment Advisor.
Please contact us if you have more questions about the value of working with a financial advisor or the differences between an RIA and a broker-dealer.