Is It Worth the Money to Hire a Financial Advisor?
Vanguard Study Calculates the True Value of a Financial Advisor
Among the most common questions financial advisors hear is, “Why on Earth should I hire you when I can manage my own money? I have a 401k and if I want to make other investments there’s a ton of information and advice available on the internet.”
We totally understand the question. Financial advice typically costs 0.5 percent to 1 percent of your portfolio per year. So, yes, people want to know if they are getting what they pay for.
Vanguard, one of the world’s largest investment companies, has been examining this question for 15 years. Based on research, analysis, and testing, Vanguard has concluded that, yes, there is a quantifiable increase in return from working with a financial advisor. Vanguard calls this advantage the Advisor’s Alpha. When certain best practices are followed, the result can be an Alpha in the 3 percent per year range.
A separate study by Russell Investments, a large money management firm, came to a similar conclusion. Russell estimates a good financial advisor can increase investor returns by 3.75 percent.
Not everyone wants or needs a financial advisor. About one-quarter of private investors are truly “self-directed,” according to Vanguard. These people truly enjoy investing. They obsessively follow the markets and enjoy creating and doing financial projections. Perhaps most importantly, these investors have an incredible level of discipline that prevents their emotions from intervening with their long-term investment strategy.
Given that three-quarters of us aren’t “self-directed” when it comes to money, it’s good to know that there is help available that can really pay off—in the right circumstances.
Vanguard says there are several ways in which a financial advisor can add value to your investment efforts. Among these benefits are guidance on developing an overall investment strategy, asset allocation, minimizing taxes, rebalancing, and how to structure/time withdrawals from your retirement accounts. Each of these services can incrementally boost a client’s returns—sometimes steadily, sometimes sporadically.
But the single biggest way a financial advisor can add value—up to 3 percent in net returns—is through something called behavioral coaching.
As every good poker player knows, scared money don’t make money. The best financial advisors are able to keep their clients’ fears and emotions in check by providing steady, fact-based advice and reassurance when the markets get wobbly or crazy. The Russell study also identified this as the single largest benefit of working with a financial advisor.
I can’t emphasize enough the importance of this function. A Vanguard study of more than 58,000 self-directed IRAs showed that investors who made material changes to their strategy EVEN ONCE in the five-year period from 2008 through 2012 suffered an 8 percent-plus hit to performance.
A Morningstar study shows that investors often receive far lower returns than the very funds they invest in. The reason: they run to funds after they have done well and ditch other funds right before they take off. In other words, they sell low and buy high. An advisor can prevent such counter-productive behaviors.