What is the Value of a Financial Advisor?

When starting out as a financial advisor, one of the more difficult processes one must go through is defining the value you add in your role for clients. It might not seem like such a difficult thing to do, but in a world where so much is determined in raw numbers (i.e. How much did your investments return last year?), defining and communicating your value as an advisor, which can be much more nuanced than simply expressing it as a number, typically takes time and experience.

Most professionals in any industry have to, at some point, be able to justify what they are compensated for, and the quality of their work, so it’s certainly not just financial advisors who are expected to do this. And I’m not talking about listing the five things I did last week that justify my employment here at TDWM (sorry, not sorry Elon.)

But due, in part, to the way financial advisors are generally compensated, that is, as a percentage of the assets they manage for a client, it is vital that an advisor is able to communicate his or her value to a prospective client. Because the question will inevitably come during the course of a client’s due diligence: “If I’m paying you 1% per year to manage my assets, are you providing more than 1% per year in value?” And if you’ve interviewed us here at TDWM, you’ll know that the answer we gave you is “no”. Not because we don’t think we provide even more than 1% per year in value to our clients; we most certainly do. The answer is “no” because, despite the temptation to define the advisor’s value as an annualized number, the true value of a financial advisor tends to be intermittent rather than consistent.

Now there are certainly some aspects of an advisor’s work that can yield an annual benefit, such as lowering expected investment costs, or increasing tax efficiency in a portfolio, but many of the significant opportunities for an advisor to add value come during times of market euphoria or duress, when a client’s fear or greed are triggered. And these opportunities tend to add value in much larger numbers than just tenths of a percentage point – more like tens of percentage points.

The problem is that these gains rarely show up on any investment statement, since they are often gains due to inaction, rather than action. For example, if an advisor keeps you from abandoning your investment strategy and stay invested according to your financial plan, especially during a sharply down market, the potential losses you would have incurred never show up in your performance numbers, but are significant nonetheless. And then there are the benefits of an advisory relationship that are even harder to define, such as the peace of mind of knowing that your investments are being monitored by a trusted professional at all times. Does that free you up to spend the little free time you do have doing something – anything – else? What might that be worth to you? The answer to that question likely differs from person to person, which makes expressing our value-add as an annual number difficult, if not impossible.

That said, starting about 10 years ago, the good folks at Vanguard set out to do just that, and have published a white paper called “Putting a value on your value – quantifying advisors alpha”. In this paper, Vanguard uses seven modules to “help quantify the benefit of an advisor’s alpha.” And the result is that Vanguard estimates the alpha (or value-add) of a client who utilizes the services of a financial advisor to be 3% or more per year.

Now it’s important to understand a few things about this paper. First, it is not really written for clients, but rather, for advisors. The point is to convince advisors that providing not just investment advice, and selling themselves on the performance of their investment portfolios, but comprehensive financial planning services as well, is the way to add real value for clients. Because the idea is not that simply hiring any advisor is going to add this kind of value to your financial performance over time. It is imperative that your advisor provides top-notch service, and fully supports you in the areas that are vital to success, such as comprehensive financial planning and advice.

And it is very clear that the gains experienced by clients will vary greatly based on the value that they place individually on such things as the freedom they are provided by having a trusted advisory relationship in place. But for those of us who have been defining and communicating the very same message since long before Vanguard tried to quantify it, it certainly does help frame what we have preached for so many years.

So what is the true value of a financial advisor? Is it 3% per year as the study suggests? Well, as with most things in life I suppose, it depends. It depends on what level of service your financial advisor is actually providing. It depends on what your peace of mind is worth, or how much you value the free time you would otherwise be spending managing your own investments or planning your financial future. In the end, I’ll be honest, 3% per year sounds about right to me; but I also know this – value, most definitely, is in the eye of the beholder.

This commentary on this website reflects the personal opinions, viewpoints and analyses of the Topel & DiStasi Wealth Management, LLC employees providing such comments, and should not be regarded as a description of advisory services provided by Topel & DiStasi Wealth Management, LLC or performance returns of any Topel & DiStasi Wealth Management, LLC Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Topel & DiStasi Wealth Management, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.