In my previous blog “Fee-Only vs. Fee Based” I discussed the different ways that a financial planning firm could structure their fees. Once you understand that, the next logical question is always…Are you worth your fee?
It may never get asked directly to a planner, but when I sit across from a perspective client and the topic of fees come up, I know they are thinking it to themselves. And don’t think for a second that you won’t do the same when you start working with a planner (or already do if you are currently working with one.)
So, why not get ahead of the conversation and show how a planner should be providing significant value. Hopefully by the end of this you will fully grasp how working with a planner can be worth multiples their fee.
Let’s dive in.
There are 5 different services that need to be looked at when discussing the value of a planner. And according to research from an independent source, if they provide these on a consistent basis they are absolutely worth their fee.
These 5 services are:
- Annual Rebalancing
- Behavioral Coaching
- Customized Client Experience
- Tax-Smart Planning & Investing
In fact, Russel Investments provides an annual report that touches on each of the topics. They even came up with a formula that looks holistically at the real, measurable value planners deliver to their clients. This formula was created to quantify (as most of what an advisor provides are intangibles) both the technical and emotional contributions provided by a planner.
So, let’s discuss how each is analyzed and the value added from each service above.
Annual Rebalancing (+0.17)
When the markets are rising, it can be easy to underestimate the importance of regular rebalancing. In its simplest form, a properly diversified portfolio is built based on a client’s long-term goals and the historical market returns of each asset class.
As the chart shows below, a hypothetical balanced index portfolio in January of 2009, if never rebalanced back to the initial allocation, would have morphed into an entirely different portfolio by December 31, 2020. In this scenario, equities would have increased 38% and fixed income would have decreased 50%. Not a bad allocation, if this was the client’s intent, but it most likely was not. Consequently, to get back to the client’s overall asset allocation and comfort level, which drives their long-term plan, you need to rebalance.
Behavioral Coaching (+2.02%)
This is by far the most overlooked topic in the formula but provides the most value added to a client. Let’s just look at 2020 as an example, which was a wild ride in the markets. Many investors were tempted to pull out of the markets in mid-March when the S&P 500 registered its largest weekly decline since 2008 - when it fell 33% from its high in February of that year.
Without the behavioral guidance of a planner, many investors would have sold in March. In fact, $335.6 billion was pulled out of U.S. equities in that month alone. These monies would remain out of the markets for some time waiting for the markets to rebound which they did at an extremely rapid rate (relative to other extreme dips in the markets we have seen throughout history). These individuals would have missed the rebound and, as the below chart shows, missing these days can be detrimental to a portfolio’s long-term-returns.
Investors who received the proper behavioral guidance should have been told to stick to their plan and stay invested through all the outside noise and would have benefited greatly.
To pile on even more, the average equity investor’s inclination to buy high and sell low has costs them 2.02% annually in the 36-year period from 1984-2020 (shown below). Which just goes to show how much value behavioral coaching can provide to a client.
Customized Client Experience (+0.82%)
When it comes to working with a planner many people ask, “well, what if I just worked with a robo-advisor? How much would that cost?” According to Russell Investments, a robo-advisor that delivers investment only management with no financial plan have a price around 0.22%. However, recent research from Russell Investments has found that investors are more willing to work with a planner who has a deep understanding of their individual circumstances and financial goals. This is where the human advisor has a significant advantage over the robo-advisors and can provide the extra value through a customized client experience. With the average planning fee being 1.04% of assets under management, the 0.82% difference from a robo-advisor allows a client to receive a wide range of quantitative and qualitative services as shown below.
The foundation of any successful planner/client relationship is a comprehensive financial plan. Let me state this simple but powerful fact one more time: it is the foundation. Anything less is smoke and mirrors wrapped in a bow of the asset management package – or what some may argue, an Investment Policy Statement (IPS for short). To be honest, if all you’re looking for is asset allocation and investment advice, which you see in many IPS’s, then you are better off using a robo-advisor.
To that point, Russell Investments shows that on average for an advisor to create this custom financial plan for their clients it takes an average of 7.7 hours. They estimate that an advisor’s average hourly rate is $400. This calculates to an additional $3,080 of value they can provide through financial planning or 0.62% based on a $500,000 account.
Tax Smart Planning & Investing (+1.20%)
Taxes can have a significant impact on the returns of an investor. Russell Investment’s research shows investors lose on average 1.74% of their returns from U.S. equities to taxes. A larger percentage than the total fees that most advisors charge.
That tax drag on a portfolio can add up quickly. For example, a $500,000 investment that had a tax drag of 1.74% annually compared to a tax managed fund’s tax drag of 0.54% annually would lose $105,000 due to taxes (assuming a 7.5% annual return), as shown below.
That difference of using a tax managed approach (1.20%) can significantly increase the money you have to work with and further invest over an extended period of time.
When we look at the formula that has been provided by Russell Investments, it is estimated that by delivering all 5 services the value you would receive as a client is 4.83%. When you compare that to the 1% advisors typically charge, the value outweighs what you would pay in fees.
The bottom line being, if you ever sit and ponder to yourself, “is this planner worth their fee?” and they don’t seem to provide the above services on a consistent basis, it may be time to meet with someone who can.
Source: 2021 Value of an Advisor Study, Russell Investments
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
Past performance shown is not indicative of future results, which could differ substantially.
Melone Private Wealth, LLC (“MPW”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where MPW and its representatives are properly licensed or exempt from licensure.