It’s a question that’s been and will be asked by clients or prospective clients (at least in their mind) - Are you worth your fee? This may not have been verbalized by your client- but do not believe for a moment they’re not thinking it. Every-Time-You-Meet-Them. Understanding these concerns- which are justifiable – by the party at the other end of the conversation, how does the advice giver demonstrate to the client/prospective client their value?
If you are a practicing CPA/CPA firm, there are tangible ways to validate your advice (although you may get the comparison to TurboTax/Jackson-Hewitt/H & R Block), however if you’re a Registered Investment Advisory (RIA) Firm or Certified Financial Planner practitioner- it can be somewhat of a challenge. Why? You cannot guarantee investment performance- nobody can. And performance of investments is the sole purpose most investors believe- falsely driven by the financial media and market prognosticators- they engaged you or your planning firm.
Again, I ask- Are You Worth Your Fee?
Research from an independent source say- Yes, you are. However, before providing the data in the study, this doesn’t cover ALL advice providers in the financial industry. You see, to add value- they must DO these activities. And as a certified financial planner (CFP®) for eighteen of my twenty-five years in this industry- most do not. Sad. But true.
Now, as Paul Harvey would say- is the rest of the story.
Russell Investments provided an annual report titled 2020 Value of An Advisor Study, “...which looks holistically at the real, measurable value advisors deliver for their clients, in their portfolios, and in vital services advisors provide. We developed a formula to calculate the full value equation of an advisor’s services.”
The formula and services analyzed were as follows:
A- Annual rebalancing of portfolio
B- Behavioral mistakes individual investors typically make
C- Cost of basic investment-only management
P- Planning cost and ancillary services
T- Tax-Smart planning and investing
Once the cost of the services is added up, they’re compared to the average Annual Advisory Fee in the industry- which is typically around 1 percent per year. The formula created was meant to quantify (as most of what an advisor provides are intangibles) both the technical and emotional contributions provided by an advisor.
Annual Rebalancing- +0.32%
One may not believe that rebalancing provides a difference in the lifetime return of the average investor, however if anyone with an adult memory recalls the peak of the dot com bubble- you know it most certainly did. In its simplest form, a properly diversified portfolio is built to match the investors most cherished long-term goals, based on the clients’ plan (more on this later) and the historical market returns of each asset class.
As the chart below reveals (a hypothetical balanced index portfolio) in January of 2009, if the allocation was based on the clients financial plan and then never touched (rebalanced)- it has morphed into a much different blend ten years later in 2019 (The allocation of 55% Equities/40% Fixed/5% Real Estate to 73% Equities/22% Fixed/5% Real Estate). Unintentionally the portfolio, left to the ebbs and flows of the market, has evolved from a typical growth and income mix to growth. Not a bad allocation, if this was the intent but most likely it was not.
To further illustrate, the actual dollar figure of how rebalancing annually added value to the client’s long-term goals from March of 2005 to December 2019 is depicted in the chart below:
Although it may not seem to be a large percentage (0.32%) but applied to a portfolio beginning at Half-a-Million dollars that has grown to 1.4 Million vs. 1.3 Million, $100,000 is a nice difference in additional gain for the client. Accomplished by just rebalancing once per year.
The next question may be, “when” should the rebalancing take place? Simple. As close to the same day each year as possible. Why the same day? Because anything other than this and the advisor/client become a “closet market timer.”
Why wouldn’t every investor do this? Annual Rebalancing is countercultural to what the average performance junkie does- buy high (or adds to what is going up) and sell low. Rebalancing forces the portfolio, which is a servant to the client’s plan, to sell what has just shot the lights out and add the proceeds to what has been in the doghouse. And cognitively/behaviorally, it’s not an easy thing to accomplish- hence countercultural.
Behavioral mistakes- +2.17%
Human Nature is a failed investor (sorry to be the messenger of historical fact). Our prehistoric brain, proven with the rise of Behavioral Science, is hard-wired with cognitive bias and heuristics that lead the average investor to react to market events as a perceived threat (shown below as the monthly inflow and outflow of money from Mutual Funds/ETF’s). This behavior is no different than how the caveman would react to the threat of a Saber-Toothed Tiger at full charge, fangs protruding.
As the chart below depicts, from January 2000 to December 2019, $100 constantly invested in the Russell 3000® Index more than tripled in value to $350. By the way, those that chose to stay in cash during that period missed a cumulative return of nearly 250%, based on the Russell 3000® Index.
Although we’re no longer running from saber-toothed tigers, the stimulus we are running from, financially, elicits the same physiological responses. In other words, when it comes to financial decisions, we tend to act like knuckle-dragging cave people (Monthly Mutual Fund & Passive ETF Flows).
The investor behavior gap (Annualized Cost to Retail “chasers”) is shown from Russell Investment research below as the comparison of the Average Investor vs. the Passive Russell 3000 Index:
Behavioral Finance tells us we have over 200 different cognitive bias (aren’t we lucky), the most common to investors pitfalls are the following:
Cost of investment-only management- +0.29%
The next obvious question- What would the cost be for a Robo-Advisor? According to Russell Investment; Robo-advisors that deliver investment-only management and no financial plan, ongoing service, or guidance have set prices at approximately 0.29%1 —for annual statements, online access, and a phone number to call in case of questions.
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 some may argue, an Investment Policy Statement (IPS). Being a self-proclaimed voice of reality, if this is all the advisor is providing, the client is most likely better off at a Robo-advisor. The “Asset Allocator” may have been sufficient in the years prior to the 1990’s, but not anymore. How can one be certain of the prior statement? There is NO historical evidence for the persistence of performance. None. So, planning is the way to financial freedom- hence the process below.
The Certified Financial Planning Board Code of Ethics and Standards of Conduct list 7 practice standards for the financial planning process:
The question was asked; How much does the financial planning component cost nowadays? Per a financial planning study conducted by Kitces, the average standalone planning fee for a comprehensive plan was around $2,080, which is 0.52% on a $400k account(2)In addition, what’s the value of typical ancillary services an advisor and their team offer? The value of the ancillary services provided to clients, such as addressing insurance needs, custom requests, and questions. These additional services can quickly consume 20, 50, or 100 hours each year. If the advisor is providing these ancillary services, Russell Investments estimate that the total planning fee goes up by an additional 0.20%.
Now adjusted, the average standalone planning fee for the most comprehensive plan with comprehensive plan with ancillary services was around $2,880, which is 0.72% on a $400,000(2)
Tax-Smart Investing- +1.31%
How much return can be added with a tax-smart approach? According to Russell Investments, the average annual tax-drag for the five years ending December 31, 2019 was significant. Investors in non-tax managed U.S. equity products (active, passive, and ETFs) lost on average 1.85% of their return to taxes. Those in tax-managed U.S. equity funds forfeited only 0.54%, that’s a value difference of 1.31%. With taxable investors holding $9.8 trillion of the $21.3 trillion invested in open-end mutual funds, this is a massive concern—and a massive opportunity for added value (3)
THE BOTTOM LINE- WHAT IS YOUR VALUE?
C- Cost of basic investment-only Management
P- Planning cost and ancillary services
TOTAL VALUE OF ADVISOR
TYPICAL ADVISOR CHARGE FOR SERVICE
The bottom line: If the provider of advice cannot provide multiples of the value of their annual fee...the client should (and is better off) going elsewhere. According to Russell Investments, the advisor can provide said value- if he/she adheres to a comprehensive approach.
In full disclosure, Vanguard provided a similar study in March 2014 titled, Advisor Alpha. They believed that the total value an advisor provided was about 3% per year, broken down into the following categories below:
Below is the overview of the study (source: Vanguard- Advisor Alpha, March 2014):
About Lou Melone:
As a board CERTIFIED FINANCIAL PLANNER(TM) professional, Lou provides behavioral coaching and comprehensive retirement planning strategies for higher net-worth families to help protect and preserve current levels of wealth, plan for retirement, as well as, designing retirement plans for closely held businesses.
Lou holds a Bachelor’s Degree from Northern Michigan University and studied at the American College for his CFP® certification. Lou was a past President for the Clarkston Area Chamber of Commerce and is a consultant for the Michigan Association of CPA’s (MICPA) Financial Planning Task Force. In addition, he has been a previous columnist for DBusiness Magazine, contributor to the MICPA’s “The Business Edge” and Authority Magazine.
For nine (9) straight years, Lou was named in the June issues by Hour Detroit and Fortune Magazine as “Five Star Wealth Manager” in South East Michigan. This recognition is given to the top 7% of Wealth Managers* in the region.
Lou has been a featured speaker at the Michigan Association of CPA’s Mega/Summer Conferences for the past eighteen (18) years. In addition, he has provided webinars for MICPA members across the United States. The topics have ranged from Behavioral Finance, Comprehensive Financial Planning Process, and types of Qualified Plans for Small Business Owners. Lou has also provided planning/behavioral finance seminars to executive retiree groups at Fortune 500, as well as, numerous other small to mid-size companies.
Lou began his career with Dean Witter which evolved into Morgan Stanley. He then moved his practice to Smith Barney before forming Budd, Melone & Co., LLC with Co-Founder Joe Budd. Lou has worked for twenty-five (25) years in the financial services industry. He is currently the owner of Melone Private Wealth.
You can reach Lou Melone at firstname.lastname@example.org or 248-499-8704
For a pdf of this article The Value of Advice click here.
Disclosure:"Melone Private Wealth LLC (“Melone Private Wealth”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Melone Private Wealth and its representatives are properly licensed or exempt from licensure.
*Award based on 10 objective criteria associated with providing quality services to clients such as credentials, experience, and assets under management among other factors. Wealth managers do not pay a fee to be considered or placed on the final list of 2019 Five Star Wealth Managers.
"The inclusion of a wealth manager on The FIVE STAR Wealth Manager Award list should not be construed as an endorsement of the wealth nor should it be inferred that the responses used from the survey represent the experience of any clients. This award does not evaluate the quality of service provided and the wealth manager may have had unfavorable ratings. The rating is not indicative of the wealth manager’s future performance."
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.
The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
The CERTIFIED FINANCIAL PLANNERTM, CFP® and federally registered CFP® (with flame design) marks (collectively, the “CFP® marks”) are professional certification marks granted in the United States by Certified Financial Planner Board of Standards, Inc. (“CFP® Board”). The CFP® certification is a voluntary certification; no federal or state law or regulation requires financial planners to hold CFP® certification. It is recognized in the United States and a number of other countries for its (1) high standard of professional education; (2) stringent code of conduct and standards of practice; and (3) ethical requirements that govern professional engagements with clients. Currently, more than 71,000 individuals have obtained CFP® certification in the United States.
To attain the right to use the CFP® marks, an individual must satisfactorily fulfill the following requirements:
Education – Complete an advanced college-level course of study addressing the financial planning subject areas that CFP® Board’s studies have determined as necessary for the competent and professional delivery of financial planning services, and attain a Bachelor’s Degree from a regionally accredited United States college or university (or its equivalent from a foreign university). CFP® Board’s financial planning subject areas include insurance planning and risk management, employee benefits planning, investment planning, income tax planning, retirement planning, and estate planning.
Examination – Pass the comprehensive CFP® Certification Examination. The examination includes case studies and client scenarios designed to test one’s ability to correctly diagnose financial planning issues and apply one’s knowledge of financial planning to real world circumstances;
Experience – Complete at least three years of full-time financial planning-related experience (or the equivalent, measured as 2,000 hours per year); and
Ethics – Agree to be bound by CFP® Board’s Standards of Professional Conduct, a set of documents outlining the ethical and practice standards for CFP® professionals.
Individuals who become certified must complete the following ongoing education and ethics requirements in order to maintain the right to continue to use the CFP® marks:
Continuing Education – Complete 30 hours of continuing education hours every two years, including two hours on the Code of
Ethics and other parts of the Standards of Professional Conduct, to maintain competence and keep up with developments in the financial planning field; andEthics – Renew an agreement to be bound by the Standards of Professional Conduct. The Standards prominently require that
CFP® professionals provide financial planning services at a fiduciary standard of care. This means CFP® professionals must provide financial planning services in the best interests of their clients.CFP® professionals who fail to comply with the above standards and requirements may be subject to CFP® Board’s enforcement process, which could result in suspension or permanent revocation of their CFP® certification.
Market data was sourced using: Russell Investments July 2020, Advice Study Vanguard Advisor Alpha March 2014, Financial Planning Study KITCES April 2019 article.
IMPORTANT INFORMATION AND DISCLOSURES:
Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.
Diversification and strategic asset allocation do not assure profit or protect against loss in declining markets.
The Investment Company Institute is the national trade association of U.S. investment companies, which includes mutual funds, closed-end funds, exchange-traded funds and unit investment trusts.
Bloomberg Barclays U.S. Aggregate Bond Index: An index, with income reinvested, generally representative of intermediate term government bonds, investment grade corporate debt securities, and mortgage-backed securities (specifically: Barclays Government/Corporate Bond Index, the Asset- Backed Securities Index, and the Mortgage-Backed Securities Index).
FTSE EPRA/NAREIT Developed Index: A global market capitalization weighted index composed of listed real estate securities in the North American, European and Asian real estate markets.
MSCI Emerging Markets Index: A float-adjusted market capitalization index that consists of indices in 21 emerging economies: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
The MSCI EAFE Index is an equity index which captures large- and mid-cap representation across 21 developed markets countries around the world, excluding the U.S. and Canada. With 918 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country. Countries include: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the U.K.
The MSCI World ex U.S. Index tracks global stock market performance that includes developed and emerging markets but excludes the U.S.
The Russell 1000® Index measures the performance of the large-cap segment of the U.S. equity universe. It is a subset of the Russell 3000® Index and includes approximately 1,000 of the largest securities based on a combination of their market cap and current index membership.
The Russell 1000® Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.
The Russell 1000® Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 companies with lower price-tobook ratios and lower expected growth values.
The Russell 2000® Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership.
The Russell 3000® Index measures the performance of the largest 3,000 U.S. companies representing approximately 98% of the investable U.S. equity market.
Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.
Past performance does not guarantee future performance.
Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.
Russell Investments’ ownership is composed of a majority stake held by funds managed by TA Associates with minority stakes held by funds managed by Reverence Capital Partners and Russell Investments’ management.
Frank Russell Company is the owner of the Russell trademarks contained in this material and all trademark rights related to the Russell trademarks, which the members of the Russell Investments group of companies are permitted to use under license from Frank Russell Company. The members of the Russell Investments group of companies are not affiliated in any manner with Frank Russell Company or any entity operating under the “FTSE RUSSELL” brand.
Securities products and services offered through Russell Investments Financial Services, LLC, member FINRA, part of Russell Investments.
Copyright © 2020 Russell Investments Group, LLC. All rights reserved. First used: March 2020. Updated July 2020. RIFIS-22447
Our CPA Financial Planning thought leadership has been curated with the intention of explaining the benefits and basics of financial planning.
We work with CPAs every day and support their member organizations in a variety of ways, including speaking at MICPA events, providing relevant thought leadership and serving on planning committees.
Lou helps clients answer two questions:
1) Do you know exactly how much money it is going to take for you to retire comfortably
2) to remain comfortably retired?