How much is your financial advisor really worth?

Steve Merrell |

A couple of years ago, Vanguard published a study trying to answer a very important question: how much is a financial advisor really worth? It was the second of two Vanguard studies focused on helping advisors look carefully at how they serve their clients. Although their paper was mainly meant for financial professionals, the Vanguard framework can help you evaluate the services you receive from your advisor.

The study divides advisory services into several distinct areas. These include asset allocation, behavioral coaching, cost-effective investment management, portfolio rebalancing, asset location, and withdrawal strategy. You may want to discuss these areas with your advisor to make sure your advisor is providing the value you need.

Asset Allocation – Asset allocation refers to how much of your portfolio is invested in various asset classes. The decisions you make about asset allocation are arguably the most important decision you will make with your investment portfolio. Best practice is to have your asset allocation formalized in a document called an investment policy statement, or IPS. Your IPS describes how the asset allocation will be implemented and managed over time. If you do not have a written investment policy, please discuss this with your advisor.

Behavioral coaching – It has been said that the financial markets turn on the emotions of fear and greed. Next to setting an appropriate asset allocation, the most valuable thing your advisor can do for you is to help you resist the pull of these emotions.

To better understand the value of behavioral coaching, Vanguard researchers compared the performance of 58,168 self-directed Vanguard IRAs with the performance of passively managed target date funds. They found that trading activity in the self-directed IRAs followed the market, meaning the investors bought after the market made gains and sold after the market declined. Overall, they lagged their passive benchmarks and the more actively the self-directed IRAs were traded, the more they lagged.

These results confirm the conclusions of several other academic studies—as a group, individual investors tend to buy high and sell low. Vanguard researchers estimate that behavioral coaching may add as much as 1 to 2 percentage points of annual net return. Does your advisor help you avoid the pitfalls of emotional investing?

Cost-effective investment management – Fees and expenses are a drag on your net investment performance. The more your advisor can reduce expenses, the better your portfolio will perform. While investing in some markets might warrant using funds with higher expenses, you are usually better off focusing your portfolio in funds that have expense ratios that are well below the average for funds of a similar style. Your advisor should periodically review your funds’ expense ratios with you.

Portfolio rebalancing – Over time, portfolios tend to drift away from their target asset allocation. Periodic rebalancing brings your portfolio back in line with its target allocation. Although rebalancing is primarily a risk management exercise, Vanguard’s researchers found that annual rebalancing can add as much as 26 basis points of risk-adjusted return relative to a portfolio that is allowed to drift. Ask your advisor about her rebalancing discipline.

Asset location – Asset location (as distinguished from asset allocation discussed earlier) refers to deciding which type of account is best for a particular type of asset. For example, growth-oriented investments held for the long-term are better suited in taxable accounts because the growth gets taxed at the more favorable long-term capital gains tax rates. Depending on your tax bracket and the size of your taxable portfolios relative to your IRAs, asset location decisions can add as much as 75 basis points to your net returns. Has your advisor discussed asset location issues with you?

Withdrawal strategy – The order in which you withdraw assets from your accounts can help minimize taxes and increase the longevity of your portfolios. This is especially true in retirement. In general, taxes are minimized if withdrawals occur in the following order: required minimum distributions (where applicable), followed by cash flows from taxable accounts, then liquidation of taxable assets, and finally other distributions from IRAs or other tax-advantaged accounts. If you are getting ready for retirement, make sure your advisor helps you develop an optimal withdrawal strategy.



Steven C. Merrell  MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey.   He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning.  Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to: