The value of professional financial advice
Underappreciated by clients and their advisers
In our Russell Academy program, we focus on adviser value in a number of areas: client segmentation, service level design, professional referrals, to name a few. However there is one topic that will reliably come up, and reveal very different schools of thought: adviser charging.
In the past, financial advice business models were most often transactional, with an upfront initial fee and an ongoing trail fee of 0.5% paid annually from the product that was sold. This style of advice provision suited large client bases who proactively came to their adviser when they needed additional services or advice.
Today’s leading financial advisers have abandoned this business model and are embracing the Jerry Maguire mantra of deeper more engaged relationships with fewer, higher value clients. Not only is this more enjoyable for the adviser, more efficient and lower risk for the business, but the client gets the attention they deserve without the risk of cross subsidising a long tail of unprofitable clients, where sometimes those that shout loudest get noticed.
Many advisers offer a full wealth management service providing comprehensive advice on a client’s financial affairs for a fee of 1% of total assets. Even though they recognise they are paying for a valuable professional service, some clients (and even their advisers) find it difficult to adjust their mind-set from that 0.5% trail fee model plus ad-hoc initial fees. Clearly appreciating and articulating the value of advice can bridge that gap.
But considering adviser value in the context of adviser charging is to miss the bigger picture – the value that advisers bring is more than just the additional benefit received over and above the adviser fee.
In this paper we intend to quantify that value by looking at the additional return that a client receiving advice beyond just investment selection may receive, as well as the monetary value of less tangible factors.
Quantifying adviser value
Behavioural biases by investors
Surely the most under-recognised contribution a financial adviser makes to a client’s wellbeing is the ‘hand-holding’ that helps investors stay on track to meet their goals and resist taking action in response to emotional stress.
The aim of many speculative investors is to ‘buy low and sell high’, however a combination of the time it takes for information to reach individual investors and ‘greed and fear’ behavioural biases mean that more often than not the result is the opposite.
The chart below shows net retail fund investment from 2004-2014, overlaid with the return of a US equity index (the Russell3000) for the same time period. There are exceptions, but the singular trend across the chart is when the market is high or rising there are net inflows of funds, and when the market is low or falling there are net outflows.
A key role for an adviser is to help manage the “buy high, sell low” biases inherent in us all.
Figure 1: Investors are wired to look for patterns: The Russell3000 equity index and individual investor fund sales, 2004 – 2015
Source: Industry flows into equities. www.ici.org/research/stats.Russell 3000. Data as of January 7, 2015. Index performance is not indicative of the performance of any specific investment. Indexes are not managed and may not be invested in directly. Data shown is historical and not an indicator of future results.
How can we quantify the effect of this particular trait? The next chart shows how the “average” equity investor’s portfolio – accounting for the investor’s buys and sells – performed relative to the same index over the 30-year period between 1984-2014. The analysis confirms again that typical investors tend to chase performance; they typically flee after equity markets go down and rush back in after they’ve already gone up. This chart shows how much that chasing could have cost: 2% annually!
Figure 2: The high cost of investor behaviour, 1984-2014
(1) BNY Mellon Analytical Services, Russell 3000® Index annualized return from January 1, 1984 to December 31, 2014.
(2) Russell Investment, Strategas & Investment Company Institute (ICI). Return was calculated by deriving the internal rate of return (IRR) based on ICI monthly fund flow data which was compared to the rate of return if invested in the Russell 3000® Index and held without alteration from January 1, 1984 to December 31, 2014. This seeks to illustrate how regularly increasing or decreasing equity exposure based on the current market trends can sacrifice even market like returns. Indexes and/or benchmarks 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
2% in additional return potential for an investor working with an advisor compared to the average investor
Advisors are extremely valuable in that they can be the behaviour coach who helps investors avoid chasing trends and buying during market highs and selling during market lows. In this instance, the value of an adviser is 2%.
Tax efficient saving and investing
It can be challenging for clients to understand the best tax structures for their financial affairs. The complicated rules and regulations, together with the pace of change of legislation means that an adviser with such knowledge brings huge benefits to an advisory relationship over time.
In fact, in many cases the benefits to a client from IHT planning, pension planning, capital gains management for example, can be in excess of investment return. The best advisers ensure they calculate and record these accrued benefits to remind clients of the great work that is being done on their behalf.
Let’s take pension contributions for the purpose of this study. An individual without advice may be forgiven for being cynical about pension contributions; it means locking away savings for decades and those investments are then at the mercy of successive government’s legislation and tax changes; conversely people often view ISA contributions as an important way to save tax efficiently.
Take Tom, who begins putting away £300 per month for his retirement at age 30. But convinced by peers to ensure access and control he opts to save this into ISAs. His contributions increase by 4% per year to his retirement at age 63 at which point his annual contributions were £13,134, and, having achieved a return of 4%p.a. over the 34 years his untouched ISA savings total £464,424
0.95% for tax-efficient investment solutions
Tom draws down £30,000 per year in retirement and his pot depletes at age 86 at which point he is dependent on his state pension.
If Tom had been advised simply to split his contributions 50:50 between an ISA and a personal pension, all other things being equal (and assuming he is a higher rate tax payer throughout), at retirement Tom’s assets total £619,232. Taking the same £30,000 a year income in retirement his pot still totals £377,033 at age 86 and at age 90 Tom’s assets remain a healthy £307,806.
To achieve the same outcomes in the ISA-only scenario, Tom would have had to achieve a 4.95% return throughout, 0.95% higher than then he did when using a more diverse range of tax-efficient solutions.
Annual rebalancing of investment portfolios
Many individual investors may avoid, lack the time, or simply may not realise the importance of a consistent rebalancing policy.
We looked at how different rebalancing strategies effect return and risk over the long term, and the results are summarised in Figure 3 below.
For illustrative purposes only. Sample portfolio consists of: 30% Russell 1000, 5% Russell 2000, 15% Russell Developed ex-U.S. Large Cap Index, 5% Russell Emerging Markets Index, 5% FTSE NAREIT All Equity REIT Index, and 40% Barclays Capital Aggregate Bond Index.
0.30% in additional potential portfolio return while a potential reduction in portfolio risk of 1.6%
Based on this study, the advisor who had set an annual rebalancing policy had the ability to potentially add 0.3% in additional annual return along with the (often overlooked) potential reduction in risk of 1.6% versus a buy-and-hold investment strategy over the course of 27 years.
Certain behavioural biases can make it particularly challenging to commit to a disciplined rebalancing approach during trending markets. However retaining focus on the big picture and the long-term value of rebalancing can help investment outcomes.
Peace of Mind
The value that clients derive in simply knowing that their affairs are being taken care of is significant, but almost impossible to quantify. In our Russell Academy work we particularly focus on a subset of psychological well-being most relevant to financial advice: that of goal-setting and goal-achievement. Interestingly, studies show that the setting of goals alone can be as rewarding as the achievement of them2.
0.2% for peace of mind
The tools we use are designed to help clients work with their adviser over time on disentangling and clarifying their aspirations, and setting them down with a roadmap for achieving them. Doing this alone has been shown to have a disproportionate effect in positive well-being.
In reality the value an individual client derives from peace of mind is dependent on that individual. But this concept of goal setting and achievement gives us a relevant framework to calculate value for this critical function, and is precisely the kind of work that life-coaching services provide which, for the purposes of this study we are using as an equivalent to calculate the value generated.
The Association for Coaching3 estimates that average cost per hour for a coaching session between £125 and £150 when offered in a business context. Taking the lower of these values, and assuming a quarterly meeting, that equates to 0.2% annual value for a £250,000 client.
The bottom line
If we sum up the individual components discussed here, the value an adviser’s services individually may be 3.45%.
While this can only be viewed as a semi-scientific analysis of adviser value, it does expose the senselessness of trying to seek financial advice at the lowest possible price point; a good financial adviser is worth so much more than that, particularly when is it something as important as you and your dependants’ financial security.
For financial adviser, it is also an important exercise in recognising the important work they do and ensuring that clients are at the very least profitable.
According to the Financial Planning Association’s 2011 fee study, a financial planner spends 1 to 3 hours during the initial discovery with a new client and 3 to 14 hours building the financial plan with an average cost of £1800.
On this basis, by providing a financial plan with ongoing goal and risk tolerance monitoring, the value of both the initial plan and ongoing adjustment are worth approximately 0.8% on a £250,000 account.
And don’t forget, this is just an analysis of the monetary value a good financial adviser brings. Ask any adviser what their client most values, and they will inevitably answer, “our relationship”.
Try putting a figure on that – as Warren Buffet says, “Price is what you pay, Value is what you get.”