finance
I also run into many financial advisors who are convinced their services are so valuable they should be paid millions. In the last couple of years, advisors have taken to pointing toward two studies, one by Vanguard and one by Morningstar, that seem to argue that the services of an advisor provide an incredible amount of value.
DIY investors are fond of adding up all the asset-based fees associated with advice and extrapolating them out for decades. For example, they might use 1% for the financial advisor fees, another 1% for the mutual fund expense ratios and commissions, and another 0.5% for the account fees (such as a 529 or a 401(k)).
Vanguard did a study a few years ago, and their conclusion is routinely trotted out by financial advisors trying to convince you to use their services. The conclusion is that an advisor adds “about 3%” to the returns of a typical client. If you’re paying 1%, and getting 3%, well obviously you’re coming out ahead.
The Morningstar study discusses three greek letters—the well-known “alpha” (beating the market, as attempted by stock pickers and actively-managed mutual fund managers with negative success on average), the equally well-known “beta” (the market return captured by an index fund), and a new, unknown letter, gamma, which they describe as the value added by an advisor.
There are three main criticisms of the DIY argument. The first is that it ignores the effects of poor returns on AUM fees. For example, lots of investors think that having an advisor you pay 1% to reduces your safe withdrawal rate from 4% to 3%, or costs you about 25% of your potential retirement spending.
The second criticism is that it ignores taxes. That extra return you get from not hiring an advisor should be reduced by the tax cost of that extra return. If the return is LTCG/qualified dividends in a taxable account and you’re in the top tax bracket, it should be reduced by 23.6%.
The third criticism of the DIY argument is simply that it ignores value. As Oscar Wilde said, “a cynic is a man who knows the cost of everything and the value of nothing.” I was cynical before I ever went to medical school, and I would be an extremely unusual person if I wasn’t more cynical after 7 years of education and training.
The Advisor
It should come as no surprise that some advisors are better than others. Not convinced of that? I encourage you to try an experiment I have undertaken over the last half-decade. I’ve invited financial advisors to apply to be listed on my recommended financial advisors page.
The Investor
The value of even a good advisor depends a great deal on the investor. Consider a physician who knows nothing about personal finance or investing. An advisor who can get this doc budgeting, saving, maxing out retirement accounts, investing in a reasonable plan, buying appropriate types and amounts of insurance, and staying the course through down markets has likely provided millions of dollars.
If you don’t feel you are getting good value for the fees, either renegotiate them, change to a less expensive or less comprehensive advisor, or take over yourself.