When we need to make big financial decisions in life, most people look for a source of expertise and guidance to help make the best-educated decisions. This is often times where professional advisors, like myself, are called in to play.
The situations vary greatly of course, as does the type and quantity of the advice needed. But the big question that looms is what that advice will cost. The fees/costs involved in financial planning can vary greatly. Regardless, if you are like me when I have to pay a fee for something, I want to know what that cost is and what I will be receiving in exchange for the cost.
While advisors cannot promise returns, independent studies attempt to quantify what is exactly received by a consumer who pays for advice. These studies call it the “value” that a person receives. I’ve previously posted some studies that have been done, but here’s the latest study done by Russell Investments.
Russell says there are 5 main components to this “value” formula. Here they are, in alphabetical order:
- Annual rebalancing. This refers to buying and selling of assets in your portfolio. Rebalancing can be important to keep an allocation intact, i.e. buying more when investments are down, and selling when they are high. As simple as this may be, most people don’t do it and end up taking on more risk then they initially wanted. Rebalancing can take place annually, or more/less frequently depending on market conditions.
- Behavioral mistakes. I see this a lot. After 22 years, I can tell you that most investors do not act rationally and allow their emotions to interfere with sound decision making. Successful investing requires discipline, patience, and objectivity. Veering off track and making sub-optimal choices can be detrimental to any portfolio.
- Cost of investments. In addition to the cost for advice, there is a cost to the individual investments. Most of the time, this cost is not known unless you do some research. Costs can obviously eat away at portfolio returns, so it would be wise to be aware of the fees and what they are.
- Planning. As the old saying goes, “failing to plan is planning to fail”. Financial planning is a robust topic with many areas that need to be understood and addressed. In some way, shape, or form, have a plan and a good road map for where you are headed. Otherwise, you’ll risk operating inefficiently and be surprised of what will come up along the way that can derail you.
- Taxes. The world of tax is very complex and ever-changing. If you aren’t a tax expert, you should be surrounding yourself with people who are knowledgeable and guide your decision making. After all, it’s not about what you MAKE, but it’s what you KEEP. Tax planning is pivotal to making sure you are KEEPING MORE and successfully building wealth over long periods of time.
Thus the formula: A + B + C + P + T = VALUE OF AN ADVISOR
Now that we see the 5 components of the formula…how does that add up in terms of “value”? Various studies, including this 2017 one by Russell attribute anywhere from .20% to 2.0% from each of the above components. Cumulatively, the results suggest that an advisor may add 4+% in additional wealth. One would imply then, that if your advisor is charging anything less than 4%, you should be making out OK (the truth is advisors charge much less than that).
Knowing that all advisors charge for their expertise and services, it’s important to know that the quality of their advice can vary greatly. It can also change over time. Just because someone holds themselves out there as an “advisor”, you should not assume that they will be providing all the steps mentioned above. Nor doing so effectively.
Here’s the bottom line.
You should be working with someone you know. Someone you like. Someone you trust. And your advisor should be someone who is genuinely helping your unique needs and interests – not his/her own.
The relationship should be an ongoing and personal one, with open, honest, and helpful dialogue. And over time you should feel confident that you are getting substantial value which more than pays for the cost of the advice.