Is An Investment Advisor Worth the Cost?
Vanguard recently published a research paper that provides specific evidence that an investment advisor can be worth the cost. By how much? Vanguard says “the potential value added” is “about 3%.”
But the details are important. Not all advisors adopt the added-value strategy advocated by Vanguard:
- diversify across asset classes
- choose low-expense funds
- rebalance when needed
- locate investments by tax characteristics of account (taxable vs. tax-deferred vs. Roth)
- stick with a long-term strategy
Individual investors can be their own worst enemy, reacting to the most recent news, buying into an up-market and selling after a down-market. In his book, The Investor’s Manifesto, William J. Bernstein devotes 30 pages to a chapter titled “The Enemy in the Mirror.” The evidence shows that an investor who does not stick to a long-term strategy experiences lower returns over time. Vanguard says an advisor can add up to 1.5% in this area.
Advisor Added Value: create an asset allocation strategy for the client; stick to it.
The tax implications of investing are complicated, thanks to a byzantine tax code written by Congress over decades. Understanding where to place an investment (which account), when to sell an investment, and choosing an investment with a light tax footprint can add up to 0.75% of return, according to Vanguard. That’s an average number, and I’ve seen situations where it is much more, typically for high income individuals. I think most clients are not aware of the full value of tax-sensitive investing.
Advisor Added Value: minimize the tax impact of investing.
Mutual fund companies are like any other for-profit business seeking to maximize profit. So they spend their marketing dollars highlighting products that earn them the most profit. Fair enough. That generally means funds with high expense ratios. (Have you ever seen a Fidelity ad for their low-cost S&P 500 index fund?) Unfortunately the research shows those funds underperform lower-expense funds over long periods. (Read the article: Are Mutual Funds Free?) A fee-only Registered Investment Advisor (RIA) is required by law to act in the client’s best interest; if low-expense funds perform better over time, they are in the client’s best interest. But many individual investors don’t take the time to research which funds are a strategic fit for their portfolio AND have low expense ratios. Vanguard estimates that an advisor can add 0.45% in this area.
Advisor Added Value: use appropriate low-expense investments.
So does working with an advisor eliminate investment risk? No. The whole reason there is investment return is because money was put at-risk. In today’s low interest rate environment, “no risk” literally means “no return;” or more accurately, no risk means an after-inflation loss.
The most important question is: what is the appropriate risk for this investor? A good advisor will work with an investor to construct a risk-appropriate portfolio. That’s an important part of sticking to the strategy, which Vanguard says provides the most benefit.
Can an individual investor do all these things himself? Yes. But very few actually do, because they lead busy lives with other interests. Considering the size and importance of retirement investments, for most people it makes sense to hire a professional.
Disclosures: This article is of a general educational nature, not specific investment advice for an individual. Waypoint Financial Planning LLC does not have a relationship with Vanguard, but does use some Vanguard investment products for which it receives no compensation. Investing involves risk of loss. No investment advisor can guarantee a gain or any specific investment performance. Past performance is no guarantee of future results.