The Benefits of an Advisor

Simply put, the value of a good advisor should greatly outweigh what it costs.

Most investors can probably build their own lifetime plan and build a diversified investment portfolio utilizing information and research found on the web. There is also an ample amount of inexpensive and powerful investment software available. It’s not an impossible task. The question: is it likely?

Based on our experience, we found it is not likely. Human nature disqualifies the argument that most investors can stay disciplined and stick to a plan without any help. The value of an experienced advisor in helping the investor stay on track, avoid major mistakes that can be detrimental to their wealth, and save the time and worry expended trying to do it themselves will greatly exceed the cost of the advice. Furthermore, we have found few investors have the emotional discipline and desire to implement financial decisions on their own.

Many studies show the value of advice can add between 1.5% and 4% to annual account growth over time. A study by David Blanchett and Paul Kaplan (Alpha, Beta, and Now...Gamma, 08/28/2013) measured the excess return and value from making intelligent financial planning decisions on a retirement portfolio. The research concluded the total benefit was approximately 29% higher, which was equivalent to generating 1.82% per year of excess return.

A later study by Russell Investments (Why Advisors Have Never Been So Valuable, 2017) found the contributory value of an advisor in the U.S. is calculated at 4.08% per year. Of course, these studies contain caveats and are based on assumptions that may not be relevant for all investors. However, these studies open the door for more discussion about the value of a financial advisor and how that value far exceeds the cost.

The full equation of an advisor’s value includes building and maintaining an investment portfolio, rebalancing, behavioral coaching, financial planning, and tax savings. For purposes of this website, we won’t attempt to quantify each value proposition but will leave it up to the reader to determine if there is value. Value is subjective, and it can vary from individual to individual.

Below are some examples of how advisors add value:

Asset Allocation/Building the Investment Portfolio

Asset allocation refers to the percentages of an investment portfolio invested in various asset classes, such as stocks, bonds, and cash equivalents. The goal is to align the investor’s asset allocation with their tolerance for risk, financial situation, and time horizon. A good advisor will build a portfolio based on the investor’s goals, not on a prediction on the economy or financial markets.

Rebalancing

Establishing the right asset allocation is one of the most important factors in determining long-term investing success. This requires ongoing maintenance in order to produce the investor’s desired result and control risk. This occurs through a process called “rebalancing,” which restores the portfolio to its original asset allocation and risk profile. Because some of the investment holdings in a portfolio will invariably do better than others as the financial markets rise and fall, an investor’s portfolio can drift away from its target asset allocation over time. It is helpful to recognize that, while rebalancing involves trading, it has a different goal than market timing.

Another benefit of rebalancing is it has the effect of withdrawing capital from the highest-priced/lowest potential asset class and redeploying it into the lower-priced/higher-potential asset class. Essentially, buying low and selling high. Furthermore, rebalancing provides discipline to an investor to help offset innate behavioral biases.

Determining when and how to effectively rebalance requires constant monitoring of the portfolio and awareness of tax status and cash flow. Also, rebalancing is not necessarily free. Associated costs include taxes and transaction costs. An advisor adds value by weighing the cost benefits and minimizing costs.

Behavioral Coaching

The main driver of long-term investment returns is not investment performance but investor behavior. This is one of the most important points. Because investing can evoke so many emotions, a good advisor can help investors maintain their long-term perspective and a disciplined approach. There is ample research that illustrates the average investor grossly underperforms the overall market because of fairly common and predictable behavioral mistakes. These include performance chasing, speculative euphoria, and panic at market bottoms. A good advisor will ensure investors don’t veer off the path of their well-crafted financial plan and destroy their rationally diversified portfolio of the right kind of investments needed for the realization of their most important financial goals.

Humans suffer from many cognitive biases when it comes to investing. A cognitive bias is a systematic error in our thinking that ultimately affects our decision. Many investor biases can get in the way of sound financial decisions and potentially cost investors in the long run.

• Projection bias is the tendency for people to assume that whatever is happening at the moment will continue to happen in the future. Because of this bias, the common reaction to this news from an investor who doesn’t have sound financial counsel will more often be to abruptly sell a portion or all their investment portfolio. They do this because they are projecting. They feel if the financial market drops today, it will continue to drop in the future. Even if there is no fundamental analysis to support this thesis.
• Action bias is a belief by an investor that doing something is better than doing nothing. Meaning, when change occurs, investors believe they need to do something like sell or reallocate investments rather than doing nothing, even if abstaining from taking action is in their best interest. Assaulted by the 24/7 internet and cable financial news media, the investor is constantly made to feel that they ought to do something.
• Herd bias is the phenomenon where investors follow what they perceive other investors are doing rather than sticking to their plan and using their own information to make decisions. Investors who suffer from this bias feel that they will be left behind if they don’t act in a similar fashion to other people they know. When people are afraid, they tend to rely on the herd to guide them. Overreliance on the herd distorts the information investors use to make sound decisions.
• Confirmation bias is when an investor unconsciously selects information that supports their beliefs and ignores alternative information. Investors generally don’t want to know how they are wrong but want to know how they are right. This is mainly because any evidence that challenges an investor’s belief is usually considered a threat. Research shows the investors will usually seek out evidence that is confirming and has low standards when it comes to the quality of evidence that supports their views. Investing needs to be approached as unemotionally as possible, and investors should always seek disconfirming evidence.

Many investors feel that they are not average and that these many biases will not affect them because they are smarter than the average investor. This leads to another bias called “the bias blind-spot.” This is defined as the inability to recognize that we suffer from the same cognitive distortions that plague other investors. In the world of psychology, this is known as “illusory superiority” or the “Lake Wobegon Effect” where humans overestimate their own abilities, achievements, and performance. In an infamous statistic, 80% of drivers think they are above average drivers. This illusory superiority translates to investing as well.

Investors should recognize that they are subject to these biases and a good financial advisor can help guide them through the various market stages and eliminate these biases. Investing needs to be approached as unemotionally as possible, and a good advisor will help remove the emotion.

Tax Savings

An advisor can help an investor minimize their tax bill by identifying strategies to improve tax-efficiency. The benefits can be substantial when you work with an advisor who incorporates tax planning into the long view. Some examples include:

• Optimizing investments across taxable, tax-advantaged, and tax-deferred accounts
• Employing tax-efficient strategies when buying and selling investments
• Harvest losses, when appropriate, to offset gains or income
• Using appreciated investments to make charitable donations or gifts

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Bill Davis is a CERTIFIED FINANCIAL PLANNER? and Managing Partner with Vericrest Private Wealth LLC, a financial advisory firm in Newtown, Pennsylvania. We provide fee-only, objective advice to our clients.

Vericrest Private Wealth LLC ("Vericrest") is an SEC registered investment advisory firm.??The information provided herein should not be?construed as personalized investment advice and should not be considered as a solicitation to buy or sell any security or investment advisory service.?Past performance is no guarantee of future results, and there is no guarantee that future investments will be profitable.? ?While we believe that third party information provided is accurate, Vericrest does not guarantee or otherwise warrant such information. ?For more information please contact Vericrest or refer to the Investment Adviser Public Disclosure website?(www.adviserinfo.sec.gov) to review important disclosures about our firm.