Quantifying the Value of Advice

Earlier this year, the investment firm Vanguard released the results of a major study attempting to quantify the value of financial advice to investors. While the study was based on the US population and not in Canada, there’s every reason to accept the results for their general approach to value. 

The study concludes that, for a variety of reasons, proper financial advice may lead to improved investment returns of up to 3% over time – above that of returns achieved by do-it-yourself (DIY) investors. 

The study identifies several areas where a professional advisor can add value above and beyond that offered through financial planning and risk management strategies applying to life and health insurance needs. The major areas are: 

1. Asset Allocation 
2. Cost-effective product usage 
3. Rebalancing 
4. Behavioural coaching 
5. Asset location 
6. Income/withdrawal strategies 

Interestingly, while we may value asset allocation greatly, the study fails to quantify the value of appropriate allocation, simply stating that the value is significant, greater than zero, but the quantity is unique to each investor based on their personal risk tolerance, time horizon, and financial goals. This is well-paired with section 4 – behavioural coaching. 

In a world where we are increasingly aware of the costs related to portfolios, Vanguard (a notably low-cost producer of index ETF products) states that cost-effective investment choices can add up to 0.45% to returns by selecting lower cost products. Advisors at our firm assess the relative costs and benefits of the investments recommended so that clients benefit from a value judgment. When so much space in the media is focused on cost, we look at the benefit provided by each unit of cost. Simply selecting the lowest cost product is insufficient – we are looking for value, which I define as the relationship between cost and benefit. 

Rebalancing is a core function of proper portfolio management, which the study quantifies as adding up to 0.35% to returns. Once an asset allocation strategy is chosen and implemented, it is important to maintain that allocation over time. If one subset of the portfolio becomes overweight for an extended period of time, an implicit “call” is being made to shift the original allocation strategy. We often call this “portfolio drift”. 

The greatest return enhancement comes from behavioural coaching, at between 1% and 2%, which Vanguard found in its own study as well as in the results of other studies. While we go through an asset allocation strategy at the beginning of portfolio construction and follow through with appropriate rebalancing transactions as warranted, every once in a while, it is necessary for the advisor to engage in behavioural coaching duties. This was evidenced in the 2007-2009 market and financial crisis and to a lesser extent market downturns in 2011 and now 2015. 

To quote from the study, “Because investing evokes emotion, advisors must help their clients maintain a long term perspective and disciplined approach… Most investors are aware of these time-tested principles, but the hard part is sticking to them in the best and worst of times… Abandoning a planned investment strategy can be costly, and research has shown that some of the most significant derailers are behavioural; the allure of market timing and the temptation to chase returns.” 

Good advisors will act as a check to emotional responses. A professional understands that people have emotions; however, investing is chiefly a rational undertaking, like piloting a plane. We all have seen the calm displayed several years ago by Captain Chesley Sullenberger, who put a passenger plane in the Hudson River after a bird strike on takeoff, executing a perfect landing. Like the best pilots, professional financial advisors spend a lot of time training, monitoring systems, making small adjustments, but often our greatest value comes in to play on those occasions when a crisis comes. We don’t panic, but make a rational assessment of what to do based on the facts at hand in each case. 

Asset location can add up to 0.75% and is less talked about, yet plays a vital role in how clients experience their returns. Because of how the returns on different asset classes are taxed, investors can enjoy more tax-efficient returns by (typically) placing fully taxable interest-bearing products in RRSP/RRIF accounts, and those investments that earn capital gains and Canadian dividends in Open/Taxable accounts. 

Income strategies add up to 0.7% to returns when clients have both RRSP/RRIF and also Open accounts. Understanding when it is best to draw taxable income from a RRIF as opposed to an Open account over a client’s lifespan is a part of financial planning, not traditional investment management. Each client case is unique, and a good advisor seeks to understand as much about the client to make the best recommendations. 

We don’t always tell our clients all the steps we take in providing and implementing our advice, but these are just some of them. 

Please contact your advisory team if you have any questions.