How an advisor adds 3% in value

In March 2014, Vanguard published a paper quantifying how financial advisors can add value to their clients. Through their research, they concluded that an advisor can add “about 3%” to their clients. Now, not all of their strategies will lead to consistently higher annual returns but will add value over time. The paper found seven ways in which an advisor adds value.

1. Asset Allocation

Potential value-add: Value is deemed significant but too unique to each investor to quantify.

Asset allocation is the percentage of a portfolio invested in various asset classes such as stocks, bonds and cash. The asset allocation will vary widely depending on your financial situation, your ability to take risk and time horizon.

Asset allocation and diversification are two of the most powerful tools advisors can use to help their clients achieve their financial goals and manage investment risk.

2. Cost-effective implementation

Potential value-add: 0.45% annually by investing in low cost funds.

Net return = gross return – costs. So the lower your costs, the greater the net return.

In a low return environment, costs become even more important as a higher proportion is taken by fund expenses.

3. Rebalancing

Potential value-add: Up to 0.35%

The assets in a diversified portfolio will produce different returns over times, which leads to it drifting from the original asset allocation. Rebalancing is the practice of maintaining the asset allocation over time.

The goal of rebalancing is more to minimise risk rather than maximise growth. If risk isn’t an issue, you should invest in equities to maximise the equity risk premium but you should also be willing to accept increased volatility.

Vanguard ran figures from 1960 to 2013 for a portfolio of 60% stock, 40% bonds. They compared the results between rebalancing annually and just letting the originally weighting drift over the investment period. The portfolio that was allowed drift only had a marginally higher annual return (9.36% v 9.12%) but with significantly higher risk (14.15% v 11.41%).

The task of rebalancing can be an emotional challenge. With investing, people don’t like selling well performing funds, what if it grows even more? This is where an advisor provides the discipline to rebalance when you will fight against it most.

4. Behavioural Coaching

Potential value-add: Vanguard found that investors who deviated from their initial retirement fund investment trailed the target-date fund benchmark by 1.50%.

Abandoning a planned investment strategy can be costly, and research has shown that some of the most significant derailers are behavioural; trying to time the market and chase performance.

Advisors need to act as behavioural coaches, persuading their not to abandon markets when the going gets tough or not to go chasing the latest top performing fund (remember, past performance is that exactly, in the past. There is no guarantee that it will be replicated next year).

Vanguard found that the “average” investor who made even one exchange over the entire period from 2008 – 2012, trailed the applicable Vanguard benchmark by 1.50%. Those who stayed the course, lagged by just 0.19% (this can largely be accounted for by fees).

5. Asset Location

Potential value-add: 0% – 0.75% depending on your asset allocation and the amount of money.

Asset location is the allocation of your money between taxable and tax advantaged accounts. How can you minimise the impact of taxation on your investments?

6. Withdrawal order for client spending from portfolios

Potential value-add: Up to 0.70% depending on the amount of money and your marginal tax rate.

The order in which you take your money out of various accounts. Can you take money out of your ARF without going into the marginal rate of taxation? If not, it is better to leave this to last (besides imputed distribution), so you don’t have to pay income tax at the marginal rate plus USC and PRSI. Do you have investments taxed at CGT rates instead of 41% exit tax?

Managing the withdrawals from funds in a tax efficient manner can increase your wealth as well as adding to the longevity of the portfolio.

7. Total return versus income investing

Potential value-add: Value add is deemed significant but too unique to each investor to quantify.

Historically, retirees holding a diversified portfolio of equity and bonds could easily live off the income generated by their portfolios. Unfortunately, that is no longer the case. Investors who wish to spend only the income generated by their portfolios, the “income only” approach have three choices if their cash flows fall short:

  1. Spend less
  2. Reallocate investments to higher-yielding investments (and more risk)
  3. Spend the total return of their portfolio, which includes not only the income but also the capital appreciation.

Vanguard believes in the total return approach., which has the following potential advantages to the income only approach:

  1. Less risk – a total return approach allows better diversification
  2. Better tax efficiency – more tax efficient locations
  3. Potentially longer lifespan for the portfolio

Some of the Vanguard findings, you can implement yourself. Where the advisor adds value the most is by being there to stop you doing something silly when you shouldn’t; reminding you that you have a plan in place already and you’ve talked through what will happen when there is a market crash (there is always a crash). Who do you have to stop you doing silly things with your investments?

If you have any questions, please contact me directly at