Recent research from Northwestern Mutual in its 2021 Planning and Progress Study found that just 38% of survey respondents were working with a financial advisor, though up from 29% pre-pandemic. With the emergence—and prevalence—of robo-advisors, where investing can be done with the click of a button on an app, the common question is, are financial/investment advisors truly worth it? We firmly believe that yes, an advisor is absolutely worth it. Here’s why.

Let’s talk about a bit of history first. In 1998, 60% of Fortune 500 companies offered employee pensions; this number dropped to 14% in 2019. The U.S. Bureau of Labor Statistics reported that 26% of all employees had access to a defined benefit plan in 2019 (though state and local government workers are grossly overrepresented here, with 86% having pensions vs. 16% of private industry workers). The massive shift from employer-managed pensions to employer-sponsored retirement plans (think 401(k)s) has also shifted the burdens of investment management and financial and retirement planning to individual employees. Combine that with the complexity and breadth of the stock market, financial products available, and tax laws and it’s easy to see how overwhelming that can become for any one person—especially someone not engrossed in the financial world.

The Four Pillars of Behavioral Risk in Investing

According to Dr. Daniel Crosby, the market returned an average of about 8% annually, but the average investor saw just over 4% in returns. Why? Poor investment behavior, including four risk factors: ego, emotion, attention, and conservation. According to G&M’s “The Four Pillars of Investor Misbehavior,”

• Ego risk is made manifest in behaviors that privilege our need for feeling personal competency at the expense of clear-eyed decision making. Ego risk leaves specific evidence of its presence in overly concentrated positions, churning, failing to plan or work with a professional, and the use of excessive leverage.
• Emotion risk stems from the fact that our perceptions of risk are colored by both our transitory emotional states and our individual propensity toward positivity or negativity. Emotion leads most of us to underrate the possibility of bad things happening to us (optimism bias), to avoid even thinking about what might go wrong (ostrich effect), and to ignore the important role emotion plays in our decisions (empathy gap). When fear does break through, it can become so powerful that we can be immobilized by trying to avoid pain (negativity bias). Investors looking for examples of emotion bias in their decision-making should begin with periods of market turbulence
• Attention risk is born of our disposition to evaluate information in relative terms and let salience trump probability when making investment decisions. “Salience” is the psychological term for prominence, meaning that our attention can be hijacked by low-probability-high-scariness things like shark attacks while ignoring high-probability-low-scariness dangers. We also tend to rate the unfamiliar as riskier and show a preference for domestic stocks (home bias) and familiar names (mere exposure effect), regardless of their fundamental qualities.
• Conservation risk is a by-product of our asymmetrical preference for gain relative to loss and the status quo relative to change. We like winning much more than losing and the old way much better than the new way, all of which contorts our ability to see the world clearly. This conservation effect can be observed in our resistance to new ways of being (status quo bias), our preference for no risk at all relative to large incremental decreases in risk (zero risk bias) and an aptness to privilege our current self over the needs of our future self (hyperbolic discounting). Evidence of selling winning stocks too quickly and holding losing stocks too long, a failure to maintain appropriate risk levels when “up” and signs of taking excessive risks when “down” are all good signs that you might have fallen prey to conservation risk.

Read more about these four risk factors here.

The Potential Value of an Advisor

According to Vanguard, “As the industry continues to gravitate toward fee-based advice, there is a great temptation to define an advisor’s value-add as an annualized number. In this way, fees deducted annually for the advisory relationship can be justified by the ‘annual value-add.’ However, although some strategies … could be expected to yield an annual benefit—such as reducing expected investment costs or taxes—the most significant opportunities present themselves not consistently but intermittently, often during periods of either market duress or euphoria.” Technology and the 24/7 news cycle can keep the economy and stock market on investors’ minds nearly constantly and stoke fear—or greed in periods of high market performance—that can lead to knee-jerk reactions. When tempted to abandon a well-considered strategy, advisors can help their clients manage these emotions with both support and knowledgeable guidance on market conditions, long-term investment performance, rebalancing, and the aftereffects and recovery during corrections and downturns. These advantages are harder to quantify, as they’re often filled with what-ifs, and don’t show up on any client performance statement.

Research continues to show how valuable that relationship can be, as much 2­–3% annually in addition to returns—not to mention how that compounds over time. Vanguard performed complex modeling to arrive at a hypothetical valuation of two portfolios—one managed by an advisor and one self-managed. Please note that these do not reflect actual investment results nor a guarantee of future results. However, their research provided a powerful illustration quantifying the value of an advisor, as much as adding 3% more in value to an investor’s portfolio per year. To illustrate using actual figures, suppose that you’ve invested $500,000 with an advisor. This could grow to approximately $2.8 million after 25 years under their care (excluding annual management fees, which are often between 0.5–1.25%), compared to the expected value of $1.39 million in a self-managed portfolio with performance of around 4%. (Calculations were made using this calculator.) 

Additionally, research conducted by the Investment Funds Institute of Canada has shown that “a five-year relationship with a wealth manager can add 1.5 times the wealth compared to investors who ‘go it alone.’ And over a longer period, the performance improves to 2.73 times over 15 years.” In a research paper titled “Alpha, Beta, and Now…Gamma,” Morningstar researchers David Blanchette and Paul Kaplan quantified a 29% increase (or 1.82% higher returns per year) in retirement income by engaging in professional financial planning and employing good financial planning decisions, like effective asset allocation, dynamic withdrawal rate, spending approaches, and proper asset location.

But working with financial professionals involves fees—something that can turn some people away from seeking professional help. However, there is one significant protection for investors: When you pay-to-play with a financial planner or other financial advisory professionals, you should expect that those service providers are subject to some level of regulatory insight. This is, in fact, the case with many financial professionals, especially investment adviser representatives such as those at Liberty Group. Investment adviser representatives are held to the fiduciary standard, meaning they are bound by law to put your interests ahead of their own when advising on a strategy and building your financial plan. This can give investors some peace of mind that their advisor is acting in their best interest and not being solely driven by compensation or commission.

Of course, not everyone will need or want a financial planner or investment advisor, and some will not see the returns discussed above. Determining value for any one investor is as unique as that investor. Peace of mind, in general, is difficult to quantify but incredibly important to staying the course with any investment strategy or financial plan—a significant element to truly building wealth. For investors, especially those without the time, desire, or knowledge to confidently manage their financial matters, the value of an advisor can become even more pronounced. Investopedia states, “While good financial advice can be beneficial in the short run, it can be exponentially more profitable for investors over longer periods of time.” What’s a financial or investment advisor worth to you?

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Standard Disclosure

This blog expresses the author’s views as of the date indicated, are subject to change without notice, and may not be updated.  The information contained within is believed to be from reliable sources.  However, its accurateness, completeness, and the opinions based thereon by the author are not guaranteed – no responsibility is assumed for omissions or errors.  This blog aims to expose you to ideas and financial vehicles that may help you work towards your financial goals. No promises or guarantees are made that you will accomplish such goals. Past performance is no guarantee of future results, and any expected returns or hypothetical projections may not reflect actual future performance or outcomes. All investments involve risk and may lose money. Nothing in this document should be construed as investment, tax, financial, accounting, or legal advice. Each prospective investor must evaluate and investigate any investments considered or any investment strategies or recommendations described herein (including the risks and merits thereof), seek professional advice for their particular circumstances, and inform themselves about the tax or other consequences of any investments or services considered.  Investment advisory services are offered through Liberty Wealth Management, LLC (“LWM”), DBA Liberty Group, an SEC-registered investment adviser.  For additional information on LWM or its investment professionals, please visit www.adviserinfo.sec.gov  or contact us directly at 411 30^th Street, 2^nd Floor, Oakland, CA  94609, T: 510-658-1880, F: 510-658-1886,  www.libertygroupllc.com. Registration with the U.S. Securities and Exchange Commission or any state securities authority does not imply a certain level of skill or training.

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References

Cockerline, Jon. (September 21, 2015.) New Evidence on the Value of Financial Advice. The Investment Funds Institute of Canada. https://www.fin.gov.on.ca/en/consultations/fpfa/rfp-submissions/investment-funds.pdf

Crosby, Daniel. (n.d.) The Four Pillars of Investor Behavior. Gouldin & McCarthy, LLC. https://www.gouldinmccarthy.com/files/overcoming_limiting_behaviors_ebook.pdf

Crosby, Daniel. (August 25, 2015). Three Quick Action Steps for a Volatile Market. LinkedIn. https://www.linkedin.com/pulse/three-quick-action-steps-volatile-market-daniel-crosby-ph-d-/

Investec. (June 4, 2020). Daniel Crosby: Investing rules for uncertain times. https://www.investec.com/en_gb/focus/coronavirus/daniel-crosby-how-covid-19-will-change-the-way-we-invest.html

Kaplan, Paul. (2014). Alpha, Beta, and Now…Gamma. Morningstar. https://www.cfamontreal.org/static/uploaded/Files/Presentation/14-05-13-Presentation-Kaplan.pdf

Kinniry, Jr., Francis, Jaconetti, Colleen, DiJoseph, Michael, Zilbering, Yan, & Bennyhoff, Donald. (February 2019). Putting a value on your value: Quantifying Vanguard Advisor’s Alpha®. Vanguard. https://advisors.vanguard.com/iwe/pdf/ISGQVAA.pdf

Marte, Jonnelle. (September 5, 2014). Nearly a quarter of Fortune 500 companies still offer pensions to new hires. https://www.washingtonpost.com/news/get-there/wp/2014/09/05/nearly-a-quarter-of-fortune-500-companies-still-offer-pensions-to-new-hires/

McFarland, Brendan. (June 25, 2020). Retirement offerings in the Fortune 500: 1998–2019. WTW. https://www.wtwco.com/en-US/Insights/2020/06/retirement-offerings-in-the-fortune-500-1998-2019

Northwestern Mutual. (2021.) 2021 Planning & Progress Study. https://news.northwesternmutual.com/planning-and-progress-2021

Peters, Katelyn. (May 19, 2021). How Financial Advice Can Boost Your Returns. Investopedia. https://www.investopedia.com/articles/personal-finance/102616/how-much-can-advisor-help-your-returns-how-about-3-worth.asp

SmartAsset. (March 8, 2022). The Numbers Tell All: Financial Advisors are Worth Every Penny. https://article.smartadvisormatch.com/financial-advisor-worth-it/

U.S. Bureau of Labor Statistics. (April 23, 2020). What statistics does the BLS provide on frozen defined benefit plans? https://www.bls.gov/ncs/ebs/factsheet/defined-benefit-frozen-plans.htm