Vanguard has Alpha. Morningstar has Gamma. Envestnet has Sigma. Apparently describing the value a high-quality advisor brings to a client’s financial planning and investment management without using a Greek letter is prohibited! But those papers have a point, and I also believe a high-quality advisor adds significant value. Here’s how:
- Constructing an appropriate portfolio (I conservatively estimate the value add to be 100 bps annually from this)
- Tax savings (I conservatively estimate the value add to be 100 bps annually from this if the client has funds in multiple tax buckets and are in a high bracket, etc. but much lower otherwise)
- Proper asset location strategy
- Proper accumulation strategy (maximizing tax-advantaged vehicles)
- Proper decumulation strategy (spending order)
- Strategic use of conversions, step-up in basis, loss-harvesting, munis, etc.
- Optimal transfers for children’s education, other funds to descendants and charities, etc.
- Behavior modification (the value add is mostly unquantifiable, but perhaps as high as the gap from the Dalbar studies, I would estimate 100-300 bps annually on average, but it occurs sporadically)
- Maintaining an appropriate strategic allocation at market extremes
- Appropriate levels of saving (pre-retirement) and spending (post-retirement)
- Other financial planning (the value added is primarily either peace of mind or only shows up in a tiny fraction of cases, for example premature death with insurance, so the average improvement to performance frequently isn’t high, but in those cases it is absolutely crucial)
So for a client with pretty good behavior (though not perfect), who is in a lower tax bracket or has no investments outside of deferred accounts, the value added might be just 200 bps (100 each from 1 & 3 above) annually. For clients with more emotional behavior, who is in a high marginal bracket, and has savings in various types of tax buckets (IRA, Roth, taxable, etc.) the value added is probably around 500 bps (100 from #1, 100 from #2, and 300 from #3). Thus, advisory fees are typically covered 2-5x.