Financial Architects

Financial Planning & Wealth Management

The Quality Advisor’s Alpha/Gamma/Sigma

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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:

  1. Constructing an appropriate portfolio (I conservatively estimate the value add to be 100 bps annually from this)
    1. Proper asset allocation, factor tilts, diversification, etc.
    2. Low-cost implementation
    3. Intelligent rebalancing
  1. 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)
    1. Proper asset location strategy
    2. Proper accumulation strategy (maximizing tax-advantaged vehicles)
    3. Proper decumulation strategy (spending order)
    4. Strategic use of conversions, step-up in basis, loss-harvesting, munis, etc.
    5. Optimal transfers for children’s education, other funds to descendants and charities, etc.
  1. Behavior modification (the value added is mostly unquantifiable, not as high as the methodologically-flawed Dalbar studies claim, but I would estimate 100-300 bps annually on average – but  it occurs sporadically)
    1. Maintaining an appropriate strategic allocation at market extremes
    2. Appropriate levels of saving (pre-retirement) and spending (post-retirement)
  1. 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)
    1. Risk management including appropriate insurance and asset protection
    2. Selecting optimal pensions options (including Social Security)
    3. Liability management (optimal debt)
    4. Estate and end-of-life planning (not primarily tax-related)

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.