Is it worth paying a financial planner or wealth manager a fee to provide investment advice? What value do they add for this fee? Is it in excess of their charges? These are exactly the type of questions that a number of recent studies have set out to ascertain.
A recent study by Morningstar(*) attempted to quantify the true value of comprehensive financial planning advice when coupled with investment advice. This focused on 5 particular ways advisers can add value:
1. Total Wealth Asset Allocation – Taking account of an investor’s entire situation, including ‘human capital’, risk preference and risk capacity.
2. Dynamic Withdrawal Strategy – Regular review of withdrawal strategies and adjusting as needed.
3. Annuity Allocation – Advising on the contribution of an annuity within a portfolio (benefit, risk and cost).
4. Asset Location & Withdrawal Sourcing – Tax efficient investing in terms of both investing money and the order in which tax wrappers should be used to provide income.
5. Liability Relative Optimisation – The ability to take account of funding risks (inflation, currency, etc.) in terms of investors goals when accessing money. Most asset allocation methodologies are focused on long-term returns which can sometimes lead to short term cashflow problems.
Using mathematical formulae and simulated portfolio’s, the authors estimated the impact of good financial planning advice on the above factors contributed 1.8% per annum in additional returns.
This does not even take account of the value that a good adviser can add to investment returns. Another study conducted by the Goethe University of Frankfurt (**) analysed the returns of 8,621 DIY investors (investors who did not take any advice on investment decisions). They found that 89% exhibited ‘negative skill’ before charges (91% after charges). The authors found that the average level of underperformance was -7.5% per annum before charges (-8.5% per annum after charges).
The implications? A poor adviser can still charge a lot without adding any value (or indeed, removing value). However, a good quality adviser (i.e. one that combines an intelligent approach to portfolio investment management with comprehensive financial planning) can more than pay for their fees in additional returns.
(*) Blanchett D (2012), Alpha, Beta and Now… Gamma (Morningstar)
(**)Meyer S, Schmoltzi D et al (2012), Just Unlucky? – A Bootstrapping Simulation to Measure Skill in Individual Investors’ Investment Performance (Goethe University Frankfurt)