If you've ever wondered if the costs associated with working with a wealth advisor are worth it, you're not alone. In fact, an article at the Motley Fool described the cost of using a financial advisor as "brutal," referring to a hypothetical 1 percent of assets annual fee reducing net returns, as well as the longer-term impact of fees that aren't reinvested.
While the article may have come across as a bit hyperbolic, it wasn't all negative... and it did bring up a valid point: Investors should always evaluate the services they receive from their investment professional to determine if the services are worth it.
These tips will help you with the evaluation process.
Quantifying Alpha: What's Your Wealth Advisor's Value?
In spring 2014, a Vanguard white paper took a quantitative look at alpha -- or a risk-adjusted measure of performance -- to determine how much, if any, value that working with a wealth advisor adds. Vanguard's research found that advisors have the potential to add up to a total of 3 percent to net returns when they provided the following services:
- Potential value from 1 to 2 percent: Behavioral coaching
- Potential value up to 0.75 percent: Increased tax efficiency
- Potential value up to 0.70 percent: Spending withdrawal order
- Potential value up to 0.45 percent: Allocating assets to lower-cost funds
- Potential value up to 0.35 percent: Annual portfolio rebalancing
Does Your Investment Professional Practice Passive or Active Investing?
It's not secret that Premier advocates a passive investment strategy. After all, an overwhelming body of empirical evidence and real-world experience support passive investing's advantages.
In fact, a 2013 meta-analysis evaluates the active vs. passive approach across multiple time periods, using data from numerous independent, credible sources. The passive approach proved more effective over time; in particular, investors who invested in funds (passively) managed by Dimensional Fund Advisors gained 109 percent of returns, while those invested in actively managed index funds only 78 to 88 percent of returns.
In addition to the passive approach, the analysis posited that these higher returns may also be due to two specific services provided by wealth advisors:
- Behavioral coaching that helps investors refrain from reacting emotionally -- and selling -- when the market is on a downswing; and
- Regular rebalancing of assets, which many investors don't normally do on their own, as it may seem counter-intuitive to sell performing stocks in order to purchase stocks that are falling.
Other Investment Professional Practices to Consider
When you're determining whether the cost of working with a wealth advisor is worth it, also consider other services, such as tax-loss harvesting, or the practice of off-setting capital gains taxes by selling some under-performing stocks at a loss. While low-cost advisors may not harvest, or do it infrequently, regular tax-loss harvesting has the potential to significantly reduce your tax burden.
Another cost to evaluate is that of holding too many mutual funds. If your investment professional recommends that you hold a large number of funds, it'll cost you more to rebalance, thus decreasing your net returns.
- Estate planning
- Review of insurance policies
- Roth conversion advice
- Retirement planning
- Mortgage financing advising
While, of course, it's essential to evaluate the fees and expenses associated with wealth planning, it's also important not to view these costs in a vacuum. Instead, evaluate the added value a true wealth advisor provides.