Prior to the start of my career in financial planning, I often wondered, what true value (or alpha) does a good advisor add to an individual’s portfolio? I mean, I’m a CPA, have read several books on modern portfolio theory, asset allocation, asset location, the difference between investing and speculating, minimizing transaction costs, etc, etc, etc…how hard could it be to do this on my own? What I found the answer to that question to be was…VERY…and for a multitude of reasons, the largest of which being my personal behavior and natural instinct/attitude toward investing.
What I now believe, based on my personal experiences inside the industry, is that the single greatest role a true financial advisor can play in his or her client’s long-term success is that of a behavioral coach. We all know the mantra “buy low, sell high” but actually putting this seemingly simple rule into practice day-after-day, year-after-year, is somewhat challenging without the discipline and foresight a good advisor can provide. As humans, we all naturally tend to try and “get while the gettin’ is good” (buy high/on the way up) and “tuck and run” when the outlook is grim (sell low/on the way down) when we should, in fact, do the opposite (or better yet, not pay attention to the ups and downs very much at all). Even as a professional in the industry, it is sometimes tempting to fall prey to this natural way of thinking.
The value-add behavioral coaching (and other best-practices) provide were recently quantified in a study conducted by The Vanguard Group Inc. The value a good advisor should be able to add, based on Vanguard’s study, comes out to about 3 percentage points in net annual returns. Of these 3 percentage points, half (or 1.5% annually), was attributed solely to behavioral coaching, or preventing “The Big Mistake!” The study found that due to the emotions involved with investing, an advisor’s ability to help their clients maintain a long-term, disciplined approach during the best and the worst of times (not abandoning strategies to chase returns and/or the next “hot” investment) can be paramount to overall long-term success.
To give a very simple example of what a 1.5% value means in real life, if you were to contribute $100,000 today and earn 5% each year you would have $432,194.24 at the end of year 30. If you were to take that same $100,000 but you were to earn 6.5% each year, at the end of year 30 you would have $661,436.62, or 53% more money than you would with the 5% return. Now, this example is extremely simple and there are a ton of other factors that play into long-term investment returns (none of which can be reliably predicted or guaranteed), but I think you get the point!