The financial services industry is fragmented and many clients don't really understand how companies and financial service providers work. In general, there are two players in the industry:
- Service Providers
- Manufacturers and Distributors (of financial products)
Do you know the difference?
A service provider provides a specific advisory service. It could be financial planning, investment management or insurance. The large financial service firms can provide advisory services (like Fidelity or Vanguard) and independent financial advisors will also provide these services.
I consider a mutual fund or an insurance company a manufacturer. They might distribute their products directly to the public or through independent financial advisors. Many financial manufacturers will use both methods to distribute their products (like Fidelity and Vanguard.)
Most of the financial manufacturers spend a lot of their resources supporting the independent financial advisor. They believe the financial advisor will see the value in their products and will recommend them to their clients.
I recently read a white paper from Vanguard (a low-cost manufacturer of investment products like mutual funds and exchange traded funds) called "Putting a value on your value: Quantifying Vanguard Advisor's Alpha," March 2014. The paper is written for advisors and attempts to quantify the "value" of financial planning advice. I thought it was interesting because it suggested an advisor's value is derived "through relationship-oriented services such as providing cogent wealth management via financial planning, discipline, and guidance, rather than by trying to outperform the market."
The study outlines a variety of tools or strategies that financial planners utilize and then estimates the annual value-add of the advice to the client. The study recognizes that actual value-adds may not "present themselves consistently, but intermittently" over many years. Vanguard's summarizes the result of their study: "Paying a fee for advice and guidance to a professional who uses the tools and tactics described here can add meaningful value compared to the average investor experience..."
What are the 7 strategies outlined by Vanguard that might have "value-add"?
- Asset Allocation: A portfolio that is properly allocated between a variety of asset classes (stocks, bonds and cash) gives client's the best opportunity towards meeting their long-term investment, retirement, accumulation or income goals.
- Shaving Costs: Utilizing cost-effective financial products is important and can mean lower costs over the long-run.
- Staying Ahead of Risk: Maintaining the proper asset allocation and using a disciplined rebalancing strategy manages the risk and volatility of a portfolio.
- Dealing With Emotions: Many investors make decisions based on emotions, especially when markets experience larger than normal swings in value (both up and down). Decisions based on fear and greed tend to be disastrous for clients. Advisors help clients stay disciplined and focused on long-term goals.
- Tax Advantages: Most investors have investments in both taxable and tax-advantaged (retirement) accounts. Advisors can help clients understand the tax- advantage of locating the right kind of asset in the right kind of account. For example, tax-efficient stocks should be in taxable accounts, while taxable bonds should be invested in retirement accounts.
- Selecting Accounts: Helping clients decide which accounts to take withdrawals from can add significant value. For example, should withdrawals come from retirement accounts, taxable accounts or a combination?
- Offering Education: Helping a client understand the significant value of a "total-return" investment strategy (income from bonds and dividends and capital appreciation from stocks) versus a strategy that is primarily dependent on income from bonds or dividends from stocks. The total-return strategy may have less risk, better tax-efficiency and last longer than the income oriented strategy.
Vanguard's study speaks to the long-term value of working with a comprehensive financial planner. Vanguard looked at seven important investment strategies, but didn't attempt to quantify the value-adds of other non-investment planning tools (for example, estate, education, philanthropic and long term care planning.)
The Raskin Planning Group believes these factors can make comprehensive financial planning a valuable service to clients. Please don't hesitate to call us with questions at 617-728-7433.