Have you ever thought about hiring a financial advisor to help you grow your investments? If you have, you’ve probably wondered how to do it and if it’s worth the cost. According to research by Vanguard, an advisor can add around 3% to your overall portfolio. They call it – Advisor Alpha. And it’s why you should hire a good financial advisor.
Around 2001 Vanguard introduced the idea of Advisor’s Alpha. A few years ago they updated their research. The conclusion was that a good financial advisor can add around 3% return after fees above what you could get on your own. How do they do it? There are 7 strategies or modules. Let’s take a look:
1. Suitable Asset Allocation using Broadly Diversified Funds/ETFs. >0%
Picking the right allocation or mix of stocks and bonds is invaluable. Vanguard says this value is too subjective to give an exact number but says choosing the right asset allocation is somewhere greater than zero. Why is asset allocation so important? A suitable asset allocation’s volatility won’t scare you out of your investing strategy. In other words, you won’t need to sell when markets go down and become a market timer.
2. Cost-Effective Implementation (expense ratios) = 0.40%
The average investor pays between 0.37% and 0.54% in investment expense ratios. More if you factor in annuities and expensive life insurance. Choosing low-cost index funds to build your portfolio can save you 0.4%. On $1 million that is $4,000/yr. Over 30 years that’s $120,000+ savings.
3. Rebalancing = 0.35%
Rebalancing is buying low and selling high. When an asset class like stocks goes down and another class like bonds go up, you sell the bonds high and buy the stocks low to get back to your target allocation. Other research shows that how frequently you rebalance can add value. A good advisor will create an investment plan that works with your financial plan and rebalance accordingly.
4. Behavioral Coaching = 1.5%
Vanguard’s study of actual clients showed that said investors who deviated from the initial retirement fund investment had 1.5% worse returns than the target date fund benchmark. Other academic research parallels Vanguard’s research in that the added value of behavioral coaching can add between 1% and 2% additional return. On $1 million that is $15,000 extra return. Over the course of 30 years, that’s $450,000 additional savings. More if you include compound returns on added return.
5. Asset Location = 0% to 0.75%
When investors have tax-deferred 401k, 403b, IRA type accounts AND taxable trusts, or joint investment accounts, AND Roth IRAs, a good advisor can add up to 0.75% by allocating tax-inefficient assets in tax-deferred accounts, and tax-efficient investments in non-tax-deferred accounts. This is what I call advanced tax deferral.
6. Spending Strategy (withdrawal order) up to 1.1%
When you retire before age 59 1/2 or even 65 (Medicare) how you withdraw for income greatly affects your taxes and maybe even healthcare costs. A good financial plan, updated annually, will maximize your return while minimizing your taxes and healthcare costs. Vanguard estimates the savings to be between zero and 1.1% additional return. I’ve personally seen clients take income at zero capital gains rates while qualifying for an affordable healthcare policy at very reasonable rates, saving clients $10,000+ per year from age 58 to 65.
7. Total-Return versus Income Investing >0%
With interest rates historically low some investors can be tempted to shift to long-term, high yield, or even a non-diversified group of stocks that pay out dividends. As a result, you may be taking on more risk than is necessary or tolerable to get added income. Vanguard’s research says focusing on your total return and being willing to use a total return approach to investing can add return to your overall portfolio. Due to the subjective nature of each investor, this is hard to quantify.
Example
This past spring, I decided to put Vanguard’s numbers to my client’s portfolios. I track their year-over-year progress so I know how much they’ve gained and their average return. A comparison of the two, while not an exact science, gave me a little bit of an idea as to what value I might be adding. Again, this is not an exact science, and obviously, I can’t show you all my clients’ reports, so there is the possibility that I’m cherry-picking a good one. So take this info with a grain of salt. But here’s their progress on a typical 60/40 stock to bond portfolio through March of 2022:
| Beginning Value | Deposits | Income | WD Rate | Gain$ | Gain % | Ending Value | |
| 2015 | $1,947,329 | $66,089 | $52,500 | 3% | -$19,187 | -1% | $1,941,731 |
| 2016 | $1,941,731 | $0 | $91,668 | 5% | $137,767 | 7% | $1,987,830 |
| 2017 | $1,987,830 | $0 | $100,008 | 5% | $244,147 | 13% | $2,131,969 |
| 2018 | $2,131,969 | $220,000 | $114,000 | 5% | -$112,781 | -5% | $2,125,188 |
| 2019 | $2,125,188 | $0 | $86,400 | 4% | $346,132 | 17% | $2,384,920 |
| 2020 | $2,384,920 | $0 | $50,400 | 2% | $334,697 | 14% | $2,669,217 |
| 2021 | $2,669,217 | $0 | $57,600 | 2% | $180,839 | 7% | $2,792,456 |
| 2022 | $2,792,456 | $0 | $28,140 | 1% | -$149,671 | -5% | $2,614,645 |
| $286,089 | $580,716 | $961,944 | 6% |
And here’s their portfolio cross-referenced to the Advisor Alpha material:
| Year | Investents | Suitable Asset Allocation | Cost-effective expense ratios | Rebalancing | Behavioral Coaching | Asset Location | Spending Strategy | Total Return vs. Income Investing | Vanguard Advisor Alpha |
| 2015 | $1,941,731 | $1,942 | $6,602 | $5,049 | $29,126 | $1,942 | $6,796 | $1,942 | $53,398 |
| 2016 | $1,987,830 | $1,988 | $6,759 | $5,168 | $29,817 | $1,988 | $6,957 | $1,988 | $54,665 |
| 2017 | $2,131,969 | $2,132 | $7,249 | $5,543 | $31,980 | $2,132 | $7,462 | $2,132 | $58,629 |
| 2018 | $2,125,188 | $2,125 | $7,226 | $5,525 | $31,878 | $2,125 | $7,438 | $2,125 | $58,443 |
| 2019 | $2,384,920 | $2,385 | $8,109 | $6,201 | $35,774 | $2,385 | $8,347 | $2,385 | $65,585 |
| 2020 | $2,669,217 | $2,669 | $9,075 | $6,940 | $40,038 | $2,669 | $9,342 | $2,669 | $73,403 |
| 2021 | $2,792,456 | $2,792 | $9,494 | $7,260 | $41,887 | $2,792 | $9,774 | $2,792 | $76,793 |
| 2022 | $2,614,645 | $2,615 | $8,890 | $6,798 | $39,220 | $2,615 | $9,151 | $2,615 | $71,903 |
| Total | $18,648 | $63,403 | $48,485 | $279,719 | $18,648 | $65,268 | $18,648 | $512,819 |
Notes:
- 0.01% for suitable asset allocation as this client has not waivered from their 60/40 portfolio.
- 0.34% for cost-effective expense ratios as the client was already in indexed funds after doing a stand-alone plan with me 4 years earlier. But they still had a high expense annuity.
- 0.26% for rebalancing, not the full 0.35%.
- the full 1.5% for the behavioral coaching. This should probably be combined with the spending strategy.
- Asset location at 0.01%. They were advanced diversified with bonds in IRAs and equities in Roths.
- Spending Strategy at 0.35% which should probably be closer to 1.1% given that they retired early and had to qualify for an affordable care policy.
- Total return versus income at 0.01% for a placeholder.
- Total value add stopped at 3%.
Takeaway
The part I’m not too happy with is the behavioral coach versus spending strategy. I far underweighted the spending strategy and overweighted the behavioral coaching. But trying to apply these figures to research is impossible to really do without running the opposite scenarios with a 60/40 client that did the opposite or didn’t work with an advisor. Regardless, it is interesting that according to Vanguard’s research advisors can add around 3% value above doing it alone. In this case, that would equal a $512,819 difference over the last 7 years. Is that a risk you’re willing to take? Or do you agree with Vanguard’s Advisor Alpha research conclusion that you should hire an advisor?
If you decide to hire an advisor, check out my article How to Find a Financial Advisor.
