By Scott Hamilton, CFP®
The financial services industry has seen considerable change in the 21st century. Today, many investors question whether a financial advisor can truly add value or if the investors can match the return on investment by making their own decisions. A few years ago, Vanguard research sought to answer this question.
Vanguard Advisor’s Alpha Study was originally conducted in 2001 and updated in 2019. The research firm looked into the added value—aka “alpha”—a financial advisor’s assistance can bring to an investor’s portfolio. Vanguard research concluded that an investor could realize at least 3% in annual net returns if they used a financial advisor to help make decisions.
The study focused on seven key areas Vanguard Advisor’s Alpha strategy was applied to and how much value it added to each. The results were measured in “basis points,” represented by a basic number. Here’s a rough breakdown of the areas Vanguard research covered in the study.
Table of Contents
Suitable Asset Allocation
Asset allocation refers to how an investor’s capital is distributed across various commodities, including cash on hand and fixed income. The strategy of Vanguard research for diversifying allocation across funds and exchange-traded funds (ETFs) was found to have a greater-than-zero effect on investors’ return rates.
In a footnote on the report, Vanguard says this valuation means that “value is deemed significant but too unique to each investor to quantify.” This basically means that financial advisors add value, but results may vary among investors.
Cost-Effective Implementation
Controlling costs and fees associated with investments is a key to maximizing returns. Fee-based advisors look for ways to keep additional costs as low as possible, typically by reducing commission fees and implementing tax-efficient measures.
Vanguard found advisors were especially beneficial in cost-effective implementation and awarded them 30 basis points in added value. Keeping additional fees low supports the fiduciary industry’s maxim that advisors only do better when their clients do better.
Rebalancing
Vanguard found that financial advisors can help clients manage long-term target allocation that corresponds to their clients’ risk tolerance. The study determined that a portfolio of 60% equity to 40% fixed income that was rebalanced annually generated lower returns than an account that wasn’t rebalanced but incurred significantly lower risk. Vanguard found that financial advisors’ assistance in rebalancing benefits their clients’ ROI.
Behavioral Coaching
The most significant benefit financial advisors add, Vanguard research found, was shaping and modifying clients’ investing behavior. Overreaction to market volatility and making decisions out of panic or euphoria are fatal flaws undisciplined investors make that damage their returns.
Vanguard found that financial advisors’ reliance on data, logic, and perspective is the most direct and largest value they add.
Asset Location
Vanguard found that tax efficiency is often dictated by where investors place their assets. Fixed-income investments steer clear of instant taxation, whereas equities in taxable accounts generate lower capital gains rates and inheritance benefits. According to Vanguard, financial advisors add considerable value in managing asset location.
Spending Strategy
The order in which retirees withdraw from their investment accounts has a direct impact on their length and tax efficiency. Vanguard recommends retirees start by taking their required minimum distributions (RMDs) first, then taking dividends and interest from taxable accounts, and finally making additional withdrawals from their traditional or Roth IRAs.
Total Return vs. Income Investing
Vanguard found that total return investing—balancing dividend and interest income with high capital growth—is a particularly effective strategy for retirees.
With current low rates on dividends and interest, instruments like high-yield stocks could add an uncomfortable amount of risk. Vanguard found that diversification, tax management, and long-term portfolio management were key to controlling risk exposure. These are all items financial advisors can assist with.
Making Sense Out of Vanguard Research
While many investors are content with DIY investing, Vanguard believes an experienced, fee-only financial advisor can help a client earn at least a slight but noticeable boost in annual portfolio returns.
We at Hamilton Financial Planning specialize in helping retirees manage their wealth with solid fiduciary services. If you’d like to learn more, we invite you to schedule a complimentary get-acquainted meeting online or reach out to us at 512-261-0808 or scott@hamiltonfinancialplanning.com.
About Scott
Scott Hamilton is founder and chief financial officer at Hamilton Financial Planning, a wealth management firm that specializes in providing comprehensive financial planning for retirees. With over 20 years of experience in the financial industry, and having completed over 250 financial plans for retirees across all industries, but mostly the oil and gas industry, Scott is passionate about providing his clients with the tools and insight they need to achieve their financial goals. He has a Bachelor of Business Administration in finance from Texas State University and an MBA in international finance from Pepperdine University. Scott has also been happily married to his wife, Gayle, for over 25 years. To learn more about Scott, connect with him on LinkedIn.
