Smart Money Tips

Advisor’s Alpha: How You Benefit From Working With a Financial Planner

What value does an advisor bring to the table? Is it excess market returns? The ability to zig when the market zags downward? Spotting tax loopholes?

Not really.

It’s all about the magic of organization and accountability. The truth is there’s no crystal ball that gives advisors an advantage in investing – if you buy and hold similar quality investments over a long period of time, you’ll have similar investment results as a DIY investor versus working with an advisor. 

Alpha, or extra returns compared with going at it alone, comes from a bigger-picture view of your financial plan. An advisor’s value is also apparent when it comes to getting clients to take action and have confidence in their financial life.

A fiduciary advisor helps you get organized, integrate your goals into a comprehensive plan, and utilize that plan to help you take your best next steps to maximize all financial areas of your life.

“Oh, I’ve been meaning to get to that.” 

“Wow, I’ve never thought about that before.” 

“I don’t have a handle on everything I own; I’ve never looked at it all together.” 

“I chose my investments years ago – I have no idea if they are too conservative or too aggressive.” 

Those are just some of the kinds of comments we hear from new clients. It’s not so much that they are looking for extraordinary ROIs on their stocks and funds. Rather, they end up realizing that they need to perform a little Marie Kondo on their finances, and the expert direction from an advisor helps make that happen.

We also listen to clients describe the mistakes they have made along their financial journey. For example, back during the 2008 Great Financial Crisis, ongoing volatility and steep drops in stocks caused some nervous investors to panic and sell out at the low. And it is not only investments. One of the toughest mental hurdles for individuals and couples is to create and maintain an estate plan; an advisor can provide a friendly push to get you to not wait for ‘someday’ but to do it now. 

Did you know there is a measurement called Advisor’s Alpha which quantifies the success of people who are advised through financial decisions versus those who go it alone? It was an in-depth research report done by Vanguard in the early 2000s (updated in 2022), and there have been a few other comparable papers written on the subject.

The Vanguard study lists several areas where planners add value, including:

1. Behavioral coaching

Market volatility causes some people to make bad decisions with their money. The first thing to recognize, though, is that we are all human. That means it’s natural for emotions to drive both our short-term and long-term decision-making. While emotions give us a helpful gut sense of what’s good and bad in life, that primitive feeling actually works against us when dealing with investments and financial markets. 

Here’s where an advisor delivers value: She keeps her clients in the game by providing an objective, yet understanding, view of your long-term financial plan. Offering some emotional detachment is an overlooked source of so-called advisor alpha. And that goes for both bull and bear markets. A quality planner is by your side during volatile markets while also steering you away from high-risk speculative bubbles. A financial planner is like an emotional circuit-breaker, and the data show that the relationship’s value amounts to one or two percentage points of extra return each year.

2. Asset location

While behavioral coaching is somewhat squishy and more on the softer side of finance, asset location is a precise strategy that involves owning certain types of securities in certain types of accounts. The goal here is to minimize your long-term tax liability. Think about it like this: You probably have a pre-tax 401(k) or Traditional IRA (or rollover IRA) along with a taxable brokerage account and maybe a Roth IRA or Health Savings Account (HSA). Each of those account types has its advantages and drawbacks. While not a major source of alpha, an advisor can move income-producing assets to tax-sheltered accounts.

For example, let’s say you have some bonds or bond funds that produce significant income each month. Well, it’s not ideal to hold those fixed-income positions in a taxable account since you’ll pay tax at your marginal rate on coupon income received. Thus, it is better to place those investments in an IRA or 401(k), leaving tax-efficient stock exchange-traded funds (ETFs) in your regular brokerage account. Vanguard found that, on average, optimizing asset location can add up to 0.60% of value each year to a portfolio. 

3. Rebalancing

Asset location seems like a tricky thing considering all the accounts you might have along with so many individual investment positions. Shifting things around can be a complicated task. What’s easier, though, is simply rebalancing a portfolio. Rebalancing just means bringing your overall asset allocation back to its intended target percentages based on your risk tolerance and return objectives. The name of the game here is risk control – particularly for those who hold a sizable bond or cash position.

Many people choose their investments and then never analyze the portfolio later to ensure it still fits their risk profile. This is where the advisor’s expertise in not only investments comes into play, but also their understanding of the client. Rebalancing can be as simple as selling some stocks after a period of strong market returns and directing that cash to bonds. But it can also mean providing discipline to an investor’s plan right when it’s needed most – like selling bonds and buying stocks during a painful bear market. In all, Vanguard found that between 0.1 and 0.2 percentage points of annual extra returns are seen from an advisor’s rebalancing activities.

4. Spending strategy (withdrawal order)

Here’s where we get to the fun stuff (at least for me as a financial planner!). A retiree’s spending strategy is something they don’t often consider until the very last minute, so to speak. It is much more common for folks to be disciplined in their accumulation years as they save for retirement, but then little thought is devoted to how they will use that money during their golden years. Also neglected is the fact that a retired couple might not realize how wealthy they are when tallying up financial assets, their home, Social Security, and perhaps a pension. The bottom line here is that it often takes a comprehensive plan just for your spending and withdrawal strategy.

Getting into the weeds a bit, there is indeed a lot to consider when pulling money from your accounts to fund a retirement. Should you take IRA distributions? If so, Traditional or Roth? Should you tap cash reserves first? What about just selling some stocks or funds in your taxable account? And don’t forget about Required Minimum Distributions (RMDs). It can be overwhelming. But that is where an advisor earns her keep. We help clients construct and execute a spending strategy that keeps taxes as low as possible while staying invested. In aggregate, up to 1.2% of alpha per year can be generated with the right withdrawal order.

Advisor Alpha: Better Returns, A Better Life

There are other sources of value garnered by teaming with a quality financial planner. In total, Vanguard’s research concluded that more than 3% of long-term risk-adjusted excess returns (after fees) annually is possible by working with an advisor. That’s HUGE. And that does not even count other services like charitable-giving strategies, complex estate planning, tax-loss harvesting, and business-continuation planning. 

Also not tabulated are the non-tangible personal benefits you receive by gaining confidence, direction, and support as you navigate through your financial life. Financial peace of mind is worth its weight in gold!

The Bottom Line

Yes, there are real financial benefits to teaming up with an advisor. There is also the human side. By making the right moves, setting goals, and seeking oversight, having guidance from an advisor makes all the difference in what you can achieve.