2015 Value of an advisor: Once again, greater than 1%

A client-approved version of this post, Your Advisor…worth more than 1%, is available on Russell’s advisor website, RussellLINK. Please note that RussellLINK is only available to advisors whose firm has a selling agreement with Russell and who have a RussellLINK account. Russell’s products and services are sold only through financial intermediaries. Those who click through to RussellLINK without a login will find a password-protected site that asks for additional information. 

Please contact your Russell regional team, or visit RussellLINK to download the article for use with clients.

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Robo-advisors, passive and/or active, international and/or U.S. stocks, commodities and the impact of a strengthening U.S. dollar. And the Fed (will they or won’t they raise rates in 2015?).

What is an individual investor to do?

In my view, it’s obvious: hire an advisor who aims to deliver value well beyond the selection of investments. Period.

Indeed, the 2015 edition of our annual look at “The Value of an Advisor” reveals – for the third year running – that the value of an advisor and their team/firm outstrips the fee they typically charge for an advisory account.

For new readers of this particular blog post series, let’s review the factors we look at in determining the true value of the services an advisor should deliver to their client:

A + B + C + P > Your fee

A= Annual rebalancing of investment portfolios
B= Behavioral mistakes by individual investors
C= Cost of basic investment-only management
P= Planning costs or the costs of providing a financial plan, updates and your services
Your fee = Annual advisory fee you charge clients

In 2014, these factors added up to be approximately 4.3%, which far exceeded the fees most advisors charge for advisory accounts. How has another year of strong equity performance changed these services and the true value of advice you deliver to clients?

Let’s get going and see what the true value of an advisor may be.  (To arrive at our estimates of an advisors’s potential value, we based our estimates on a $500,000 advisory portfolio.)

A= Annual rebalancing of investment portfolios

Many individual investors may avoid, lack the discipline, or simply may not have the knowledge to set a consistent rebalancing policy.

My colleague, Natalie Miller, recently updated a rebalancing policy study through 2014, which concluded that advisors who establish a consistent rebalancing policy for a client have the potential to add incremental return to portfolios while reducing the volatility of the return pattern.

Rebalancing comparison, January 1988 – December 2014

For illustrative purposes only. Not meant to represent any actual investment. Methodology available in notes at the end of this blog post.

Through 2014, based on this study, the advisor who had set an annual rebalancing policy had the ability to potentially add .30% in additional annual return along with the (often overlooked) potential reduction in risk of 1.6% versus a typical buy-and-hold investment strategy (over the course of 27 years).

So, what is the potential value of an advisor setting an annual rebalancing policy that a client is likely to stick with?

A= 0.30% in additional potential portfolio return while a potential reduction in portfolio risk of 1.6%

B= Behavior mistakes by individual investors

As the chart below shows, from 2009-2013, investors took more money out of U.S. equity mutual funds than they put in. That all changed in 2014 as investors didn’t want to miss out on the 5-year bull run in U.S. equities (as represented by the Russell 3000® Index). Suddenly, flows into U.S. equity mutual funds were net positive. In fact, the strong push into equities when values are high is exactly how an advisor can help manage the “buy high, sell low” mentality of individual investors.

Data shown is historical and not an indicator of future results. Source: Industry flows into equities. www.ici.org/research/stats.Russell 3000® Index: www.https://russellinvestments.com/indexes (“value with dividends”). Data as of January 7, 2015. Index performance is not indicative of the performance of any specific investment. Indexes are not managed and may not be invested in directly.

Data shown is historical and not an indicator of future results.
Source: Industry flows into equities. www.ici.org/research/stats.Russell 3000® Index: www.https://russellinvestments.com/indexes (“value with dividends”). Data as of January 7, 2015.
Index performance is not indicative of the performance of any specific investment. Indexes are not managed and may not be invested in directly.

The next chart shows how the “average” equity investor’s portfolio – accounting for the investor’s buys and sells – performed relative to the Russell 3000® Index over the 30-year period between 1984-2014. The analysis confirms again that: typical investors tend to chase performance. They typically flee after equity markets go down and rush back in after they’ve already gone up. This chart shows how much that chasing could have cost them: 2% annually!

Cost of investor behavior

(1) BNY Mellon Analytical Services, Russell 3000® Index annualized return from January 1, 1984 to December 31, 2014.
(2) Russell Investment, Strategas & Investment Company Institute (ICI). Return was calculated by deriving the internal rate of return (IRR) based on ICI monthly fund flow data which was compared to the rate of return if invested in the Russell 3000® Index and held without alteration from January 1, 1984 to December 31, 2014. This seeks to illustrate how regularly increasing or decreasing equity exposure based on the current market trends can sacrifice even market like returns.
Indexes and/or benchmarks are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

So, when you, as the advisor, help manage your clients’ behavior, you have the potential to favorably influence their returns relative to what they would be likely to earn without your guidance. In this instance, the value of an advisor is 2.0%.

Advisors are extremely valuable in that they can be the behavior coach who helps investors avoid chasing trends and buying during market highs and selling during market lows. Advisors who build a diversified asset allocation plan have the potential to help their clients achieve better portfolio returns than those experienced by the average investors making decisions without professional guidance.

B= 2.0% in additional return potential for an investor working with an advisor compared to the average investor

C= Cost of basic investment-only management (aka- Robo Advisors)

What is a Robo advisor and how are they setting the price for investment-only management? Robo advisors/firms offer investment-only management, often without a financial plan, and little to no ongoing service or advice outside of investments. Basically, these firms are setting the price for advisors who tend to build portfolios based on risk tolerance profiles without adding significant value beyond portfolio implementation.

Advisors who only focus on the “C” in their business are competing with firms such as Betterment, Schwab Intelligent Portfolios, Wealthfront and Personal Capital. This is a poor strategy and you will more than likely get beat while competing on price, rather than creating value for your time, advice and experience. The “C” in our equation is the smallest component within the value an advisor can deliver to a client. If you compete on fees, then by definition, you are competing with the $1 Value Menu instead of delivering the value your clients deserve and need.

The competition is fierce for basic, investment-only management. Relative to our 2014 study, the cost of basic investment only management continues to decline on a $500,000 portfolio. Based on my research of the three most popular flat-fee options offered by these firms, the cost of basic investment-only advice is approximately 0.25% on a $500,000 portfolio.

So for advisors, the market has set the price of your investment-only advice to be 0.25% of your advisory fee.

C= 0.25% for the cost of investment-only management

P=  Planning costs or the costs of providing a financial plan, updates and your services

As part of a fee-based relationship, advisors may add value through services that may cost thousands if purchased ala carte.

Additional services may include building a financial plan. According to the Financial Planning Association’s 2011 fee study, a financial planner spends 1 to 3 hours during the initial discovery with a new client and 3 to 14 hours building the financial plan with an average cost of $2,855. This does not include annual adjustments which are typically billed at $200 per hour. (We assume creating and maintaining the financial plans are part of the annual advisory fee in this example.)

By providing a financial plan with ongoing goal and risk tolerance monitoring, the value of both the initial plan and ongoing adjustment are worth approximately .60% on a $500,000 account.

Plus, there is the value of time. Advisors consistently underestimate the value of the time and peace of mind they may provide their clients. When you consider annual tax return preparation, social security planning, setting up retirement distributions, and many of the other requests clients may have, you can quickly arrive at time-savings on a clients’ behalf at 20, 50 or 100 hours each year. While it may seem difficult to know how to value this time, I estimate the value of what you provide adds another .25% (again assuming these are part of the annual advisory fee).

P= 0.85% (0.60% for annual planning and 0.25% for other services outlined above)

The bottom line

So what is your true value as an advisor in 2014? Are you still worth more than 1%?
Based on our research, you bet you are…but only if you are delivering value beyond the cost of investment-only advice.

A + B + C + P > Your fee

The value of your services individually may be:

Value of an advisor

For illustrative purposes only.

0.30% + 2.0% + 0.25% + 0.85% = 3.4% > Your fee

There you go…you are definitely worth more than the typical 1% fee you charge for advisory services.

I want to end on this quote from Warren Buffet….”Price is what you pay, Value is what you get.”

As advisors continue to examine their practice, it is important to remember that price is only one component. When you consider the value you should – and must – be providing to your clients, it is easy to see how the value of advice may be greater than the fee you charge.

Methodology for the Rebalancing Comparison, January 1988 – December 2014: Portfolio returns are based on a diversified portfolio consisting of 30% U.S. large cap, 5% U.S small cap, 15% non-U.S. developed, 5% emerging markets, 5% REITs, and 40% fixed income. Returns are based on the following indices: U.S. large cap = Russell 1000® Index; U.S. small cap = Russell 2000® Index; non-U.S. developed = MSCI EAFE Index (through June 1996), Russell Developed ex-U.S. Large Cap Index (July 1996 to present); emerging markets = MSCI Emerging Markets Gross Index (through June 1996), Russell Emerging Markets Index (July 1996 to present); REITS = FTSE NAREIT All Equity REIT Index (through February 2005), FTSE EPRA/NAREIT Developed Index (March 2005 to present); and fixed income = Barclays U.S. Aggregate Bond Index. Longer period data analysis start dates correspond to index start dates (January 1988 is the inception of the MSCI Emerging Markets Index).

The Russell 3000® Index measures the performance of the largest 3000 U.S. companies representing approximately 98% of the investable U.S. equity market.

Indexes are unmanaged and cannot be invested in directly.

Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

Strategic asset allocation and diversification do not assure profit or protect against loss in declining markets.

Russell Investments is a trade name and registered trademark of Frank Russell Company, a Washington USA corporation, which operates through subsidiaries worldwide and is part of London Stock Exchange Group.

Copyright © Russell Investments 2015. All rights reserved.

This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty.

RFS 15436

 

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  1. avatar
    FAM
    April 9th, 2015 at 13:42 | #1

    Brad:
    I very much appreciated the 2014 edition of this piece, and I am thrilled that you decided to continue to update this research each year (as with this newest 2015 edition) with updated statistics. I have found pricing, and building rationale behind that pricing, to be one of the most challenging aspect of running my business. While remaining competitive is still very important, almost as critical is confidently explaining the value and rationale of pricing. This analysis is an excellent source of information to assist with that challenge. Thanks for posting the 2015 edition and please continue to update this annually.

  2. avatar
    Brad Jung
    April 13th, 2015 at 13:44 | #2

    @FAM
    Mark, I’m glad you found the study helpful. Rest assured, you aren’t alone in finding it challenging, at times, to justify the value of your fee with your clients. Some of our other practice management blog posts – especially those about building a service model that aligns the revenue a client generates with the resources you dedicate to that client, and about WOW’ing your top clients to groom them into advocates – may also have some helpful ideas for you to consider building value for all clients you wish to serve. I wish you all the best!

  3. April 30th, 2015 at 14:16 | #3

    Does Russell or you provide or have a client ready piece showing your results? If not, why not? It would be a good thing to help educate people on the value of using an advisor.

  4. avatar
    Brad Jung
    May 5th, 2015 at 12:51 | #4

    @Allan Moskowitz
    Allan –

    Thank you for the suggestion! We do have a client-approved piece on Russell’s advisor website, RussellLINK. Please note that RussellLINK is only available to advisors whose firm has a selling agreement with Russell and who have a RussellLINK account. Russell’s products and services are sold only through financial intermediaries. Those who click through to RussellLINK without a login will find a password-protected site that asks for additional information.

    The client-approved article, “Your Advisor…worth more than 1%?,” contains 3 reasons and benefits of working with an advisor. It is one of our most popular marketing pieces, and I will be working on updating it for 2015 to include a few more of the graphics you enjoyed in my recent post.

    Please contact your Russell regional team, or visit RussellLINK to download the article for use with clients.

    Hope this helps.

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