In the world of finance, the quest for generating above-market returns, commonly referred to as “alpha” has always been a central concern for investors and financial planners alike. In 2014 an article titled, “Vanguard Shows How Investment Advisors Can Add Up to 3% in Returns” stirred intrigue by asserting that financial planners posses the potential to boost their clients’ portfolios by as much as 3% in alpha. Let’s dive into this assertion to understand the compelling factors that support this claim.
Unraveling the Claim
The article in reference spotlights Vanguard’s comprehensive research, showcasing how investment advisors can elevate returns for their clients. According to the research, advisors have the capacity to contribute an additional 3% in returns through strategic financial planning, adept behavioral coaching, and skillful investment management.
Exploring the Key Factors
1. Behavioral Coaching – The assertion highlights advisors’ role in guiding clients away from behavioral pitfalls, such as making hasty decisions during market downturns or succumbing to speculative trends. Behavioral coaching, undoubtedly, is a pivotal aspect of an advisor’s service. By providing clients with the tools to navigate emotional market swings, advisors can potentially lead to better decision-making and enhanced returns.
One example of this would be the year-to-date market (S&P 500) results. As of August 1st, 2023 the U.S. Stock Market is up 19.52%, which in many cases has taken most investors and advisors alike by some surprise after coming off of a bear market year in 2022 (-19.44%). As a planner our role is to help manage our client’s emotions and keep them invested through the market ups and downs so that they don’t miss out on potential growth.
2. Asset Allocation and Investment Strategy – The article underscores the significance of advisors in assisting clients with selecting optimal asset allocation and investment strategies. While market conditions are unpredictable, an advisor’s experience in crafting personalized strategies based on individual risk profiles can potentially translate to improved returns over the long-term.
One overlooked strategy from an asset location stance is the Staged Roth Conversion Strategy. Investors are taught traditionally to maximize the use of pre-tax retirement contributions in order receive intra-year tax-deductions. What they neglect to see is an ever growing “tax bomb” that will come due at the most inopportune time of their financial journey, i.e., retirement. The greater an investors pre-tax account value the larger their share owed to the IRS and Uncle Sam in the future. This strategy alone can potentially improve the qualify of overall assets in retirement for investors with tax-exempt assets for spending.
3. Cost Management – Vanguard’s research accentuates the impact of cost management on portfolio performance. The ability of advisors to strategically lower fees and taxes can create a tangible positive effect on returns. By optimizing costs, advisors contribute to maximizing the overall profitability of an investment portfolio.
Often times the value of investible assets being managed will help dictate which form of investment vehicle is being used. Today Planners have the option of using traditional mutual funds, exchange traded funds (ETFs) and individual stocks. Individual stocks tend to have greater tax efficiency, however can lead to higher management costs, as compared to mutual funds or ETFs. Most investors today leverage the use of index-funds to keep overall cost low, however indexing isn’t always the better best option for some investors. This is where working with a Financial Planner that understands yours goals and expectations comes into play.
4. Financial Planning and Goal Setting – The claim posits that advisors aid clients in defining clear financial objectives and devising tailored strategies to achieve them. This service can be instrumental in aligning investments with long-term goals, thereby potentially optimizing returns.
JP Morgan’s “Guide to the Markets” looks at the S&P 500 returns from 2001 to 2020 and shows that the 20-year annualized average return is roughly 7.5%. A traditional 60/40 portfolio comes in closely at an annualized average return of 6.4%. However, we find that that the average DIY investor received an average return of roughly 2.9%. The reason for this wide disparity is in short, the human element around emotions and behavior.
Charts are for illustrative purposes and are not intended to suggest a particular course of action or represent the performance of any particular financial product or security. Past performance is not a guarantee of future results.
The Multifaceted Nature of Alpha
It is important to acknowledge that generating alpha is a multifaceted endeavor shaped by diverse elements, some of which are within an advisor’s realm of influence. While uncontrollable factors like market volatility exists, the experience that advisors bring to the table through their services can certainly contribute positively to investment performance. To take this train of thought further it is important to denote the difference between investment management and financial planning.
Financial Planning by definition involves looking a client’s entire financial picture and advising them on how to achieve their short- and long-term financial goals. Covering everything from saving for education, planning for retirement, to effectively managing taxes and insurance. Financial Planners develop valuable relationships with their clients to provide them with confidence today and a more protection tomorrow.
The contention that financial planners have the potential to consistently amplify client returns by up to 3%, as highlighted in Vanguard’s research, merits thoughtful consideration. Financial Planners offer invaluable services that encompass behavioral guidance, strategic asset allocation, cost management, and personalized financial planning that is continuously reviewed and monitored. While market complexities cannot be underestimated, investors should recognize that advisors play a crucial role in building wealth and consider the multifaceted ways in which their experience contributes to achieving alpha.
If you’re on the fence whether or not you’re ready to partner with a Financial Planner or have the sentiment of, “I don’t have assets to manage so I can’t work with an advisor” I’d encourage you to start with interviewing a trusted Financial Planner. Go through the exercise to see if you like the person, trust the person and feel compatible with their philosophy and process. Financial Planning is more than just investment management, it's objective advice that spotlights the areas of your own personal financial wellbeing that you might be blind to!
Material discussed is meant for general informational purposes only and is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice.
This material contains the current opinions of Michael Acosta but not necessarily those of Guardian or its subsidiaries and such opinions are subject to change without notice.
Data and rates used were indicative of market conditions as of the date shown. Opinions, estimates, forecasts, and statements of financial market trends are based on current market conditions and are subject to change without notice. Reference specific securities, asset classes and financial markets are for illustrative purposes only and do not constitute a solicitation, offer, or recommendation to purchase or sell a security. Past performance is not a guarantee of future results.
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