We can broadly classify investors into two categories – DIY (do-it-yourself) and those who seek advice from a professional financial advisor.
A financial advisor helps her/his clients with many aspects of their financial portfolio management:
- Financial goal setting
- Handling finances
- Making investments
There are many other services that a financial advisor could offer, which are not per se financial in nature – staying the course in troubled times and saying no to unnecessary risks in the portfolio.
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But most people still want to know, do they really need an advisor or The Value of Advice Financial Advisor? This question arises because most are unaware of the value that a financial advisor offers to clients. Many investors also have various doubts when it comes to hiring an advisor.
Most doubts arise because it is not easy to quantify the value that an advisor brings. In market parlance, people are not aware of the alpha that an experienced financial can add to your portfolio.
Does one need a financial advisor?
With far too many blogs and videos available from everyone who has made some money in the stock markets, there is no dearth of online advisors. Mostly they make stock-specific recommendations with a “NOT-A-RECOMMENDATION” tagline after each one. Or dish out general stuff without knowing anything about their audience.
The basic presumption with DIY investors is that they will take care of all aspects of their financial needs in a manner a qualified advisor would.
In the past two years of online classes, we have seen how learning outcomes have been impaired because of the unavailability of access to a teacher/trainer. Just like that, without a readily available financial advisor, most investors cannot go through their financial journey for long.
There are only a fraction of people who exercise the DIY finance principles by themselves.
There are many reasons:
- Lack of proper support.
- You get busy with your regular work and life so much that you do not get time to check your financial status until the 11th hour.
- If you are not deeply interested in finances, then you can lose the initial motivation very soon.
- There is no expert (if you don’t count relatives and friends) to compare notes with and discuss important matters.
In the beginning finances and investments may seem easy, but going forward, you just can’t handle all the nuances by reading a few articles or watching videos.
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Value addition and how to quantify it?
Most people, do not wake up in the morning with the thought that, “I would make investments, buy insurance, or manage taxes & retirement funds today.” That’s the last thing anyone is thinking about.
When you sit with a financial advisor, that’s when the desire to cut the middleman and do something yourselves gets in the way.
Value can be financial or non-financial and is highly subjective. What is of little value to one person, maybe high on the list of another?
According to Vanguard’s “Advisor’s Alpha” framework, an advisor can generate up to 3% superior net returns annually. This they can do in a mature market like the USA with the help of tools and best practices including:
- Financial planning and wealth management
- Asset allocation
- Retirement withdrawal sequencing
- Behavioral coaching
- Portfolio rebalancing
The recent market volatility in stock prices, interest rates, property prices, and inflation apart from the loss of human lives made people sit up and realize the value a financial advisor brings to the table. Many investors who heeded the advice of their advisors, and continued their goal-based investments, and came out unscathed in the aftermath of the crises.
Moreover, the average fee an advisor charge is much lesser than the average cost of lost returns due to inefficient investments, tax implications, and lost opportunities.
it is estimated that through strategic planning alone an investor could add up to 2.5% to their returns annually.
The non-financial value can be explained with the help of this somber example.
One of our long-standing clients passed away during the peak of the second wave of COVID, leaving behind a wife a teenage college-going daughter. He was the only person in his family who knew which investments were made, what was the reason behind them, how he wished to pass on his legacy, and so on.
We used to continually nudge him to prepare a will, but as he was in his mid-40s, he was always reluctant. But he did listen to us on a few key important matters – he bought term life cover for a good cover, insured all his loans, and maintained a financial diary with us with all major transactions and investments.
After the family came to terms with his loss, they were almost in a destitute position. However keenly we wanted, we could not come to terms to get the wife to sign some papers for many weeks. But later as we approached her and discussed how he took care of everything in his lifetime.
The only expressions that came on the faces of the wife and her daughter were gratitude, love, pain (from loss), and a sigh of relief. Later, as they came to terms with their emotions, we advised them on how to manage their insurance money. We helped them invest in securities to cover their daily expenses, as well as to provide growth to meet future needs.
This is something, that any financial advisor would always wish that they never have to face. But this is exactly the kind of situation where you need a financial advisor the most.
In addition to handholding, an advisor can:
- Educate their clients on how to delicately tread the financial battlefield.
- Help them control their emotions.
- Help them identify financial goals, which are closely tied to their life goals.
- Plan on achieving financial independence by smashing the inertia.
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Quantification of value
Well, now comes the real question. How do we quantify the value an advisor delivers?
The value of an advisor is difficult to quantify. But a majority of professional investors strongly the value the advice financial advisors.
Of course, quantification is a difficult process.
When it is said, this is the ‘best’ strategy, if we do not have a reference, how do we compare it, and with what?
The advisor could add two types of values: alpha and beta.
The alpha value is the additional return on investments compared to the benchmark. Whereas the beta measures the relative risk at which such returns are achieved.
The advisors can achieve superior alpha by actively managing the portfolio, applying optimized financial strategies, planning portfolios to align with goals, more efficient tax planning, planning withdrawal strategy, and doing this taking care of the risk appetite of the investors.
What does the research say?
People want to know whether it is beneficial to hire an advisor or not.
Research by Envestnet PMC, Morningstar, and Vanguard says an advisor can add up to 3% to your annual returns.
Over the long term, an annual 3% additional return can result in significantly higher returns.
Some advice for advisors
Unlike a doctor of a CA, a financial advisor’s relationship with their clients is more fragile and takes longer to build. Therefore, the advisor must be upfront and candid at all times to earn the trust of their clients. Even if it means, saying the not so convenient thing.
A financial advisor also benefits if they understand the client’s psychological framework before pushing them to follow the investment plan.
The quality of service, response time, easy-to-read reports, clear & simple disclosures, and clear understanding of the fee/charges are some other necessary aspects.