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Financial Planning Fees – An Expense or an Investment?

In a recent column, I talked about one aspect of the value provided by a financial planner being the combination of detachment and knowledge that can keep a client from making “the big mistake.” I have since read an article that goes even further to answer the question of whether clients really receive value for their financial planning fees.

Since KFG’s 25-year client retention rate tops 90 percent, our clients apparently feel they are getting good value. Still, about once a year someone raises this question. It is a pertinent one that every savvy client should ask from time to time.

It’s hard to quantify an answer. However, a recent article by Roy Diliberto, CFP®, from Ft. Myers, FL, sheds some new light on the real value of having a financial planner manage your investments. In his article in the November Financial Planning magazine, Diliberto cites a recent study by Dalbar, Inc. According to Dalbar, a financial planner or investment advisor will earn you up to an additional $85,000 on every million dollars you have invested in equities.

Dalbar studied various returns on a portfolio of stocks from 1984 to 2002. During this 19-year time frame, they found the average do-it-yourself investor, who did not use a financial planner or investment advisor, earned less than the inflation rate. The average return garnered by such investors was a dismal 2.57% per year. The inflation rate was 3.14%. During that period, the S&P index earned 12.22%.

Put into dollars, go-it-alone investors earned about $25,000 on every million invested in the stock market. Had they simply put that million into the S&P index and left it alone—the most basic strategy an advisor might have suggested—they would have earned $120,000 a year. That’s a loss of $85,000 annually. That makes the annual cost of an investment advisor or financial planner, at $10,000 or less per million, a phenomenally good buy.

Why do investors without professional help do so poorly? While the article didn’t state a conclusion, I have an idea. My experience, plus data from other studies done on behavioral finance, indicates that most go-it-alone investors do not diversify among asset classes. In addition, they make most of their decisions to buy or sell emotionally, using factually irrational analysis and conclusions.

So far we’ve been talking only about the returns garnered by using index funds. In the investment business, a good portion of the compensation for most mutual fund and money managers is based on their “beating the market,” or obtaining a return that is higher than the index. Likewise, many investment advisors and financial planners, myself included, spend a lot of time constructing portfolios that will beat the market. Investment professionals consider it exceptional if they beat the market by 1% or 2% over a period of time.

Diliberto points out that the time spent to squeeze out that extra 1% or 2% may be better used in providing other important financial planning services to a client. He makes a good argument that if a financial planner can add 8.5% of additional annual return to clients just by helping them manage expectations and keeping them from making the big mistake, an extra percent or two return is not highly meaningful. Even further, he suggests that if a financial planner underperforms the market index by 2%, he is still adding 6.5% of additional return to the client.

He has a point. Maybe his message to financial planners is, “Don’t sweat the small stuff.” Certainly, his message to those not using a financial planner is resoundingly clear. Financial planning fees are an investment that pays bigger dividends than even most planners are aware.

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