If you do the math quickly, that seems like an incredible deal. Since most financial planners charge a starting fee of around 1%, earning an extra 4% for that expenditure should be a no-brainer. Why, then, aren’t people lined up outside the doors of financial planners waiting to get a chance to become clients?
Let’s take a closer look.
First, this analysis was done by an investment advisory firm. I’m guessing they were unlikely to fund an analysis that found investment advisors to be a terrible waste of money.
That said, everything in their report is true. It valued five investment functions: rebalancing, behavioral mistakes, investment management, financial planning, and tax planning.
1. Rebalancing. The study found that annual rebalancing—bringing your portfolio back in line with its target asset allocation—adds 0.20%. While that is a seemingly small number, it can add up to a lot over a long period of time.
2. Behavioral mistakes. The analysis concluded that an average investor’s behavior of trying to time markets and chase returns costs them 2.0% a year. The study found that if an advisor can motivate an investor to not try to beat the market but to stay in an index come hell or high water, this will add 2% to their annual return. There is a huge caveat here that was not mentioned in the article. To add the 2.0% annual return, the advisor must believe in following a passive index allocation and not timing the markets.
3. Investment management. This is just investment-only management that includes no financial planning, ongoing service, or guidance. Just an annual statement, online access, and a phone number to call, which is what robo advisors offer for about 0.33%.
4. Russell analyzed the value of financial planning based on cost data of doing financial plans obtained from the Financial Planning Association. They defined financial planning services as those over and above investment management, including investment advice, customized financial planning with annual updates, Social Security and retirement income planning, and custom requests. They concluded the value was 0.75%.
5. Tax planning. The analysis concluded that a non-tax-managed U.S. equity mutual fund costs the average investor 1.53% annually in reduced return because of taxes, while a tax-managed fund cost just 0.73% annually. They concluded the value of tax-aware planning and investing was 0.80%.
Adding all that up, the study concluded the value of an advisor was 4.08% a year.
The study didn’t mention some of the advisor services that you could do for yourself if you chose. If you are willing to do your own annual rebalancing, invest in a passively managed portfolio of sensibly selected tax-managed index funds, and never sell out during market drops, you could add 3.0% of annual value yourself. Granted, most people don’t want to do that, but it’s not that difficult.
That leaves investment management and financial planning being worth 1.08%. This is just a bit higher than what the average fee-only planner charges, but it’s considerably lower than what most people pay in commissions to an insurance company or brokerage firm.
Here’s the bottom line: If your financial planner is a fiduciary, charges a fee of around 1%, doesn’t try to time the markets, uses index and tax-managed mutual funds, rebalances your portfolio annually, and encourages you to stay in the market during a crash when you desperately want to bail out, you are probably getting great value.