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Quantifying the Value of Financial Planning Advice

One of the largest obstacles financial advisors have is explaining what we do and how it benefits clients. Most of the advice that is delivered is intangible, making it difficult to quantify the value of that advice. Several recent studies, which attempt to provide more definition around this, have been summarized by Michael Kitces into the following one page summary.

(Click picture for full image)

I recommend first opening the attachment and simply scanning through it to see all of the areas mentioned. The various areas where advisors add value are ranked in top to bottom order from easier to measure to more difficult. Note some items are quantified in a potential dollar range while the more investment-centric are expressed in percentages.

A couple of realities here. First, not all line items apply to all people (e.g. not all clients are subject to the estate tax and not everyone can take advantage of tax loss harvesting or asset location). Next, some of the items are truly unquantifiable and the value of some items could vary greatly between clients. However, the bottom line question in hiring an advisor (or lawyer, accountant, plumber, landscaper, you name it…) is whether more value will be added than the sticker price of the cost.

If an advisor such as myself charges around 1% of assets under management, or some similar structure, what is the value delivered for that fee? It should be fairly obvious from the attached summary that value is likely to be something greater than 1%. Again, the amount will differ by client situation, so let’s try to at least quantify a baseline amount using (1) items that are likely to apply in most all cases and (2) conservative estimates of each item. Also, I have attempted to do this in percentage terms to make things easier to compare.  Here are the results:

So, using conservative estimates for only the items that are likely to apply in most cases, added value outweighs fees without much contest. Then, think about what happens when you are able to add on the benefits of other items such as tax loss harvesting, asset location, ensuring assets are protected during life and after death, strategies to reduce Medicare premiums and so on. The value becomes an even bigger number! Then add the less quantifiable items such as freeing your time, off-loading the emotional stress, knowing you are following a plan to attain goals, having an advisor/coach to keep you from making big mistakes and the list keeps growing and the value gets larger.

Vanguard’s analysis on this subject concluded, “We believe implementing the Vanguard Advisor’s Alpha framework can add about 3% in net returns for your clients and also allow you to differentiate your skills and practice. The actual amount of value added may vary significantly, depending on clients’ circumstances.” Note that their study was more limited in its scope than the attached work by Michael Kitces. That seems like a very good return for fees paid to an advisor.

The final thought I would add here is this. Advisors can do all sorts of things for clients, but in the end it really comes down to crafting a well thought out plan, making good decisions and then avoiding big errors. Particularly on that last point, having an advisor is really the equivalent of having big mistake insurance, and is frankly where I believe we add the most value. Considering the various insurance coverages I have, I think of car, homeowners, disability and life insurance. I don’t want my car insurance and homeowners insurance to pay off.  And I REALLY don’t want my disability or life insurance to pay off, at least not anytime soon! I would be quite happy to look back on years, even decades, of paying these premiums, knowing they provided necessary coverage, but in the end were actually an erosion of value.

And therein rests the difference between most forms of catastrophic insurance and big mistake insurance via a financial advisor.  In the former case, we hope it never pays off, know it will be painful if it does and can only erode value if it doesn’t. The financial advisor, on the other hand, is a cost that will add value and makes things less painful along the way.

As always, we are glad to talk about your specific situation to see how we might add value.

Any information presented here is general in nature, believed to be reliable as of the date published and is not intended to be and should not be taken as legal, tax, investment or individual financial planning advice. Competent, licensed professionals should be consulted when implementing any kind of financial, estate, tax or investment strategy.

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