Periodically, we revisit research asking the fundamental question: Does an advisor add value? It is an important question for us since it is the reason we exist. Our goal as a firm is to add value to our clients’ lives by providing customized, well researched solutions for their financial situation. We think a lot about whether we are achieving that goal and how we can continually improve the service that we provide.
Vanguard has produced some of the best research in this area, showing that advisors can add as much as 3% per year when compared to the investment returns that most retail investors experience on their own. The report, first introduced over 10 years ago and updated annually, offers a compelling model to help the typical investor improve returns. Vanguard Advisor’s most recent update once again concluded that advisors, when acting appropriately, can significantly add value compared to the typical retail investor. Vanguard found that the largest areas of value were found in 3 key areas: Behavioral Coaching, Spending Strategy (withdrawal order), and Asset Location. Let’s discuss each in turn.
Behavioral Coaching (0 to >2%)
Many investors destroy returns by chasing returns, buying, and selling at the wrong time and jeopardizing their long-term goals. Essentially, the typical investor, as demonstrated by flows in and out of mutual funds, trails the returns of the market, and often the very funds that they are invested in. According to a study by Morningstar, the mutual fund rating company, for the ten years ending December 31, 2015, mutual fund investors trailed the funds they were invested in by .86% to 2.29% per year.
Some investors are locked in the fear and greed cycle that dominates the news cycle. Some are enticed by advertisements of mutual fund companies touting their outperformance. Others have a habit of moving their investments to the funds that have most recently performed the best, a strategy that often results in ‘buying high’ and ‘selling low,’ creating a cycle of underperforming the market.
Therefore, advisors can add value by creating a strategy to help investors avoid the trap of buying and selling at the wrong time. This “Professional Stewardship” begins with a specific plan and investment strategy. Having a plan gives investors confidence to stay the course during market disruptions, a confidence that can be of significant value during times of stress.
Spending Strategy (withdrawal order) (0 to 1.2%)
Advisors can also add value through an effective spending strategy. Once investors begin living off their savings, an effective strategy for withdrawal can result in significant tax savings. We have written about these strategies in the past. Retirees often have more control over their taxable income. By strategically drawing funds from the appropriate ‘tax bucket,’ or using strategies such as Roth conversions to make best use of the tax brackets, retirees can lower the long-term tax on the overall portfolio.
Asset Location (0 to 60)
Asset location strategies also take advantage of tax laws to help reduce the overall tax burden on the portfolio. For example, taxable investment income is often categorized by the IRS into capital gain income and ordinary income. Capital gain income receives preferential tax treatment that results in lower federal income tax rates at every income level. Therefore, locating capital gain producing assets, such as stocks, in taxable accounts and locating ordinary income producing assets, such as bonds, in tax deferred accounts, can reduce overall taxes when compared to spreading investments equally across both taxable and retirement accounts.
Of course, At Cedarstone Advisors we are proud of the value that we create for our clients. We utilize each of the above strategies and many more to add value to our clients lives. If you are interested in learning more about how we can add value to your situation please give us a call, we would be glad to help.
If you would like to read the full Vanguard study you can find it here: https://advisors.vanguard.com/iwe/pdf/IARCQAA.pdf