What is the value of a financial advisor for his or her clients? It’s a question the advisory industry has been grappling with for years to help justify fees in a world where investment costs have been declining and competition from lower-cost digital advisors has been growing.
Fidelity defines the value of financial advice as the Value Stack pyramid, with managing money at the bottom, fulfillment at the top, and achieving goals and peace of mind in between.
Now Vanguard has developed its own three-part framework for assessing the value of financial advice, beyond investment advice, based on research using client data from Vanguard Personal Advisor Services (PAS), a hybrid service combining digital and human advice.
“The advisory industry is increasingly interested in clarifying what constitutes value for investors and how to assess value for money paid,” according to a new Vanguard report, Assessing the Value of Advice, written by Cynthia Pagliaro, senior research analyst with the Vanguard Center for Investor Research, and Stephen Utkus, principal and director of the center.
“Our framework demonstrates the importance of defining value in the broadest sense, going beyond portfolio outcomes to include both financial outcomes and emotional well-being. In time the industry will need to develop widely acceptable and comparable measures that encompass all three dimensions.”
All three elements were developed based on data from analysis of PAS client accounts, whose median age was near 65 and median portfolio balances were between $250,000 and $500,000 (PAS has a minimum account balance of $50,000 and charges a 0.30% annual fee for accounts of less than $5 million.)
Portfolio Value: Quality of Portfolio Construction
Portfolio value can be quantified in several ways, measuring risk-adjusted returns, the impact of taxes and portfolio fees on returns and diversification. The Vanguard paper focused on diversification, comparing the portfolio construction decisions of more than 44,000 clients six months after they had switch from self-directed Vanguard accounts to PAS.
Vanguard found that portfolio diversification increased after investors made the switch, reducing cash allocations from 16% to 1% and increasing bond allocations from 26% to 39%. (Remember: Most of these investors were near retirement age.)
Equity allocations rose slightly from 58% to 60%, but the allocation to international stocks increased for over 90% of investors, effectively eliminating home bias. Single-stock holdings were reduced for 10% of investors who held significant positions in individual stocks. The biggest change in portfolio allocations were seen among investors who held concentrated holdings of individual security or cash reserves.
Financial Outcomes: Achieving Investment Goals
Vanguard examined the success rates related to achieving a secure retirement, which was the goal most commonly identified by the more than 104,000 PAS investors. As of January, eight in 10 of these investors had an 80% or greater probability of achieving their objective.
Some investors may have even been over-prepared for retirement, living more modestly than they needed to, according to Vanguard. That can provide an opportunity for advisors to discuss their clients’ current and desired standard of living.
Emotional Outcomes: The Role of the Advisor Relationship
This factor relates to the emotional security that an advisor’s services can contribute to an investor’s feeling of financial well-being.
Vanguard asked a sample of just over 500 PAS investors to rank 24 statements about their relationship with an advisor in terms of importance and satisfaction, then used regression analysis to analyze how each individual statement contributor to an investor’s perception of value.
Trust in an advisor garnered the highest value followed by having a personal connection with an advisor and reassurance in down markets. Vanguard determined that the emotional aspect of advisory relationship represented close to half (45%) of the total value assigned by investors.
The report concludes that its results “highlight the need for a broader advisory industry investment in value metrics. … As the industry grows in scale and impact and the emphasis on investor value continues, additional data-driven benchmarks will be needed to evaluate advisor quality and efficacy.”
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