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Last year, we published Part 1 of a series that discusses the value of having an advisor. From asset allocation to spending strategies to rebalancing, a Vanguard study seeks to measure these added values which they call, “Advisor’s Alpha.” Not all strategies are applicable to every investor, and the value added will vary based on individual circumstances.
Strategies that add value include:
Asset Allocation, Cost Effective Implementation, Rebalancing, Behavioral Coaching (adhering to a plan), Asset Location, Spending Strategy (withdrawal order), and Total-Return Investing
Vanguard quantifies the value-add of best practices in wealth management
Value-add relative to 'average' investor experience:
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Notes: Return value-add for Modules I and VI was deemed significant but too unique for each investor to quantify. Also, for “Potential value added,” we did not sum the values because there can be interactions between the strategies. Source: Vanguard
Strategies of focus:
Rebalancing, Behavioral Coaching, and Asset Location
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| III. Rebalancing |
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 The importance of asset allocation to portfolio returns was discussed in-depth in Part 1 of this series, and rebalancing is the process that allows for an appropriate asset allocation to be maintained over time through continued market shifts. A portfolio that is not rebalanced on a regular basis will drift from its original asset allocation as asset classes have varying returns.
Typically, this means that assets with greater return AND greater risk will grow to be a larger portion of the overall portfolio. Rebalancing is mostly about maintaining an appropriate level of risk for a client and maximizing return given that boundary. Rebalancing is a built-in “buy low, sell high” strategy that keeps portfolios in-line with asset allocation targets while removing emotion from the process. Disciplined rebalancing during significant market shifts - selling the best performing assets to buy the worst performing assets - is counterintuitive yet beneficial to the probability of an investor’s long-term success.
Potential value added according to Vanguard: ~ 0.35%.
We believe that rebalancing adds value by controlling risk and eliminating portfolio drift from long-term market trends and that any performance advantage is most likely gained in volatile, short-term market movement.
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| IV. Behavioral Coaching |
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 One of the most important roles of an advisor is to take a pragmatic approach to investing and remove emotion from the process. Study after study has shown that investors can be their own worst enemy when it comes to investment decisions. Significant disruptors to a sound investment strategy occur when the plan is abandoned for the emotional behaviors of market-timing, performance chasing, and panic selling. Investors can prevent many self-destructive investment behaviors by building a trusted relationship with an advisor who provides ongoing communication, education, transparency, and a consistent investment process.
Two examples of market environments that led many investors to make poor decisions are the dot-com bubble of the early 2000’s and the Great Recession of 2008-2009. In the first instance, many investors flocked to high growth, technology and internet related companies as stock prices soared. This led them to abandon an appropriate asset allocation in an attempt to chase performance. Ultimately the bubble burst and those that had allowed their portfolios to shift towards greater risk suffered the consequences as the NASDAQ fell 78% from its peak! The Great Recession began with the bursting of an $8 trillion housing bubble that crippled the economy and led to stock market declines of over 50%! As markets tumbled, many investors could not stomach watching their retirement nest egg deteriorate. Fear led them to an emotional decision to sell investments at significantly reduced values and abandon long-term investment strategies. These investors locked in losses and missed much of the recovery as markets rebounded.
Good advisors can add significant value in times of market euphoria or despair by reminding clients of the plan that is in place and addressing and preventing emotional decisions to abandon the plan.
Potential value added according to Vanguard: ~ 1.5%.
We believe that behavioral coaching can be of tremendous value to many investors and that value added varies significantly from 0% – 2%.
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| V. Asset Location |
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 Investors that have assets in both taxable and tax-advantaged accounts can benefit from working with an advisor to help locate assets in a tax efficient manner. For example, equities should be held in taxable accounts to benefit from favorable tax treatment of dividends and capital gains, while taxable bonds can be held in tax-sheltered retirement accounts like IRAs and 401ks. This strategy also captures the yield advantage that is gained by investing in taxable bonds. The incremental difference of investing in a tax efficient way can have a significantly positive effect on a portfolio when compounded over time. A good advisor can help manage a client’s optimal asset location strategy.
Potential value added according to Vanguard: 0% - .75%.
We believe that investors with significant assets split between taxable and tax-advantaged accounts can benefit from tax-efficient asset location. That benefit will vary based on individual tax circumstances. |