Measuring the Value of a Financial Planner
Updated: Aug 7
One of the most common questions I get from prospective clients is, “What kind of value can I expect to receive from working with you?” And my initial response is often the one we all dread hearing, “It depends..." But really the point I am trying to make is that there are a number of ways a financial planner can add value, and how that value exchange occurs will depend on the client's unique set of circumstances.
So instead I try to boil that question down in a way that is easier to understand. More generally there are 2 situations where working with a financial advisor makes a lot of sense:
When a person has a lower level of financial knowledge and lacks the necessary skills or discipline to successfully manage their money.
When a person with excellent financial knowledge doesn't have enough time to keep money matters organized and finds that he/she is procrastinating to follow through.
In both of the scenarios discussed above, money is being left on the table. Therefore, it is clear that a client will benefit from the services of a financial planner. The planner can help the client avoid costly mistakes either due to lack of know-how or not having any time. Unfortunately, I realize my standard response does not adequately address what people are really asking... "Will the value I am getting from you exceed the fee I am paying?” Or even more to the point, “How much money are you going to make me?”
My answer to #1: "Yes, especially in the long-run." My answer to #2: "A lot." If only the answers were really that simple. Look I get it, I prefer a direct response and would much rather bypass all the fluff. Americans are busy people, especially if you are raising a family or knee-deep in your career. Quick answers have become the expectation. The problem is that financial planning is circumstantial and therefore a good answer must be adjusted to the person asking the question.
Rather than manufacture a blanketed response, I created a detailed guide to quantifying the value of financial advice.
In addition, I touch on some of the intangible ways financial advisors are able to enhance the life experiences of their clients. Due to the fluid nature of financial advice, the points outlined in this guide should help anyone on the fence determine whether or not the value of working with an advisor is worth the personal investment (a much nicer way of saying cost).
Before diving into the details, I want to give credit where credit is due. Aside from borrowing from my personal experience (12 years as a financial advisor), the following are the primary sources of data provided throughout this guide: Michael Kitces, Vanguard, Mitch Anthony, Shawn Tydlaska, Travis Hornsby, and Student Loan Hero.
This is the obvious place everyone wants to point to but investments really make up a fraction of the value provided by a financial advisor. Nevertheless, there is still a lot of value to be had. According to a research study completed by Vanguard, a financial advisor can add roughly 3% per year to portfolio returns over time -- net of fees. In other words, an investor with a $500,000 portfolio realizes about $15,000/year in value from working with an advisor. Not bad I’d say.
It’s a bit ironic that a cost-conscious company like Vanguard sees the value in paying a financial planner. Essentially the value proposition Vanguard outlines is broken up into 3 prongs: 1) portfolio construction = 1.20%, 2) wealth management = 1.05%, and 3) behavioral coaching = 1.50%. Note that Vanguard acknowledges their research isn’t an exact science. In other words, the "3% value add” is in contrast to the advisors who are not practicing the principles outlined below.
Suitable asset allocation = >0%
Use of low-cost index-based products = 0.45%
Asset location = 0.75%
Total-return versus income investing = >0%
Regular rebalancing = 0.35%
Withdrawal sourcing = 0.70%
Advisor guidance to help adhere to financial plan = 1.50%
Data Source: Vanguard
The value-add category that stands out most is behavioral coaching at 1.50%. Although I would argue that an advisor could add as much as 10%-50% of portfolio value during a time period like the Great Recession. Why is behavior so important? Because during moments of crisis, humans usually make emotionally reactive decisions. However, a key element of a successful financial plan is following a set of proactive behaviors.
The problem is investing in the market is counterintuitive to what our emotions tell us. When people are thinking logically, we all believe in the saying, “buy low, sell high.” However, in practice, the average investor rarely follows such a rule of thumb. Don't believe me? Read this CNBC article about how investors underperformed the S&P 500 by 7% in 2016.
What might explain some of this underperformance? Back to analyzing the emotional aspects. Greed motivates investors to buy speculative assets like Bitcoin after it’s up 50% during a 6 month time period. Additionally, fear during times of panic overrides prudent decisions about one's retirement account. A prime example is when most retail investors sold their stocks and moved to cash when the housing market collapsed in 2008. Our basic instincts aren’t necessarily wrong in either situation -- reacting to our body's signals is how we as a species learned how to survive. It's a primitive trait that has allowed humans to thrive on this planet.
Unfortunately, that primitive part of our brain is not a useful resource for achieving consistent investment returns. The stock market requires investors to practice emotional restraint both on the way down and the way up. Therefore, if you lack the discipline to make the right decisions during times of euphoria and panic, it makes perfect sense to enlist the services of a financial planner who can help you stay the course. An advisor does this by ensuring your investments are allocated in the appropriate percentage of stocks, bonds, and cash that you can tolerate. Proper alignment between asset allocation and one's risk tolerance has proven to help keep investors in the game even when markets get choppy.
Taxes are one of the easiest areas to quantify value because it usually has a more tangible economic benefit. The dollars saved are explicit. Besides, who doesn't want to stick it to Uncle Sam? Furthermore, we can all agree that the tax code is highly complex and most of us don't want to deal with it. This burden is a big reason why taxpayers put a good portion of their financial livelihood in the hands of a CPA.
However, a financial planner is absolutely an integral part of ensuring your investments, estate, and retirement plan are all properly coordinated with your tax expert. If your CPA and planner are not on the same page, a breakdown is likely to occur at some point and cause potential tax costs that the CPA or planner could have helped you avoid in the first place. Communication is key!
Furthermore, it's not a CPAs primary duty to understand what after-tax investments should be sold in order to minimize capital gains taxes, the turnover rate of a mutual fund, or what bond fund is best suited to reduce your federal tax liability. These are more forward looking concepts that a good financial planner will help you with.
With that in mind, the following are some of the methods a financial planner uses to add value to your tax situation:
Tax deductions, tax credits, and tax-free investing opportunities = $1,000 - $10,000+
Maximizing efficiencies of tax-deferred retirement vehicles = $10,000 - $100,000+
Roth conversions and tax-sensitive liquidations = up to 30% of total wealth
Tax loss harvesting = 0.20% - 0.60% of the portfolio value
Data Source: Michael Kitces
In terms of estate planning opportunities for upper-middle class and wealthier families, strategies might include revocable trusts, irrevocable trusts, grantor trusts, tax bypass trusts, family trusts, special needs trusts, spendthrift trusts, qualified personal residence trusts, charitable trusts, QTIP elections, ILITs, business buy-sell life insurance agreements, life estates, and more.
By the way, if you come from a prestigious upbringing and have a name like Jenkins Calloway Abernathy IV, you should probably enlist the expertise of an estate attorney. Even if your name is Joe Blow, it's probably a good idea to make sure your estate affairs are in good order whenever you are no longer around.
For the average citizen, the actual value provided by a financial planner is going to be their ability to ensure your assets pass on to the intended parties upon your death while bypassing probate. Probate is both costly and a significant time investment for the executor of an estate. So it's best practice to ensure assets are properly titled and that any beneficiaries on your bank, investment, and retirement accounts are up to date. Otherwise, you put your family in an awkward position when it comes time to settling who gets what. It's not a pretty site to see.
The following summarizes the estimated value provided towards estate matters by a financial planner who is working in concert with your estate attorney:
Federal estate tax savings = $1M+
State estate tax savings = $100k - $1M+
Probate and settlement savings = $1,000 - $10,000+
Ensure assets get passed to the intended party
Data Source: Michael Kitces
Side story. A few months ago, I reviewed a good friend's family trust being managed by a large national bank who will remain nameless. That trust account was being charged a 1.50%/year asset management fee, which is at least 0.50% too high. What's worse is that the expense ratios of the funds were also very expensive. Furthermore, the investment assets held in that trust were not positioned in a tax efficient manner.
Egregious costs to the client like the ones previously mentioned are hard to fathom, especially when the portfolio is valued in the millions. You would think incompetent advice doesn't affect the wealthy. Wrong! Even wealthy people get ripped off. Let that be a lesson to avoid complacency. If you have any shred of doubt about your accounts, it never hurts to get a second opinion from a CFP® that is a fiduciary.
For those who never want to retire (like me), you can swap out the word retirement for financially independent. I like to think of those two terms as interchangeable.
In addition to social security, your retirement accounts will be one of your primary sources of income. Deciding to leverage the guarantees of an annuity versus creating an income portfolio using the right combination of bonds and dividend-paying stocks are one of the many difficult decisions a retiree is faced with. Remember the good old days of following a monthly budget? Understanding your spending limits during retirement is essential to a successful outcome.
Ultimately, a well-thought-out retirement plan requires a considerable amount of analysis, projections, assumptions, and long-term planning. While the planning process is not perfect, it certainly is better to have a dollar amount in mind for the day you turn 65, than it is to blindly retire one day and hope your money will last.
Quite frankly all of my clients who are at or nearing retirement share the same fear -- running out of money after their earnings power disappears. Sure, the Walmart greeter job will always be there, but that really isn't what my clients have in mind for themselves. It's the very reason why starting a retirement plan at an early age -- ideally in your 20s but no later than your 30s -- is crucial to ensuring a successful outcome.
So then, how does a fee-only advisor add tangible value when it comes to retirement?
Maximizing social security benefits = $10,000
Tax planning strategies related to Medicare Parts B & D = $1,000 - $100,000+
Projecting likelihood of successful outcomes so adjustments can be made in advance
Income and spending strategies so that your bank accounts don't eventually go to $0.00
Data Source: Michael Kitces
Buying insurance is about as much fun as getting a root canal. Unfortunately, it's a necessary part of the financial planning toolkit. Without a risk management plan, a person's financial well-being can blow up in their face when they don't have the proper amount of insurance coverage in place.
Why does insurance cause so much pain? First, no one wants to think about dying, getting in an automobile accident, going to the hospital, becoming disabled, or losing their mind to Alzheimer's. Secondly, insurance is a product we all pay into but hope that we never have to use. Last but not least, commission-driven insurance representatives are notoriously aggressive at upselling more coverage than is necessary. This is an instance where an independent and objective financial planner can offer a second set of eyes and ensure clients are protected with the appropriate level of coverage.
As a general rule of thumb -- buy term insurance and invest the difference. Don't buy whole life and variable universal life policies unless you are maxing out your retirement plan and IRAs. Even then, it's best to consult with a fee-only financial planner who will act as your fiduciary.
The following are some of the quantifiable ways a financial advisor might add value with regard to insurance and risk management:
Optimize cost structure = $100/year
Replacing or cancelling bad life insurance policies = $1,000 - $12,000/year
Proper use of HSAs = $100 - $2,000/year
Proper use of FSAs = $100 - $1,000/year
Help avoid financial disasters with proper coverage limits so you don't go broke
Use of umbrella policy to increase liability protection
Example. A married couple with 2 kids and household earnings of $180,000 is debating whether or not they should use the wife's HSA plan offered through her employer. Assuming they max out their contributions at $6,750/year their projected tax savings is about $2,000.
A word of caution. Be sure to evaluate the merits of using a high-deductible health insurance plan with an HSA versus the other lower deductible options presented by your employer. Don't let tax savings be the only driving force behind your decision.
To get a full scope of what's at stake I suggest reading my other blog posts, 4 Bone Chilling Student Loan Mistakes to Avoid and Beware of Private Student Loans! Don't Make this Mistake or It May Cost you Thousands.
Most borrowers understand that their student debt is the center of their financial agony. However, very few have the time and knowledge to navigate past the land mines that trip up so many borrowers. Here's a common thought process most of my clients come to me with, "Is it better to refinance, or do I pay off my debt aggressively using a tactic like the 'snowball' method, or should I try to minimize my payments and get the debt forgiven? What happens when my debt gets forgiven? Some people tell me I have to pay taxes, others say that I don't."
Very rarely is the answer straightforward. However, not knowing what to do, especially for physicians and attorneys, could add up to a six-figure mistake. That's not a typo. In fact, many physicians are now leveraging Public Service Loan Forgiveness (PSLF) as a way to negotiate a higher salary with private sector opportunities.
The following summarizes the value an independent financial planner with a student loan expertise can add to your bottom line:
Public Service Loan Forgiveness (PSLF) = $1,000 - $100,000+
Private sector loan forgiveness = $1,000 - $100,000+
Refinancing = $1,000 - $50,000
BUDGETING, SAVINGS, & DEBT
A recurring observation with my clients is that they withhold too much from their paycheck because they like getting a tax refund the following year. In theory, this sounds great, you get a bonus sum of cash that you can use towards a home project or socking the funds away in your Roth IRA. However, doing so is the equivalent of loaning your money to the Federal government interest-free.
Instead, withhold the right amount and use those extra dollars to accelerate paying down debts, increase retirement savings, and start making contributions to little Johnny's college fund. Even if that money goes into your savings account, you will earn interest on those dollars versus letting the government have a free lunch.
This list could be more extensive, but for the sake of brevity the following points are a good high-level summary of how a Certified Financial Planner® can add value planning your cash flow:
Appropriate paycheck withholding (W4)
Encouraging consistent and increased savings
Debt consolidation using a HELOC or 0% interest credit card = $1,000+
Credit card cash back bonuses = $500 - $1,000/year
Shopping savings accounts for higher interest rates = $100+
Airline miles = $1,000+
Data Source: Shawn Tydlaska with Ballast Point Financial Planning
Something that often gets overlooked is the actual life enhancements that a good financial planner provides for their clients. Frequently, we focus too much on the numbers are forget that living a fulfilling life is really what most of us care about. So then how does a financial planner fit into this part of a client's life?
According to nationally recognized life planning guru, Mitch Anthony, there are 6 ways a financial planner can offer a "Return-On-Life" to their clients (the following points outlined in italics were originally posted on Kitces.com):
Organization. We will help bring order to your financial life, by assisting you in getting your financial house in order (at both the “macro” level of investments, insurance, estate, taxes, etc., and also the “micro” level of household cash flow).
Accountability. We will help you follow through on financial commitments, by working with you to prioritize your goals, show you the steps you need to take, and regularly review your progress towards achieving them.
Objectivity. We bring insight from the outside to help you avoid emotionally driven decisions in important money matters, by being available to consult with you at key moments of decision-making, doing the research necessary to ensure you have all the information, and managing and disclosing any of our own potential conflicts of interest.
Proactivity. We work with you to anticipate your life transitions and to be financially prepared for them, by regularly assessing any potential life transitions that might be coming, and creating the action plan necessary to address and manage them ahead of time.
Education. We will explore what specific knowledge will be needed to succeed in your situation, by first thoroughly understanding your situation, then providing the necessary resources to facilitate your decisions, and explaining the options and risks associated with each choice.
Partnership. We attempt to help you achieve the best life possible but will work in concert with you, not just for you, to make this possible, by taking the time to clearly understand your background, philosophy, needs and objectives, work collaboratively with you and on your behalf (with your permission), and offer transparency around our own costs and compensation.
You don't have to be. Hiring a financial planner isn't for everyone. We come at a price. Our cost can vary within a very wide range, depending on who you hire. Sometimes the higher price is worth it. Other times not so much. However, don't let cost get in the way if you see enough value. Better yet, a financial planner should have a good grasp on what you need and want. Therefore, finding the right planner is equally as important as understanding that you need one.
As you search for the right financial planner, you should know the answers to these questions:
Is the advisor a fiduciary?
Can the advisor help me solve my primary concerns?
What's the advisor's fee structure? Fee-only, fee-based or commissions?
What will it cost me?
What kind of value am I getting in return?
Will this be a good working relationship?