Advisers looking to quantify their worth in terms of the added return they can provide clients are being offered a concrete answer of 3 percentage points in a new report from The Vanguard Group Inc.
The first of five factors influencing this extra return has to do with behavioral finance. Keeping clients focused on the long term and making them stick to a regular investing plan can add 1.5% or 150 basis points, according to the report, "Putting a Value on Your Value: Quantifying Vanguard Advisor's Alpha," which was released Monday.
Two of the most significant behavioral factors that derail investor performance are “the allure of market-timing and the temptation to chase performance,” said the report by Vanguard, which manages $2.5 trillion in mutual fund assets. “Advisers as behavioral coaches can act as emotional circuit breakers by circumventing clients' tendencies to chase returns or run for cover in emotionally charged markets.”
Francis Kinniry Jr., an author of the study and a principal in Vanguard's Investment Strategy Group, emphasized how critical client-adviser conversations are and pointed out, for example, why it wasn't a good idea to have all Internet stocks in 1999 or all emerging markets in 2011.
Financial advisers can add up to another 75 basis points with thoughtful allocation of assets between taxable and tax-advantaged accounts, the report said.
While it's probably not too much of a surprise coming from a leader in low-priced funds, the Vanguard report said about 45 basis points can be added to investor returns simply by keeping investment costs down.
Re-balancing, or making sure a client's portfolio remains consistent over time with the client's risk/return characteristics and preferences, will contribute up to 35 basis points of performance, according to the 28-page report.
“It's hard to sell your best-performing investment and put it in your worst-performing investments, but that is what re-balancing and staying the course is really about,” Mr. Kinniry said.
And finally, advisers potentially can add about 70 basis points by helping clients decide how to spend down their assets, specifically the withdrawal order, the report said.
The greatest benefits occur from an asset withdrawal strategy “when the taxable and tax-advantaged accounts are roughly equal in size and the investor is in a high marginal tax bracket,” the report said.
The value comes from minimizing the total taxes paid over the course of a client's retirement, which increases their wealth and the longevity of their investments. The report recommends this spending order as a framework for most investors: required minimum distributions, cash flows on assets held in taxable accounts, taxable assets and finally tax-advantaged assets.
The 3%, which represents the total average impact each of these changes would have on results instead of the maximum impact stated for each practice, should not be considered an annual addition, as it is more likely to be intermittent, the report said.
The most significant opportunities for added client value occur when there are periods of “market distress or euphoria” that tempt clients to change their investment strategies. During these periods, advisers could tally tens of percentage points for investors, according to the report.
If the results sound familiar, Vanguard chief investment officer Tim Buckley gave a sneak peek at some of the research results to InvestmentNews senior columnist Jeff Benjamin at the Inside ETF conference in Fort Lauderdale, Fla., in January.