Weekend Reading: Assessing the value of financial advice

Vanguard Research recently published a paper on how to assess the value of financial advice. They mention that the global demand for high-quality, cost-effective financial advice is growing. In many countries, increasing reliance on defined contribution systems means more households will be retiring with substantial savings and will need affordable and effective help in managing them. More broadly, the financial services industry faces rising demand to improve client outcomes and value for money. How should investors measure the value of financial advisory services provided?

Vanguard suggests a three-dimensional approach. Investors should evaluate the adviser’s services in three areas.

Portfolio value. The first dimension concerns the portfolio designed for the investor. Value comes from building a well-diversified portfolio that generates better after-tax risk-adjusted returns net of all fees, suitably matched to the client’s risk tolerance. Portfolio value can be quantified in many ways, including different measures of portfolio risk-adjusted return, diversification and allocation metrics (such as active/passive share), the impact of taxes, and portfolio fees.

Financial value. The second dimension assesses an investor’s ability to achieve the desired goal. A portfolio does not stand on its own. It is in service to one or more financial goals, such as retirement, growth of wealth, bequests, education funding, and liquidity reserves. One way to evaluate success is to estimate the probability of achieving a financial goal or wealth target at the end of a specified period. Ultimately, an advisor should seek to improve an investor’s chance of achieving his or her desired future spending goal. To do this, the advisor must consider a myriad of planning-related metrics that extend beyond portfolio outcomes. These include financial behaviours such as optimal savings and spending; the assumption of debt; budgeting; insurance and risk management; various elements of tax-efficient retirement planning; and legacy, bequest, and estate planning.

Emotional value. The third dimension is an emotional one: financial well-being or peace of mind. The value of advice cannot be assessed by purely quantitative measures. It also has a subjective or qualitative aspect based on the client’s emotional relationship with the advisor. Underlying elements include trust in advisor, the investor’s own sense of confidence, the investor’s perception of success or accomplishment in financial affairs, and the nature of behavioural coaching such as hand-holding in periods of market volatility.

I believe that most of the times investors are overly focused on returns and cost of service (portfolio value) and overlook the other two (financial and emotional value) until it is too late.