The ROI: Return on Investment (of getting a financial adviser).

Feel free to reach out to PSG Wealth Manager Jac De Wet directly.

How value can be placed on a qualitative factor

The value of advice is a complex concept to quantify. Financial planning or advice is much more than making investment decisions. It starts with a thorough understanding of clients' personal and financial situations, including income, expenses, investments, insurance, family dynamics, and personal goals.

Advisers are often, mistakenly, only measured by investment performance, where portfolio returns are simply compared to market returns. The value of other services offered by financial advisers in terms of cost savings, tax savings, and the prevention of financial mistakes (including risk coverage, wills, estate planning, guidance to overcome behavioural biases, etc.) must also be considered, and this is where the real value is added.

How a financial adviser is compensated for their value-added services

Typically, an adviser charges a management fee on a portfolio, which is a percentage of the assets being managed. This is the investment management aspect of financial planning. The management fee on the managed assets is the compensation, and it's merely a mechanism to pay for services. But often, the other services provided are simply included in this fee.

Recently, we conducted planning for a client and restructured their portfolio. It included comprehensive advice across the financial planning spectrum. Through tax-efficient planning, we helped our client realise a very large saving. Our client had a direct benefit here that came from the value of our advice. We didn't send him an invoice for this work and advice, however, we are compensated through the management fee on the assets we continuously manage.

Another example is where a business owner's personal risk coverage policies was properly reviewed and adjusted to comprehensively cover all relevant risks, both on a business and personal level. He was then diagnosed with a critical illness and was then unable to work. Through this planning, for which there was effectively no payment/billing, his business's survival, and also the value of his business interest, was protected. This example clearly illustrates the benefit of holistic financial planning.

With investment portfolios, it's simple. When investment portfolios are managed, and the adviser charges, for example, a 1% fee on the assets under management, and due to the advice, the portfolio outperforms the general market or index by 4%, the client received a net value of 3% for the 1% they paid.

A measure of value to value-added services

In the investment world, there's talk of adding alpha – it's the amount of additional return or value a client or investor gets (above what the index or benchmark delivers) due to the decisions of the investment manager. This term is insufficient when it comes to financial planning. There is immense value in comprehensive financial planning and sound financial decision-making.

It's important to remember, and easy to forget, that the ultimate goal of comprehensive financial planning goes beyond investment selection.

Vanguard, one of the largest asset managers in the world, introduced the concept of advisor alpha in 2001. Their overall estimate for advisor alpha is 3% on a net basis (4% minus an assumed 1% fee). The goal is to shift the focus from "traditional beat-the-market objectives" (i.e., traditional alpha) to what is considered the "best practices of wealth management."

Best practices of wealth management

These best practices are divided into various categories that focus on:

1.     tax efficiency,

2.     costs,

3.     risk management, and

4.     making good investment decisions.

Interestingly, more than 1.5% of this 3% advisor alpha is derived from something Vanguard calls behavioural coaching, described as providing support to clients to stay on course in times of market volatility.

The overall net impact of good advice delivering the 3% outperformance can be explained through an example:

Suppose a good financial adviser who does all these things charges a fee of 1% of assets under management. An investor who can do all the above on their own can retain all these benefits. However, an investor who doesn't know how to effectively implement these financial planning aspects or who prefers to spend their energy and time elsewhere loses this extra advisor alpha. Even though they saved the 1% advisory fee, they ultimately landed themselves in a worse-off financial position.

Assuming the overall market return is 8%. Without good financial decision-making, the combined impact of fees, taxes, and poor investment decisions is about 4%, according to Vanguard's study. This leaves a net return of 4% for the investor. However, for someone working with a trusted financial  adviser, they eliminate poor investment decisions, invest tax-efficiently, and only pay the 1% fee, resulting in a net return of 7%. This is the advisor alpha, or value the adviser adds. The value that good advice adds can significantly exceed the fees.

Contact us today to schedule an appointment where we can discover the value-add of holistic financial planning within your investment portfolio. Your well-earned savings, deserves to be well-managed.