How much are your financial services worth to clients? It’s a tough question to answer precisely, but making a yeoman’s effort on guesstimating (or at least staying mindful on the topic) is critical in your travels as a financial advisor. The answer, after all, goes a long way in determining the health and growth prospects (or the lack thereof) of your business as well as your clients’ wealth.
In the search for perspective, several studies in recent years have made some headway in ranking the various tasks in financial advisory for distinguishing your labors on behalf of clients. This research is hardly the last word on the subject, partly because quantifying the worth of financial advisory can be a mix of art as well as science.
Despite the caveat, researchers have carved out useful baselines for thinking about advisor-crafted value. As we’ll see, quite a lot of the insight is bound up with common sense as well as quantitative estimation.
Stepping back and considering the big picture reminds us that everything becomes a commodity eventually. As a result, staying competitive and relevant is Job No. 1 in the fast-moving financial industry. True for your firm as well as for your client’s financial health. Going out of business, after all, is in no one’s best interest.
The main challenge can be summed up by recognizing that the best practices for staying ahead of the curve are a moving target. Financial services are especially vulnerable to change and shifting perceptions, thanks to the rapid evolution of investment products and trading technology, the relentless slide in fees, and the growth of automated portfolio management services. Considering the expanding array of regulations that soak up more of your time and it’s clear that independent advisors, especially, face a rising onslaught of headwinds.
The good news is that there’s a clear roadmap for creating advisor alpha—otherwise known as adding genuine value for clients! The key lesson: Focus on those slices of financial counseling that offer the most opportunity to shine. Let’s take a closer look at the details. We will start by looking at how the possibilities for alpha stack up according to recent studies, then get some commentary from advisors considered thought leaders on maintaining a competitive edge.
Vanguard’s estimate of advisor alpha
A 2016 research report published by Vanguard (“Putting a value on your value: Quantifying Vanguard Advisor’s Alpha”) estimated how several aspects of wealth-management activities rank for boosting returns in client portfolios (Table 1). At the bottom of the list is asset allocation…sort of. Although this is a critical facet of prudent money management—essential, in fact, as an investment foundation—it’s easily achieved and so charging a fee for this service alone isn’t practical.
|Table 1: Vanguard Estimates: Value-Add of Best Practices in Wealth Management
|Advisor’s alpha strategy
||Typical value added for client (basis points)
|Suitable asset allocaton using broadly diversified funds/ETFs
|Cost-effective implementation (expense ratios)
|Spending strategy (withdrawal order)
|Total return versus income investing
|Total potential valued added
||About 3% in net returns
Source: Vanguard: Putting a value on your value: Quantifying Vanguard Advisors’ Alpha
* Value is deemed signifiant but too unique to each investor to quantify
As for quantifying the advisor alpha associated with asset allocation, the calculus is difficult, in part because results can vary dramatically from client to client, according to the Vanguard report. For simplicity, the study identifies asset allocation as offering value-added return for portfolios somewhere north of zero, albeit at an unknown level.
The main takeaway? Providing asset allocation services is necessary for wealth management, and it almost certainly adds value for real-world results. But the relative simplicity of the task (outlining a plan for holding various asset classes and selecting a mix of funds to implement the plan), along with a rise in free and low-cost asset allocation advice, has arguably turned this aspect of portfolio strategy into a loss leader.
By contrast, other facets of wealth management offer clearer paths to creating value and distinguishing your services for clients. The primary examples, according to the Vanguard study, include:
- Reducing costs that eat away at investment portfolios (shifting to lower-cost index funds from higher-priced active funds, for instance)
- Portfolio rebalancing
- Behavioral coaching—helping clients stay focused on their investment goals and avoiding emotion-based decisions that can be detrimental to results, such as selling assets at or near bear-market bottoms
Efficiently executing on all the opportunities in Table 1 can add 300 basis points to a portfolio, based on a typical client, according to Vanguard’s estimates. In other words, a portfolio that returned 7% a year over some period of time would generate 10% a year if managed by an advisor who successfully delivered all the value enhancements noted above.
The specific value-add will, of course, vary depending on the client, writes David Hultstrom of Financial Architects in Woodstock, Ga. A client with a high degree of discipline in a lower tax bracket with no investments outside of deferred accounts might earn an extra 200 basis points through a savvy advisor. By contrast, for clients subject to a greater level of emotional behavior, in a high marginal bracket, with savings in various accounts (IRA, Roth, taxable, etc.), the value added can be as high as 500 bps, he estimates.
For anyone who excels on these fronts, advisors have access to a powerful message for differentiating their practice from the competition, strengthening relationships with existing clients, and laying the groundwork for expanding their business.
Keep in mind, however, that on the margins the opportunities are continually fading. In a related study published earlier this year (“The evolution of Vanguard Advisor’s Alpha: From portfolios to people”), Vanguard observed that six of the seven opportunity areas in Table 1 are now automated to some degree. The main exception: behavioral coaching. Accordingly, Vanguard urges advisors “to redefine their value proposition away from solely managing their clients’ portfolios.”
Envestnet’s estimate of capital sigma
A similar study by Envestnet (“Capital Sigma: The Return on Advice”) arrived at an equivalent estimate: successfully executing on five main areas of wealth management can add roughly 3% of value-add on an annual basis.
Envestnet’s definitions of the major categories of financial planning vary a bit versus Vanguard’s lineup, but the similarities outweigh the differences. It’s fair to say that both studies are more or less focused on the same opportunities and agree about the prospects for juicing performance results.
Consider portfolio rebalancing: Vanguard’s estimate of advisor alpha for this slice of oversight is 35 basis points; Envestnet’s is slightly higher at 44 basis points, as show in Table 2, below.
|Table 2: Envestnet Estimates: Capital Sigma The return on advice
||Annual value-add (basis points)
|Asset class selection and allocation
Source: Envestnet Capital Sigma: The Return on Advice
One difference in the two estimates is Envestnet’s effort to put a number on value-add for asset allocation design. Whereas Vanguard offers a warm and fuzzy view that it’s worth something but otherwise difficult to quantify, Envestnet reports 28 basis points as a ballpark figure.
Focus on conversations
Rita Cheng, a certified financial planner with Blue Ocean Global Wealth in Gaithersburg, Md. says that asset management, including asset allocation, is a core part of her business, but the opportunities for delivering advisor alpha tend to be found elsewhere.
“Advisors need to focus on conversations around financial planning,” she recommends. She reasons that numerous opportunities to add value are likely to arise during discussions. As an example, she recalls a recent conversation with a client that turned to projections for payments from a pension. Cheng noticed that the predictions had been reduced from a previous estimate and she recommended that the client contact the employer and question the discrepancy. The inquiry led to the company recognizing that it had erred and the client’s projected pension payments were raised by $200 a month.
Ashley Foster of Nxt:Gen Financial Planning in Houston embraces a similar philosophy by focusing on each client’s character traits as a platform for customizing financial advice. He recalls a simple but illustrative example: noticing that a client was a “sharp dresser.” Foster struck up a conversation on the topic and learned that the client was fond of custom-made suits, a preference that evolved from a childhood that was marked by budget clothes. The insight opened the door for “tying that little detail into money conversations and now I carve out a piece of his financial planning for looking good.”
It is all about understanding and respecting a client’s money preferences. “Helping clients make better financial decisions in a way that enhances their lives is one way to remain relevant as a planner,” Foster explains. “A robo-advisor can’t do that, AI [artificial intelligence] can’t do that, and a random person over the phone can’t do that.” He continues:
Only a financial planner with a fiduciary duty to clients can get to know their dreams, values, goals, and create an environment where a client can achieve their financial objectives. That can’t be commoditized because machines can’t empathize with clients.
Friend or foe?
The advantages of a human advisor who understands the finer points of a client’s financial profile may be obvious as the basis for a healthy business model. But that doesn’t stop some planners from wondering if a threat is still lurking in the rise of so-called robo-advisors in recent years.
The concern isn’t misplaced when you consider that robo-advisors, such as Betterment, Wealthfront, and other firms, are (1) enjoying rapid growth in assets under management; (2) charge rock-bottom fees; (3) typically have low or even zero minimum balance requirements; (4) offer performance results that are competitive, if not superior, to actively managed alternatives.
Although some advisors, perhaps many, have been pinched by the ascent of robos, others see this rising aspect of wealth management as an opportunity to exploit rather than a threat to fear.
Joshua Mungavin, a principal at Evensky Katz/Foldes Financial Wealth Management in Coral Gables, Fla. tells Horsesmouth that embracing automated investment capabilities improves the firm’s efficiency.
“A robo-advisor is an absolutely wonderful thing,” Mungavin insists. “We’ve invested in our own quasi robo-advisor,” which he defines as rebalancing software—Envestnet’s Tamarac product in this case. “It saves time so we can focus on where we can add value.”
Scott Bishop of STA Wealth Management in Houston also uses a robo via private labeling of the Schwab Intelligent Portfolios platform. He says that the tool turns a potential threat into a resource by bringing in new accounts that might otherwise be uneconomical…for now. Small accounts can grow into full-service customers, he reminds us.
Bishop also points to his firm’s federally trademarked strategy on retirement planning as a resource that helps distinguish STA from other firms, strengthen ties with existing clients and generate leads.
“It’s brought me so much great business,” he says of Planning for Retirement the R.I.T.E. Way (RITE = Retirement Income Taxed Efficiently), a program he developed to help clients understand and plan for this period of their financial life. This retirement survival guide, as Bishop calls it, is a 30-page pdf that he sees as a roadmap for STA’s management services for retirement planning. Available for the asking via a website (after providing basic contact information), the document has proven to be a successful marketing and lead-generation tool that’s boosted STA’s reputation as a retirement-planning specialist. As an added bonus, the guide earned kudos from Ed Slott, a nationally recognized certified public accountant (CFP), who praised the publication in a recent update.
“It’s something that distinguishes me,” Bishop says. “If you’re going to stay relevant and charge a one-percent fee, what are you doing other than asset allocation?” he asks, noting that big-picture portfolio advice is widely available gratis from various sources.
“Liquid asset management and asset allocation should not be the way advisors demonstrate their value to clients,” counsels Matt Chancey, a CFP in Orlando. The good news for advisors searching for ways to provide value for clients: “Planning is much bigger than that,” he wrote in a recent email to Horsesmouth, explaining
Being a great advisor is the human element of combining all the elements of financial planning: investments, insurance, retirement, taxation and estate planning and communicating with them so that not only will clients understand the process but feel motivated to take action and implement those recommendations. AI and fancy software won’t replace this part of the profession.
Robos will commoditize portfolio management
The avenues are many for convincing clients that they should pay a fee for your services (and one that’s higher than what robos charge). Generating advisor alpha certainly strengthens the logic of the argument.
Keep in mind, however, that the robo business model is constantly evolving, driven by improvements in technology, and those improvements will continue to eat away at the competitive edge that human advisors enjoy at any point in time. Perhaps, then, it’s understandable that a recent TD Ameritrade survey of 300 registered investment advisory firms found that 45% of respondents were “somewhat concerned” about digital competition. Although robos aren’t likely to replace conventional wealth managers anytime soon, history suggests that the competitive threat will continue to rise, if only on the margins.
“Robo-advisors, with the help of appropriate technology and innovation, will in the longer term commoditize the simpler and technical aspects of wealth management,” predicts an article published earlier this year in the Journal of Alternative Investments (JAI).
This future implies that the market for wealth management services will increasingly split into two camps: investors looking for relatively basic asset management services at a low cost with low minimums versus clients (usually those with relatively high levels of assets) in need of more sophisticated advice.
For obvious reasons, the latter group offers better opportunities for growing a financial advisory business and offering customized services that resonate with clients. The danger is thinking that the current set of opportunities for tapping into this market are written in stone, which is the equivalent of thinking that financial-related technology will remain the same in the years ahead.
The arrival of digital competition “is a wake-up call for all wealth managers to step up their performance or be replaced by robo-advisors,” write the authors of the JAI article. “We expect traditional wealth managers to respond to this disruption with new and improved products and services at competitive fees.”