One of the hardest things for a financial advisor (and/or financial planner) to articulate is his or her value. So much of what a financial advisor does is based on how he or she invests your money, but at that same time, there are many other areas where an advisor adds value outside of the performance of your investments.
In investing, there are terms like Alpha and Beta to measure value. Alpha is the measure of risk-adjusted performance of an investment compared to its benchmark. For example, if the S&P 500 had a performance of ten percent, a large cap fund you where invested in had a performance of twelve percent, and they both took on the same amount of risk, then the Alpha would be 2.0 or two percent. Beta is a measure of how closely an investment’s performance moves with swings in the market. For example, a beta of one means the investments price (and therefore performance) will move with the market. A beta of 1.2 means that the investment is twenty percent more volatile than the market, so in theory if the market is up one percent it would be up 1.2 percent. These are fine and dandy when analyzing investments, but that is what you pay your financial advisor to do. How do you judge the performance of your financial advisor? So enters Gamma.
Morningstar recently issued a paper titled, Alpha, Beta and Now Gamma, which has coined the word Gamma. The paper defines Gamma as the additional value achieved by an individual investor for making more intelligent financial planning decisions1. Many financial advisors do much more than investing; they may review portfolio rate of withdrawals, taxation, estate planning, insurance, Social Security strategies, Medicare, and all of this play into a person’s overall financial outcome. The paper, Alpha, Beta and Now Gamma, specifically looks at five areas for retirees where an advisor can add value. By choosing the most financially optimal choice in each of the five areas, the value added equated to approximately an additional 1.82% average annual return for the retiree1.
So, if you are paying between one to 1.5 pecent fee for the advice and investment management provided by a financial advisor, but get 1.82 percent in return, you could still come out .32 to .82 percent ahead and have the ability to get counsel and peace of mind when making financial decisions. I would dare say this paper underestimates the value of financial advisors, as it only looks at five areas for making a financially optimal decision, and many advisors cover more than the five areas cited in the paper. In addition, the average equity investor has an investment return of 3.83 percent2, whereas institutional investors have average returns of 8.12 percent to 9.27 percent3. I hope an individual working with a financial advisor would be able to invest more like an institution and thereby achieve much better long-term performance.
Measuring the value of a financial advisor is still tough. When I look at a mutual fund, I can compare it to its peers and tell you which one I think is better based on measurements like Alpha and Beta. I am not sure there will ever be a way to have a measurement like Alpha and Beta and compare financial advisors against one another. Every client I work with has their own unique situation, variables, and needs, so it would be impossible to measure the value I add to one client vs. another, and then compare the value I add to my client’s as a whole verses the advisor’s value next door.
However, hopefully you can be rest assured that good, competent, financial advisors who look at the whole financial picture and help you make investments and optimal financial decisions can add additional value and help you achieve better financial outcomes.
Melissa Stewart is a CERTIFIED FINANCIAL PLANNERTM practitioner and Financial Advisor with the VanderWeele Stewart Group of Raymond James. She speaks at local events and is passionate about financial education in the community. Visit www.vswealth.com to learn more.
1 Alpha, Beta, and Now Gamma. David Blanchett, CFA, CFP® and Paul Kaplan, Ph.D., CFA. Morningstar Investment Management. September 8, 2012.
2 : “Quantitative Analysis of Investor Behavior Report,” 2011 Update, DALBAR, Inc. 20 Year Average Annual Returns for 1990 to 2010. The Average Equity Investor is calculated using results supplied by the Investment Company Institute. Investor returns are represented by the change in total mutual fund assets after excluding sales, redemptions and exchanges. Results capture realized and unrealized capital gains dividends, interest, trading costs, sales charges, fees, expenses, and other costs.
3 Callan Associates. Data as of 12/31/10. The fund sponsor databases are supplied by Callan Associates and are not limited to Callan client fund sponsors. The Total Fund Sponsor Database consists of return information for public pension funds at the city, county and state levels; a wide variety of corporate pension funds; endowments and foundations; and Taft-Hartley union pension funds. Each of these fund sponsor groups is also represented individually.
The S&P 500 is an unmanaged index of 500 widely held stocks. It is not possible to invest directly in an index. Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee success. Raymond James & Associates, Inc., member New York Stock Exchange/SIPC and not affiliated with the West Michigan Woman magazine.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNERTM and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.