The value of advice goes beyond money
17 January 2020 | Practice Management
Measuring the value of financial advice is challenging. Data are rarely gathered on a sufficient scale or consistently over time. Success is subjective and it is difficult to know, over the longer term, if an alternative course might have proved superior.
Vanguard's Adviser's Alpha shed considerable light on the subject using a modelling approach to show the value of different components of advice. Other institutions, including Morningstar, have used similar methodologies.
In a recent study1, we have been able to observe the effects of professional advice on a large number of clients with comparable experience. The data were mapped over a period of five years and we looked at the impact of advice from three perspectives, portfolio changes, financial outcomes and emotional wellbeing.
The median age of the participants was 65, though ranges in separate areas of the study extended from under 30 to over 70. Median investible portfolios were between £190,000 and £390,000.
- Portfolio value: Over 44,000 participants were observed six months before and six months after obtaining professional advice. We saw that good advice can be particularly helpful in addressing private investors' typical handicaps, such as procrastination, inertia, and home bias.
- Financial value: We looked at the likely financial outcomes for over 100,000 participants, finding that around 80% of the individual advised investors were highly likely to reach their retirement goals.
- Emotional value: In a survey of over 500 respondents, we found that the emotional, or personal, component of advice accounts for nearly half of the value assigned to the receipt of advice.
For this part of the study, we observed more than 44,000 investors who had been 'self-directed' and had subsequently joined Vanguard's professional financial advice service over a period from 2014 to 2018. We looked at their portfolios six months before they received advice, that is, when they were constructing their own portfolios. We looked at them again six months after they had received professional advice.
The most common change seen 'post advice' was the reallocation of cash to bonds. Self-directed investors tended to prefer holding cash rather than buying longer-duration fixed income assets (see charts below).
In aggregate, there was little change in the equity allocation, rising from 58% to 60%. At a client level, by contrast, there were significant changes. Two-thirds made material changes to their equity holdings of over 10%, either up or down. Nearly a third reduced their cash holdings by over 10%. Over 90% altered the balance between domestic and international holdings. Some 80% lowered costs by switching allocations from active to passive, while 10% sold off their single-stock holdings.
Attaining an investment goal involves a number of financial planning activities beyond the management of the portfolio itself, including saving and spending, budgeting and handling debt. We measured the financial benefit of advice through a probabilistic forecast of an investor's ability to meet a particular financial goal, in this case one of the commonest among advised clients, a secure retirement.
Our data were drawn from success rates predicted in January 2019 for more than 100,000 advised investors.
We found that 76% had a 90-100% probability of achieving their objective. Another 4% were 80-89% likely to achieve their goal. Put together, this means that eight in ten of advised investors had a probability above 80% of meeting their goal of a financially secure retirement.
In this part of the study, we surveyed 504 advised investors to understand the value in the emotional security of the advisory relationship. In other words, we wanted to see how much advice contributed to clients' 'financial happiness'.
Respondents were asked to rank 24 statements 1–5 for importance and satisfaction. The statements were organised into three categories: 'relationship with a trusted adviser', where we felt the emotional value was highest, 'protection and assurance' and 'planning'.
On analysis, it was apparent that many of the most highly rated statements were those with a significant emotional component. 'Trust in the adviser' was the most important factor driving the highest value rating, followed by having a 'personal connection with the adviser'. Feeling 'on track to meet goals' and 'reassured in down markets' were also significant.
Overall, statements relating to 'relationship with a trusted adviser' accounted for 55% of investor perceptions of value. Across the three categories, emotional value was rated at 45% against 55% for functional value.
Our aim in this study was not to define all of the possible measures for each of the three dimensions we observed, but to highlight the need to see advice from these different perspectives when assessing value. On the portfolio metric, getting good advice helped address well-known issues affecting previously self-directed investors, such as home bias and inertia. In terms of financial outcomes, with the right advice, 80% of advised clients were put on track to meet their long-term financial goals for retirement.
But the third, emotional, dimension, while harder to measure, was just as important, or maybe more so – accounting for almost half (45%) of the value assigned to the advice relationship by investors. Without trust or the feeling of a personal relationship with their adviser, most investors are less likely to feel a sense of financial wellbeing.
Good financial advice, it turns out, has more than the potential to underpin financial security. It can add to the quota of our happiness.
Written by Cynthia A. Pagliaro and Stephen P. Utkus.
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