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Advisers Alpha

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You know you add value...

As an adviser, you know the value you add to your clients’ financial health. But do you always target your efforts to the areas clients most appreciate? And do you always know how best to explain what you do?

Drawing on years of in-depth research, Vanguard's Adviser’s Alpha breaks out the seven critical benefits that advisers offer clients.

1. Asset allocation is key to investment success

Strategic asset allocation is the most important driver of long-term performance. It is fundamental to investment success and therefore to Adviser’s Alpha. It is not about maximising returns. The essence of asset allocation is to make use of the long-term characteristics of financial markets to fulfil a client’s life goals.

Points for client discussions

  • Asset allocation means the choice of assets, or financial markets, in which we invest. For example, should we invest in shares of companies or would we be better off with bonds, which pay interest? Should we invest in the UK or China?
  • Experience shows that the great majority of investment returns comes from the big decisions, shares or bonds, China or the UK. Making the right choice is critical.
  • A curious characteristic of financial markets is that they tend to be noisy and unpredictable day to day. There is a lot of news and prices jump around. It is a confusing place. Over the long term, by contrast, market behaviour is surprisingly consistent.
  • Good asset allocation does not seek to maximise returns. The art of asset allocation is to create a portfolio likely to fulfil an investor’s life goals, using the known long-term behaviour of financial markets.
  • The portfolio should reflect an investor’s willingness to take more or less risk to achieve the returns needed to meet their goals.

2. Rebalancing keeps a portfolio aligned to goals

Because different assets perform differently, the initial asset allocation will drift over time. Higher risk assets will tend to outperform in the medium to longer term, altering the risk profile of the portfolio. Regular, disciplined rebalancing will keep the portfolio aligned with client goals.

Points for client discussions

  • A portfolio consisting of different assets will need to be rebalanced over regular periods to keep it in line with client goals.
  • Higher risk assets will tend to have higher returns over the long term and will gradually begin to dominate a portfolio that is not rebalanced.
  • Ensuring that the portfolio is rebalanced in a regular, disciplined manner helps to keep it within its required risk limits and focused on planned returns.

3. Lower costs can improve investment outcomes

The power of compounding applies to costs. An amount that might seem small at the beginning can turn into a significant charge over time. Advisers can add real value through cost-effective implementation.

Points for client discussions

  • We know the power of compounding. A lender earns interest on a loan, and then earns interest on the interest. Over time, small amounts add significantly to the lender’s return. The same power applies to costs, but it works in reverse, detracting from investment returns.
  • Fund costs can vary widely. Compounded over time, the difference between a low and high cost portfolio can have a major impact on returns.
  • For example, on a static £100 investment, with an annual charge of 2%, only 82% will be left after 10 years. With an annual charge of 0.2%, over 98% of the fund will remain in 10 years. A big difference.
  • Unlike in other areas of life, more expensive is not necessarily better. Research shows that lower-cost funds are more likely to outperform in the longer term.

4. Maintaining discipline is crucial to success

Behaviours that work in most areas of life do not necessarily apply to investment. Vanguard research shows that investors too often sell when they should buy and buy when they should sell. Advisers can make a critical difference by helping their clients avoid these mistakes.

Points for client discussions

  • Our life experience tells us to be cautious in difficult times and to take advantage of good times, 'make hay while the sun shines'! In financial markets, this sound wisdom does not always apply.
  • Vanguard research shows that most investors travel in the wrong direction, selling when they should be buying and buying when they should be selling. In almost every type of market, investors lose money when they try to respond to news, or to anticipate events.
  • It’s interesting to compare when investors shift their money, and the performance of the funds in which they invest. The data reveals that annual gains are rarely more than 0.2% over ten years, but that losses over ten years often run to 1—2% a year.
  • The best course is almost always the simplest: stick to the plan, rebalance regularly, keep costs low.

5. Tax efficiency adds value

Ensuring the tax efficiency of an investment portfolio is a core competence for financial advisers. Using the right vehicles for different assets is one of a number of ways to add value.

Points for client discussions

  • As with costs, tax is a charge that will compound over time. Tax efficiency is critical to support good investment outcomes.
  • The UK offers a number of tax-efficient investment vehicles, including Individual Savings Accounts (ISAs) and Self-Invested Personal Pensions (SIPPs).
  • There is further potential to take advantage of differences between equities and bonds. Dividends, paid on equity investments, are deemed as already taxed prior to receipt. Interest payments, paid on bonds, are paid out pre-tax. Both investments, though, are liable to capital gains.
  • It is likely to make a difference, for example, to prioritise bond investments in a tax-efficient vehicle such as an ISA, since interest payments as paid on bonds are normally taxable (unlike dividends paid on equity).

6. Retirees need good spending strategies

Drawdown strategies will become increasingly important in the years ahead. Advisers can add significant alpha by ensuring that post-retirement spending is undertaken as tax-efficiently as possible.

Points for client discussions

  • Withdrawing money in a tax-efficient manner is important. Tax-efficient accounts will grow faster than those attracting full rates of tax, and should be kept in reserve for as long as possible.
  • Vanguard research suggests that a well-managed spending strategy can make a significant difference to an investment portfolio.
  • A higher-rate taxpayer with a £1m portfolio could achieve a £4,800 advantage in the annual rate of return over a 30-year retirement.
  • A client with a £250,000 portfolio, within the capital gains allowance and with only 20% in taxable accounts, could generate savings of £725 annually through efficient spending strategies.

7. Sustaining income with lower risk

With yields at historic lows, advisers can add significant value through good advice addressing the challenge of income. A key issue is to provide income without unduly increasing the risk level of the portfolio.

Points for client discussions

  • In a world of low interest rates, investors have three options.
    • They can spend less, which is unlikely to be attractive.
    • They can move into higher yielding investments, which increases risk.
    • Or they can spend from ‘total return’, which includes both capital and income.
  • A total return approach supports robust risk control as it avoids the need to seek income in higher risk assets. This supports investors maintaining a broad and appropriate portfolio of investments. It allows greater flexibility and tax-efficiency.
  • Vanguard research shows that significant value can be added to an investment portfolio through a tax-efficient, total return strategy.

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.