An Advisor’s Value: Bridging the Behavior Gap
Those of us who have chosen a career in the financial services industry believe in the value of financial advisors. We know that financial experts are important for any individual who is trying to achieve a financial goal, and we firmly believe that working with an advisor improves the client’s life. But not everyone agrees with us.
Too often financial advisors are dismissed as a costly luxury by those who believe that a computer program can do what an advisor does for much less money. It’s been difficult to prove those people wrong because most of the stories describing an advisor’s value are anecdotal and situational, until now.
As fortune would have it, there’s actually a healthy body of quantitative research that proves that individuals who work with a financial advisor actually earn better investment returns. Often these improved investment returns aren’t the result of great investment recommendations. Instead, they’re an indication that the client has avoided falling into the behavior gap, a term coined by author Carl Richards that describes the difference, or gap, in investment performance between analytical and emotional investment decisions.
While the amount of the gap differs from study to study, it appears that emotional decision-making is costing investors somewhere between -1.17% and -4.33% per year.
In a 2013 Vanguard white paper titled, “Advisor’s Alpha”, authors Bennyhoff and Kinniry estimated that working with a financial advisor added 3% per year to an investor’s returns. In their paper they stressed that this advisor premium is not earned in a linear fashion; instead, more is earned during periods when investors are particularly fearful or greedy.
In their 2013 white paper, “Alpha, Beta, and Now…Gamma”, Morningstar’s David Blanchett and Paul Kaplan defined gamma as “the extra income an investor can earn by making better financial decisions” and quantified that amount to be an extra 1.82% per year. Then, taking it a step further, the famously advisor-neutral organization attributed the improvement in decision making to be the result of working with a financial advisor.
In its 2012 “Value of Advice Report”, the Investment Funds Institute of Canada found that “investors who purchase financial advice are more than one-and-a-half times more likely to maintain a long-term investment strategy compared to investors who do not purchase financial advice.”
Finally, Dalbar, an organization that has studied investor behavior for 25 years, reports that during 2018 investors continued to get it wrong. In their 2018 “Quantitative Analysis of Investor Behavior” report they calculated that average investors who pulled their money from stock funds saw their investments decline more than 9.42% in a year when the S&P 500 declined 4.38%, results which further underscore the existence of a behavior gap during a year of excessive swings in the investment markets.
While those examples quantify the value of an advisor, there is also a great deal of qualitative proof that financial advisors make a difference. A financial advisor’s guidance may make the difference between whether or not a family has the financial security provided by life insurance when a breadwinner suddenly passes away; a financial advisor can help a couple ensure that their children will finish their education with little or no indebtedness; a financial advisor can help a client achieve her goal of retiring in Italy or provide the financial assistance from long-term care insurance when a family’s matriarch is diagnosed with dementia.
All of these examples, whether proven by research or anecdotal in nature, reflect the value of a financial advisor.
This material is for investment professional use only.