Financial advisors can add at least 3% a year in average returns to their clients’ portfolios over time by concentrating their efforts in areas such as cost reduction and encouraging rational client behavior, according to new research that Toronto-based Vanguard Investments Canada Inc. released on Tuesday.
Vanguard has published a series of educational modules called Vanguard Advisor’s Alpha as a guide to best practices in helping clients. The modules cover seven separate topics, including asset allocation, cost-effective implementation, rebalancing, behavioral coaching, and total-return vs income investing.
These concepts can help advisors add value in important ways at a time when there is growing emphasis on fee-disclosure through measures such as the second phase of the client relationship model, says Francis Kinniry Jr., a principal with parent firm Vanguard Group Inc.’s investment strategy group in Philadelphia.
“We have provided a framework to help advisors focus on the areas that offer the most value to clients,” Kinniry says. “If advisors can help clients in the most important areas, clients will be better off as a result of their services.”
Vanguard’s research shows the best way advisors can add value is by being an effective behavioural coach when it comes to investments. Helping clients maintain a long-term perspective and a disciplined approach can potentially add 1.5% a year to client returns.
Next in importance is employing cost-effective investments, a critical component that can add as much as 1.31% a year to client returns.
Other important services advisors can provide include maintaining an appropriate asset allocation through rebalancing, with a potential value of 0.47% a year.
Applying an appropriate asset allocation strategy between taxable and non-taxable accounts can add up to 0.42% to annual returns, according to Vanguard’s research.
Implementing an effective spending strategy as more people move into retirement and begin to live off their nest eggs can add up to 0.41% a year.
In the past, advisors focused their efforts traditionally on areas such as picking individual stocks and bonds, sectoral rotation and market timing, but these efforts provided little value and were often negative, Kinniry says.
“As opposed to trying to determine which financial market or sector will outperform, it’s important to use low-cost products, as its been proven that costs are an important determinant of investment success,” Kinniry says. “They can be index funds or actively-managed, what’s important is that they are low-cost.”
Vanguard’s research emphasizes that the benefits of advisors adding value in these areas are likely to be intermittent rather than steady every year, and says some of the most significant opportunities to add value can occur during extreme markets when clients are tempted to abandon their investment strategies.
Acting as “emotional circuit breakers” and helping clients stay the course in the midst of a bear market or periods of extreme euphoria — as well as convincing them to rebalance when it doesn’t “feel’ like the right thing to do at the time — has high value even if it doesn’t show up as a separate item on a client statement, according to Vanguard’s research.
Advisors may save their clients from significant wealth destruction and add percentage points rather than mere basis points of value, Vanguard’s research suggest. In fact, a single client intervention that encourages rational behaviour and sticking to a financial plan could be equivalent in value to several years of advisory fees.
“There is a global push for more fee transparency and a move toward fee-based practices, Canada is not alone in this,” Kinniry says. “At Vanguard, we’ve been seeing the trend since 2001. With more downward pressure on fees and new technologies changing the investment landscape, advisors should concentrate on the areas that provide the most value to clients and can help the advisors build a scalable business model.”