The Value of a (Good) Financial Planner

by Michael on Sep 26, 2012 · 2 comments

Photo of Financial Graphs and Charts on a Computer Screen

While we’re on the topic of financial planners, and at the risk of getting stuck in a rut… Have you ever wondered what the advice of a good financial planner or advisor is worth?

In other words, what sort of benefit are you actually deriving from their planning services (and the associated fees)?

Well, now we have an answer. According to a recent study by Morningstar, a good planner can increase your retirement income by nearly 29%. In other words, those with a “good” planner will have $1.29 to spend in retirement for every $1.00 the unwashed masses will have.

Under Morningstar’s assumptions, this works out to the equivalent of having earned an extra 1.82% in investment returns per year. This benefit comes from advice in the following five key areas:

  1. Total wealth asset allocation (based heavily on risk capacity, and including your human capital)
  2. Dynamic withdrawal strategies (i.e., varying the withdrawal rate vs. adopting a fixed safe withdrawal rate)
  3. Annuity allocation (i.e., how heavily to rely on guaranteed income products)
  4. Asset location and withdrawal sourcing (basically tax efficiency)
  5. Liability-relative optimization (i.e., development of investing strategies with a specific goal in mind)

Taken at face value, this analysis supports the view that financial advisors are well worth the cost. After all, even if you’re paying your advisor 1% annually, you’re still coming out ahead if you’re benefiting 1.82% per year. Right?

Digging deeper

Not so fast. I would argue that many of you can consider the same factors at least as effectively as a planner does. Sure, the average investor, who pays little attention to the details and has no interest in doing so, might benefit substantially from a (good) planner, but…

If you’ve taken the time to educate yourself and construct a solid investment plan, then I’d be surprised (shocked, even) if you would derive anywhere near the benefit touted by the Morningstar study. This isn’t to say that you should necessarily avoid financial planners. I’m just saying that you shouldn’t take this at face value.

If you’re savvy (geeky?) enough to be reading a site like this, then chances are you’re perfectly happy learning about asset allocation, tax efficient investing, optimal withdrawal strategies, etc. And, assuming that to be true, I’d bet that you’d be equally happy putting your knowledge into action.

There are, of course, other benefits to hiring a financial planner — not the least of which is the fact that doing so frees you up from having to spend your time managing your money. But the larger point still stands: there’s nothing magical about the services that a planner provides.

Going it alone

Importantly, the study concludes that “we find that [these benefits] can be achieved by anyone following an efficient financial planning strategy.” Yes, anyone. Not just those with a CFP designation. Here again, if you’d rather not tackle things on your own, then finding a good advisor is probably your best strategy.

Of course, there are no guarantees that you’ll wind up picking a “good” financial advisor if you go that route. In fact, you might pick someone who’s incompetent at best, and dishonest at worst. I’m not sure about you, but I trust my ability to manage our money more than I trust my ability to pick a capable and trustworthy advisor.

Anyhoo… If you do decide to go it alone, where should you focus your attention? There are five key areas listed above. Are they equally important? Or do some provide more bang for the proverbial buck?

Well, according to the Morningstar analysis, two areas in particular stand out when it comes to improving your overall portfolio performance — #2 and #4 from the list above. Dynamic withdrawal strategies and asset location/withdrawal sourcing.

Just how important are they? As it turns out, these two factors combine to account for nearly 60% of the benefit provided by a professional advisor — a total of 1.06% of the 1.82% in annual (effective) outperformance.

In other words, strategic determination of your optimal (safe) withdrawal rate (adjusted on an ongoing basis) and paying extra attention to tax efficiency will get you most of the way there.

Next most important is #1, total wealth asset allocation, accounting for roughly 20% of the benefit. The least important are #3 (annuity allocation) and #5 (liability-relative optimization), accounting for a combined 20% of the benefit.

Other (cost) considerations

Another important consideration — beyond the cost of the planner — is the cost of your resulting investments. Morningstar did another study a couple of years ago (available here, membership required) that concluded that expense ratios are the number one predictor of mutual fund performance.

So… Who’s more cost sensitive? You or the person that you’re paying to manage your investments? There’s probably not a universal answer to this, but I’d be willing to bet (yet again; apparently I’m a gambler…) that you’re more likely to choose low cost investments than whoever you might hire to manage your money.

Once I again, I’m not trying to pile onto financial planners. Really, I’m not. I’m just trying to help you think things through and consider the alternatives. Whatever path you choose, just be sure to go in with your eyes open.

Source: Morningstar

1 Dylan September 30, 2012 at 4:04 pm

Hi. I found this post from The Finance Buff’s blog. I thought this was a good synopsis of Morningstar study and don’t think you’re piling on financial planners at all. The authors of the study even conclude that added 29% “can be achieved by anyone following an efficient financial planning strategy.” If a planner can assist with that, it’s a good value (assuming it’s not negated by the planner’s fees). I like that you highlight the focus on being efficient in certain areas as opposed to something magical about the services that a planner provides. I really liked that (and I’m a financial planner).

2 Michael September 30, 2012 at 4:44 pm

Hi Dylan: Yes, a trustworthy planner can be a good option for people who are finance-averse or otherwise unwilling take a proactive role in managing their money. And even if you’re a do-it-yourselfer, it can’t hurt to periodically meet with a fee-only planner to be sure you’re on the right track. Thanks for your comments.

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