Building wealth is a long-term goal for most people. Achieving it requires careful planning, intelligent investment decisions, and disciplined savings.
A critical decision for many is whether to manage their finances themself or retain a financial advisor. This decision is complicated because index and exchange-traded funds have made “DIY” investing easier.
When should you seek professional assistance, and what benefits can wealth management provide?
What is Wealth Management?
Wealth management helps individuals and families manage and grow their wealth. It includes financial planning services like investment management, tax, estate, and retirement planning. Wealth management services provide customized strategies that help clients achieve their financial goals while mitigating risk.
DIY or Professional Help?
Retaining a financial advisor would be much easier if the benefits could be quantified. Unfortunately, it can be challenging to do so.
As Vanguard notes in this white paper, we confront the issue of “do it yourself or hire someone” in other contexts. We may hire an accountant without knowing whether we’ll pay less tax. We may employ a house painter even though we could do the job ourselves.
In these situations, many factors go into our decision that doesn’t necessarily involve quantifying the benefit. We may feel the professional will save us time or do a better job.
Can the Value of an Advisor be Quantified?
An analysis by Vanguard found that advisors can add up to or exceed 3% in net returns. However, this increase is unlikely to be earned annually, and the extent of the value will vary based on each client’s unique circumstances and the advisor’s expertise.
Not All Advisors Have the Same Qualifications
The benefits of retaining a financial advisor should include an assessment of the advisor’s qualifications. There can be a difference in the quality of advice between an advisor who doesn’t have a high school diploma and one with meaningful education and advanced study in finance-related subjects.
Advisors who have earned the Certified Financial Planner® certification, also known as a CFP®, have passed an examination that tests their ability to apply their financial planning knowledge to real-life scenarios. They must have two years of experience before offering financial planning services and follow ethical standards that benefit the public.
Another notable qualification is being a certified public accountant (CPA). Becoming a CPA means passing a rigorous exam with a 50% passing rate, focusing on financial accounting and reporting topics.
Additionally, CPAs must continually complete 120 hours of education every three years to stay certified and be able to practice.
An advisor who is also a CPA can help define your financial goals, seek opportunities to save on taxes, create financial statements, advise on retirement account distributions, and prepare financial statements.
How Financial Advisors Add Value
To understand the value of a financial advisor, it’s essential to understand what’s involved in being a wealth manager. Here’s a summary of what financial advisors do and how they potentially add value:
A competent advisor will focus on asset allocation, global diversification, and keeping fees and expenses low. The advisor may recommend funds with a low turnover to minimize transaction costs and may consider tilting the investor’s portfolio towards factors that have been shown to enhance returns over long periods.
Rebalancing a portfolio is the process of readjusting the weights of the different assets in a portfolio. It’s done to maintain the investor’s original asset allocation and risk level. Advisors can add value by recommending the appropriate time to rebalance.
The “behavior gap” is the difference between the actual returns of an investment (like a mutual fund) and the returns investors earn.
According to a study by Morningstar, in 2021, the average gap between mutual fund returns and investor returns was 2.7%.
This gap is caused by investors buying and selling their investments based on emotions rather than implementing a carefully crafted, long-term plan.
Advisors can add value by encouraging clients to stick with an investment plan and ignore short-term market volatility.
Advisors can also add value by placing tax-inefficient holdings in tax-qualified accounts, advising clients on tax-efficient withdrawal strategies, advising on Roth 401(k) conversions, reviewing insurance policies (life, disability, and long-term care), charitable gifting, and estate planning.
While not every investor needs to retain a financial advisor, a highly competent advisor can add anywhere between 1.5% and 4% to portfolio returns over the long term, depending on many factors. The scope of services financial advisors offers transcends investment advice and includes comprehensive financial planning, which can provide a roadmap for your financial journey and give you peace of mind.
At Aura Wealth, we are financial advisors and CPAs. We offer comprehensive planning and investment advice.