Experienced advisors understand that clients often have the misconception that an advisor’s primary value lies in generating "alpha." Success is seen as consistently beating market performance. Yet, as most advisors recognize, actually achieving such outperformance is exceedingly rare and, in many cases, accidental, not based on some “special” active management approach.
Clients tend to think about outperformance as a measure of your value because it’s quantifiable; if an advisor is charging 1% on assets, for example, clients are looking for indicators that the services provided deserve the fee. Sadly, many clients will discount the value of comprehensive financial planning and laser-focus on how your investment approach alone will cover this. That leaves some advisors feeling uncomfortable with how to clearly articulate their value.
Performance misconceptions can extend long into the client relationship, to avoid this, it’s critical to educate prospective clients about the true benefits you provide, specifically within investment management. Your expertise can be invaluable, offering tangible benefits that significantly enhance investment outcomes. We’ll explore how your work can deliver quantifiable value through appropriate asset allocation, avoiding bad market timing decisions, tax-efficient strategies, personalization, and more.
Appropriate Asset Allocation
One of the primary roles of a financial advisor is to ensure that your clients' investments are aligned with their financial goals. Appropriate asset allocation can make a significant difference in portfolio performance. Studies have shown that asset allocation accounts for over 90% of the variability in portfolio returns, underscoring its critical importance.1,2 By diversifying investments across various asset classes, advisors help mitigate risks and optimize returns, ensuring that your clients' portfolios remain resilient under varying market conditions and lead to outcomes that align with short- and long-term needs.
Helping People Avoid Bad Decisions
Emotional decision-making, especially during market volatility, can severely impact investment performance. Financial advisors play a crucial role in preventing clients from making impulsive decisions, such as panic selling during market downturns or chasing high returns in bullish markets. Research indicates that market timing often massively harms returns, with average investors earning significantly less than the market due to poor timing decisions.3,4 By maintaining a disciplined investment strategy, advisors help clients avoid these pitfalls, leading to more consistent and superior long-term performance.
Tax-Efficient Transition into New Allocations
New clients often have portfolios that may not align with their goals. However, transitioning investments from one allocation to another can trigger tax liabilities if not managed correctly. Skilled advisors can implement tax-efficient strategies to minimize these impacts, particularly by selling certain lots, trading at losses where possible, and then creating a plan to sell out of the existing portfolio over time. Advisors can create a plan with clients that strikes an appropriate balance between tax liability and deviations from a target asset allocation. By carefully managing transitions, advisors ensure that your clients' portfolio adjustments do not come at a hefty tax cost.
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Optimizing Asset Location
Different types of accounts offer various tax advantages, and placing the right assets in the right accounts can significantly improve after-tax returns. For instance, placing income-generating assets in tax-deferred accounts and growth-oriented assets in taxable accounts can optimize tax efficiency. Financial advisors can navigate these complexities, ensuring your clients' investments fully utilize available tax benefits.5,6 This optimization can lead to enhanced portfolio growth over time. A Vanguard study, for example, found that effective asset location strategies can add up to 30 basis points to annual returns.
Consistent Tax Loss Harvesting
Regularly harvesting losses is another strategy financial advisors use to improve tax efficiency. By systematically selling securities at a loss to offset gains, advisors help reduce taxable income, thus enhancing after-tax returns. According to research, consistent tax-loss harvesting can add up to 0.5% to 1% in annualized returns.7,8 This seemingly small percentage can compound significantly over time, contributing to substantial long-term growth.
Optimizing Rebalancing
Rebalancing a portfolio is essential to maintain the desired risk level and asset allocation. Left unchecked, a portfolio’s level of risk will be higher over time than intended due to more concentration in higher return/higher risk assets. This can be problematic for goals with shorter time horizons or higher degrees of confidence (rent, mortgage, food). Financial advisors ensure that rebalancing is done efficiently, considering transaction costs and tax implications. Studies have shown that systematic rebalancing can improve returns by maintaining a disciplined investment approach, potentially adding up to 0.35% in annual risk-adjusted returns.9
Tax-Efficient Cash Withdrawals
As investors approach retirement, investment strategies typically shift from accumulation to decumulation. In this stage, tax-efficient withdrawals become an increasingly important part of a financial advisor's value. Advisors can expertly manage the tax implications of withdrawing funds across multiple accounts by strategically selecting which accounts to draw from while managing constraints such as Required Minimum Distributions (RMDs) and maintaining the desired asset allocation. A large part of the value of a financial advisor lies in their ability to navigate these complexities in order to optimize their clients' financial outcomes.
Personalization
Personalization in investment strategies is a significant benefit that financial advisors offer to end investors, particularly when aligning investments with clients' specific values and preferences. A skilled advisor listens to their clients' unique goals, including their interest in Environmental, Social, and Governance (ESG) criteria or specific stock preferences, and empowers them to build a portfolio that reflects these priorities. This tailored approach allows clients to invest in companies and sectors they believe in, fostering a sense of personal fulfillment and alignment with their values. By understanding and incorporating individual preferences, advisors help clients create a more meaningful and satisfying investment experience.
The tangible benefits you provide as financial advisors extend far beyond basic investment management. From strategic asset allocation to tax-efficient strategies and disciplined rebalancing, you offer comprehensive support that can significantly enhance your clients' financial well-being. By leveraging your expertise, you help clients avoid common investment mistakes, optimize their portfolios for better performance, and ultimately achieve their long-term financial goals with greater confidence. Investing in financial guidance is not solely about managing wealth; it’s about desiring a secure financial future.
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1. Brinson, G.P., Hood, L.R., & Beebower, G.L. (1986). Determinants of Portfolio Performance. Financial Analysts Journal, 42(4), 39-44.
2. Ibbotson, R.G., & Kaplan, P.D. (2000). Does Asset Allocation Policy Explain 40, 90, or 100 Percent of Performance? Financial Analysts Journal, 56(1), 26-33.
3. Dalbar, Inc. (2021). Quantitative Analysis of Investor Behavior.
4. Barber, B.M., & Odean, T. (2000). Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors. The Journal of Finance, 55(2), 773-806.
5. Dammon, R.M., Spatt, C.S., & Zhang, H.H. (2004). Optimal Asset Location and Allocation with Taxable and Tax-Deferred Investing. The Journal of Finance, 59(3), 999-1037.
6. Morningstar. (2020). The Impact of Asset Location on After-Tax Returns.
7. Kitces, M. (2015). The Value of Tax Loss Harvesting.
8. Wealthfront. (2021). The Tax-Loss Harvesting Value Add.
9. Kitces, M. (2015). Evaluating Financial Planning Strategies And Quantifying Their Economic Impact.
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