When influential commentators position ongoing adviser fees as a ‘wealth tax’, they ignore the significant level of value added by the provision of good advice and planning.
In this episode, why the wealth tax is really a wealth multiplier, and how financial advice adds 3% a year to the size of your portfolio.
I’m Martin Bamford and here at Informed Choice we help remove the stress associated with money by offering a clear explanation of your choices and options.
The value of financial advice is under relentless attack. Influential commentators are so focused on the cost of advice, especially its ongoing cost, they are completely ignoring the incredible amount of value added.
Writing an opinion piece in the FT at the start of the month, journalist Paul Lewis, writing under the headline “Financial advisers and the ‘wealth tax’ toll”, explains, “Taking a 2 per cent charge will slash the rate at which your money grows and can mean your adviser gets most of that growth.” Now leaving aside the fact that I’ve never come across a financial adviser who charges 2 per cent a year, this sensationalist statement ignores the value delivered by financial advisers.
Picking up on this use of the term ‘wealth tax’, journalist Ali Hussain writing in the Sunday Times went as far as advising clients of St James’s Place to turn off their ongoing advice fee. He explained that one reader had saved more than £2,000 in two years by ordering the firm to “turn off” the ongoing 0.5% annual advice fee that was cutting into his pension.
Cost is absolutely an important factor to consider when it comes to financial advice and investing money. By keeping costs as low as possible, you get to keep more of your investment returns. The importance of low cost is why index tracker funds have risen in popularity in recent years; instead of wasting money on expensive actively managed funds, investors are slashing the cost of investing by choosing low-cost index trackers.
But if cost is one side of the investing coin, then value is on the other. And it’s value being so conveniently ignored by the commentators throwing the term ‘wealth tax’ around. Rarely do they explain that, by paying a financial adviser an annual fee, you benefit from value far in excess of the cost of advice. This value is demonstrated across multiple pieces of research and it’s what investors need to understand before dismissing the cost of regulated advice or ‘turning off’ the ongoing adviser fee.
My favourite study into the value of financial advice is called Adviser Alpha and it comes from investment manager Vanguard. They concluded that financial advice adds 3% a year to investment returns. This 3% a year of added value comes from five key things advisers do for their clients, which combined add three percentages points to the net investment returns of their clients.
The first way in which financial advice adds value is through behavioural finance, keeping investors focused on long-term goals and helping them stick to a regular investing plan. According to Vanguard, this first element can add 1.5% a year to net investment returns. Financial advice helps investors avoid the temptation of trying to time the markets or chase performance. As behavioural coaches, Vanguard explains that financial advisers “can act as emotional circuit breakers by circumventing clients’ tendencies to chase returns or run for cover in emotionally charged markets.”
The second way in which financial advice adds up to 3% a year is through considered allocation of assets between taxable and tax-advantaged accounts. This contributes a further 0.75% a year to net investment returns. Keeping the costs of investing down is the third way in which financial advice adds value, contributing 0.45% a year to net returns.
Another way in which financial advice adds 3% a year to net investment returns through regular portfolio rebalancing. This aims to keep the underlying asset allocation of an investment portfolio constant over time, in line with the chosen risk profile of the portfolio. Regular rebalancing along can contribute up to 0.35% a year to net investment returns.
Finally, financial advice can add about 0.7% a year to net investment returns by helping investors understand the best way to spend their assets, specifically the order in which they withdraw assets in retirement. The value of advice on an asset withdrawal strategy was calculated by Vanguard to be greatest “when the taxable and tax-advantaged accounts are roughly equal in size and the investor is in a high marginal tax bracket,”
All of this means financial advice adds 3% a year to net investment returns; not the total of the maximum impact stated for each practice, but the total average impact each of these changes would have on investment results. According to the report authors, financial advice tends to add the most value during periods of “market distress or euphoria” as these tempt investors to change their investment strategies.
The report concludes that financial advice adds 3% a year to net investment returns, but this should be considered as an intermittent rather than annual addition to investment returns. In other words, don’t expect working with a financial adviser to be a magic bullet that adds 3% to your investment returns each and every year. In some years, the value of advice will be minimal, and in other years it will be significant. It all depends on what’s happening in your life and what’s happening in the markets.
The study from Vanguard is only one indicator of value by working with a financial adviser. Another study, this one from the International Longevity Centre and Royal London, found that investors who received financial advice in 2001 to 2007 had accumulated significantly more liquid financial assets and pension wealth than their unadvised peers by 2012 to 2014. Their report, ‘The Value of Financial Advice’, looked at the ONS Wealth and Assets Survey, and concluded that those who receive regulated advice do better than the equivalent group who don’t.
They found that an affluent by advised group accumulated on average 17% more in liquid financial assets than affluent and non-advised investors. They built up 16% more in pension wealth as a result of working with a financial adviser. For those who started with less wealth, a group described by the study as ‘just getting by’, those who had the benefit of advice accumulated an average of 39% more liquid financial assets than those in the non-advised group, and 21% more pension wealth.
One of the biggest areas of value we provide as financial advisers, in addition to the five factors described in the Adviser Alpha study, is to encourage greater levels of savings and investments. Indeed, the biggest driver of returns isn’t low costs or compound returns due to time, but putting more money into the pot in the first place. The study found that the affluent but advised group were 6.7% more likely to save and 9.7% more likely to invest in the equity market than the non-advised group.
I would love to see journalists writing about and talking about the value of financial advice, instead of hammering away at trust in the profession with their constant focus on cost. We know that what we do for our clients adds significant value, and of course we charge accordingly for generating that value. All investors have the choice to work with a regulated adviser or go it alone. The evidence points to the DIY approach leading to less wealth, more mistakes and generally worse outcomes for investors. It’s not a wealth tax, it’s a wealth multiplier.
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Until next time, I’m Martin Bamford and this is Informed Choice Radio. And remember, when it comes to your money, the more you know, the faster it can grow.