Even financial superstars need a coach. Here’s how to choose your adviser

Markets are pretty efficient these days, so advisers aren’t likely to create value by picking stocks.

They can create some value from building well-structured portfolios and counselling about investments, but not enough to justify the bulk of their fees by those activities alone.

On the other hand, there is often enormous potential for advisers to add value by providing broad financial advice and in-depth financial planning. If it is done well, an adviser can often fully justify their fees and more.

Focus on value rather than fees

Innovations like online brokerage accounts, low-fee passive ETFs, and online portfolio managers (also called robo-advisers) are making it easier to invest at low cost.

As a result, investors are rightfully questioning the relatively high fees they pay for advice.

In the mass market, advisers typically use mutual funds with total fees of about two per cent of assets a year (for investment management and advice combined). Combined fees for other types of financial advisers (often serving wealthier clients) ranges from about one to two per cent a year.

While the amount you pay in fees is important, the key thing to focus on is value — the benefits you get from advice net of the fees you pay.

To provide the most value, advisers shouldn’t just focus narrowly on investments, but should provide broad advice including financial planning.

‘Advisers have multiple dimensions’ 

Look for “holistic financial advice,” says Stephen Horan, former head of credentialing and education at the CFA Institute, a global organization of investment professionals.

Advisers can help with day-to-day financial issues such as maintaining an adequate emergency cash reserve, managing debt, providing tax and savings tips, making sensible use of insurance, making good use of employer and government pensions, and optimizing tax-advantaged accounts such as: RRSPs, TFSAs, FHSAs, and RESPs.

“Advisers have multiple dimensions to add value in simple ways,” says Horan, now associate professor of finance at the University of North Carolina Wilmington.

As the investor accumulates wealth, advisers can often add value with in-depth financial planning. This typically includes preparing a comprehensive retirement plan, then later preparing a withdrawal plan to help generate cash flow in retirement in a tax-effective manner. The adviser can also help with tax planning and estate planning. Clients who are wealthy or who own businesses may have complex planning needs across numerous disciplines.

“That’s where financial planning can absolutely provide a tremendous amount of value,” says Jason Pereira, financial planner and portfolio manager with Woodgate Financial Inc. and associated companies. “Putting in place a financial plan that looks at where they are, where they want to be, what they own, what they owe, and it helps them have the fullest version of their lives,” says Pereira, founding ex-president of the Financial Planning Association of Canada.

‘Stock picking doesn’t work’

One area that doesn’t provide much value is stock picking. With so many smart investors out there, markets are reasonably efficient and tough to beat, so it’s unlikely that advisers can justify their fees if they spend a large portion of their time on this largely futile goal.

“There are still plenty of advisers out there who are evolved ‘80s-style brokers selling the story that they can basically outperform the market,” says Pereira. “Nothing has ever supported that. Academia has proved this a million times over. Stock picking doesn’t work.”

Advisers can generate a modest amount of value through adroit management of the portfolio, essentially focusing at the level of the forest instead of the trees. That starts with understanding the investor’s objectives, risk tolerance, time horizon, tax situation and other personal circumstances.

Then the adviser can help construct a well-diversified portfolio with the right asset mix that best meets the investor’s needs. Over time, the adviser counsels the client on how to respond sensibly to market conditions and helps with portfolio rebalancing.

But there are limits to value that advisers can provide from portfolio management. Robo-advisers can create and manage portfolios competently for total fees of about 0.4 to 0.7 per cent a year.

That provides a rough benchmark for the proportion of adviser fees that can be justified by human portfolio management. However, if an adviser is particularly experienced, skilled and good at communicating, they might justify fees for that activity that are a bit higher.

Some benefits, like tax savings, are tangible

Assessing value from advice isn’t cut-and-dried. Some benefits from advice are tangible and quantifiable — like tax savings. Other benefits are intangible and subjective — like peace-of-mind. 

Realization of value also depends on an investor’s individual situation and perspective. “Value is in the eye of the beholder,” says a 2022 Vanguard white paper on adviser value.

Several studies have attempted to quantify the typical value of good advice, although by necessity they focus mainly on more easily quantified benefits. Organizations as diverse as Morningstar, Vanguard and Envestment Capital have estimated typical hard economic benefits ranging from 1.6 per cent to over three per cent a year, as U.S. financial planner Michael Kitces has reported.

However, realized value depends critically on the investor’s individual circumstances, and how well the individual would do in the absence of an adviser, Kitces points out. The studies also don’t agree among themselves as to what the adviser’s typical value-added contributions are and how much each is worth, Kitces notes.

Value of advice can be obvious when provided to financial novices, but even highly knowledgeable investors can get value if the advice is geared to their knowledge level and needs. As an analogy, even top professional athletes benefit from coaching.

“Tom Brady has a coach,” says Horan, also co-author of the “New Wealth Management,” an adviser’s guide. “He is the greatest football player of all time, because he has a coach, not in spite of having a coach.”