This article first appeared in Personal Finance Magazine 3rd quarter 2017
A professional financial adviser adds considerable value to a household’s wealth over time, but not in the way that many people think.
Janet Hugo, an accredited Certified Financial Planner and director of Sterling Private Wealth, says: “I am sure that many people believe they hire a financial adviser to outperform the stock market. But investment returns are not the whole package. Advisers add value in numerous ways.”
Research studies conducted in 2012 found that what investors gain from employing a financial adviser far outweighs what they pay in advice charges.
A study by the international data and ratings company Morningstar put a number to this added value: 1.82 percent a year. This may not sound like much, but over many years it compounds to form a considerable portion of an investor’s assets.
The second study, by the Centre for Interuniversity Research and Analysis on Organisations (Cirao) in the United States, found that households that had used a financial adviser for between four and six years possessed 58 percent more financial assets, on average, than those that hadn’t.
What is interesting, Hugo says, is that this added value did not come from the advisers choosing better-performing investments than the investors could necessarily have chosen themselves. The Morningstar report found that it is not the performance of specific investments in a portfolio that determines long-term value to the investor. Rather, it is a number of factors that many investors tend to overlook that makes the biggest difference.
So how do advisers really add value? Hugo outlines factors identified in the Morningstar and Cirao studies and ones she has identified in her interactions with clients:
1. Focusing on the long term and providing guidance through market fluctuations. Advisers act as counsellors in this regard, Hugo says, talking their clients through market volatility. “It has been shown that another voice besides one’s own during turbulent times can be invaluable.”
Advisers also help clients to identify their biases. “Many of us think we don’t really have any … which is exactly the point,” Hugo says.
2. Drawing up a financial plan with the goal of meeting a client’s specific requirements. Advisers are required to undertake a thorough analysis of their clients’ personal circumstances and financial needs before drawing up a financial plan, recommending investments and building a portfolio.
Says Hugo: “Very few people ever plan. It takes time and can be uncomfortable, and yet it really matters. Without a full cash-flow analysis, how will an adviser determine an asset allocation within a risk strategy that the client can live with and have faith in?”
3. Allocating assets based on appropriate levels of risk. Investment capital is allocated across the main asset classes of equities, bonds, listed property and cash, as determined by the financial needs analysis and financial plan drawn up by the adviser.
For example, a young professional beginning a career will have a larger portion of his or her portfolio in the higher growth assets of equities and listed property. A pensioner, on the other hand, will have his or her investments distributed across the asset classes in a way that provides an income, with a far lower risk of capital loss.
4. Identifying risks in clients’ portfolios that the clients might look past. Examples include being overweight in South African assets, chasing equity performance, being too conservative for the long term, having insufficient manager diversity and being too concentrated in a single market sector or company, Hugo says.
5. Ensuring a sustainable withdrawal strategy. This applies to clients drawing an income from their investments. The Morningstar research found that advisers added value by using a “dynamic” strategy whereby the withdrawal amount is regularly reassessed in the light of market conditions to ensure that the portfolio and income arising from it are sustainable.
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6. Ensuring tax efficiency. This was one of the top ways in which advisers added value, the Morningstar research found. Hugo says an adviser can help you take advantage of tax breaks that may be available to you but that you are unaware of. The more you save in tax, the more the money you save can work for you in your portfolio, adding to the compounding over time.
7. Checking that clients are saving enough to build sufficient retirement capital. “Perfect investment returns will not magically produce retirement income out of too little savings,” Hugo warns.
8. Pressing clients to answer questions they don’t want to be asked. For example, Hugo says, advisers will ask clients how they plan to take care of their aging parents, whether their will is up to date, how they are going to educate their children or what they will do if they lost their jobs.
“Advice is hardly a scientific thing and, even when it comes packaged with the best intentions, it’s still subject to human error. There is also, of course, significant variability in terms of the results advisers produce for their clients. Even so, the research does suggest that investors are generally better off in the hands of a trusted adviser,” Hugo says.
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