Financial Advice: The Value Equation

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Part 3 of our 3-Part series in which we analyze the Value of Financial Advice, and how you can ensure that you are receiving true value for the fees you pay.

Part 1: Time is the Stuff that Life is Made of
Part 2: Trust Me!
Part 3: Financial Advice: The Value Equation


Price is only a consideration in the absence of Value
– Bill Bachrach

The Value of Financial Advice

In the first article of our series, we explored the “Rule of 168”, which is a Law of Nature which states that there are only 168 hours in every week, and that the quality of your life is largely dependent upon how you choose to spend those hours. We proposed the idea that the true value of any personal service provider is to enable you to pay someone else to do some task for you – like mowing your lawn, laundering your shirts, or filing your taxes – that you prefer not to do for yourself. In that light, the true value promise of a financial advisor is to enable you to:

Delegate the management of your wealth to an advisor you trust, so that you can spend your time focused on the things that are more important to you.

In our second article, we analyzed the phrase “an advisor you trust” as part of this value statement. After all, if you plan to delegate the management of your financial future, it is of utmost importance to develop a very high level of trust in your advisor. We explored recent developments in the advisory business which are moving the industry into a more “client friendly” direction, and which may help to address the perception of mistrust that much of the investing public has in our industry.

In this final piece, we will explore the “Value Equation” you should expect when you engage with a financial advisor. Presuming you have found an experienced advisor who you can trust to act as your family’s fiduciary, what should you expect to pay, and what services should you expect to receive, and how can you evaluate the “Value” you are receiving for those fees you are paying? In this article we hope to create a framework for answering these questions.

Wealth and Complexity

As we know, there are known knowns; there are things we know we know.
We also know there are known unknowns; that is to say we know there are some things we do not know.

But there are also unknown unknowns – the ones we don’t know we don’t know. And if one looks throughout the history of our country and other free countries, it is the latter category that tend to be the difficult ones
– Donald Rumsfeld, Former Secretary of Defense

If the true purpose of financial advice is to allow you to delegate the function of managing your wealth, the value of that service will rise in direct proportion to the level of complexity at stake in your wealth management. In the discussion below, we explore the service offerings you should expect from a highly competent financial advisory firm, and what you should expect to pay for them. As a preface to that discussion, it is worth developing an understanding of the relationship between wealth and complexity.

Unique Success
As we survey the financial services landscape in America today, we find that there are roughly 30 million people who are more successful than average, and who find themselves in need of paid financial advice. As depicted in the diagram below, there is a large population of people who are less successful than average, and who do not seek financial services.

However, there is a small population of people, typically the top 10% of the population, who have achieved the status of “uniquely successful”, and have accumulated significant wealth, of at least $1 million in assets. This very small number of people have crossed the threshold into an unusual and unfamiliar situation. It is difficult to be prepared and knowledgeable about how to navigate this position in life until one has been there and experienced it.

success-diagram

Once an investor crosses this $1 million threshold into this situation, the risks and opportunities faced are very different than the average investor faces. Importantly, most financial advisors do not work in this space either, and as a result do not understand the risks and opportunities that are present there. Most advisors are very competent in working with “Successful” clients, as their problems and opportunities are much simpler, but do not understand the problems and opportunities of uniquely successful investors. As a result, it is often hard for these uniquely successful families to find qualified advisors with the appropriate caliber of knowledge and insight.

The Implications of Complexity
For many people, a growing base of wealth is desirable, as greater wealth means a greater level of comfort and freedom, and a lower degree of stress. However, there is also a direct and positive relationship between wealth and complexity. Simply put, as your wealth grows, so does the complexity involved with the proper management and decisions of that wealth.

This relationship between wealth and complexity is positively correlated for average investors, but for Uniquely Successful investors, there comes a point above $1 million in wealth, at which complexity begins to accelerate, and increase more significantly. Again, because most financial advisors work with average clients, it may be difficult to obtain qualified advice to help deal with these complexities.

complex-lives

Wealth and Anxiety
The accumulation of wealth can also have an interesting correlation with the level of anxiety that a family may feel.

On the one hand, there can be a negative correlation between the accumulation of wealth, and the feelings of fear and anxiety. As wealth represents the key to security and freedom, investors who are able to grow and accumulate wealth are able to escape the fear of answering the question “Will I be OK?”, and develop a feeling of financial security and confidence. As wealth grows, this anxiety is reduced dramatically at first, but then the process slows down and requires more wealth to create the same level of relief. At a certain point, wealth has a “diminishing marginal value”.

For most families, answering the question “Am I going to be OK” is the central issue, and they are concerned for their basic financial security. It is for this reason that many families can become fixated on their investment strategy and performance, because their portfolio is their tool being used to achieve security, and their performance is the evidence of that security.

On the other hand, for uniquely successful people it can also be true that the level of anxiety may increase as wealth grows above $1 million. While the first kind of anxiety is the fear of being destitute and insecure in old age, this kind of anxiety is the insecurity that comes from coping with a complex financial life. For many wealthy families, complexity means that they don’t know what they might be missing. Importantly, they don’t know what they might be missing that could hurt them, or that they could benefit from, possibly in large measure. As wealth increases, risks and opportunities increase dramatically, but the knowledge about these risks and opportunities does not automatically accompany the complexity.

concern-security

We think of the complexities of wealth as Donald Rumsfeld described the “Unknown Unknowns” in the quote above. These complexities are those problems, risks, and opportunities that cause wealthy families with assets in excess of $1 million to fear the question “What are we missing”. Such families are constantly chasing after the knowledge and capability they need to cope with these complexities, but may have difficulty finding that knowledge and insight, because most financial advisors also do not have the required level of insight and sophistication to understand these issues either.

Managing Complexity: What Should you Expect?

The value of the services you receive from a financial advisor should be generally correlated to her level of skill in helping you to deal with the complexity of your financial situation. We have created a simple diagram to visually represent the important component pieces of an effective wealth management solution, and which you may use to help evaluate potential providers. Any competent advisory platform should be prepared to demonstrate value in each of these key areas:

wealth-mgmt-value-prop

Individual Investments
Of course, the most fundamental task of a Financial Advisor if to recommend investments. Most advisors spend a great deal of time and effort to research investment recommendations, and new fiduciary guidelines should help you to choose an advisor in a way that ensures that only your best interests influence that process.

The Portfolio
The larger foundation of your work with an advisor is your investment portfolio as a whole, which is the way he or she is able to bring together all of your individual investments into a coherent strategy, and personal Investment Policy Statement. Portfolio Construction is one of the important engines of your future financial security and the foundation of your wealth management.

The Financial Plan
Of course, the portfolio by itself answers only a few of the important questions that you have about navigating the complexities of your wealth, which is why the portfolio should be built on the foundation of a comprehensive financial plan. While the portfolio strategy may help you to navigate current market conditions, the Financial Plan sets the stage for a long term strategy for ensuring your peace of mind.

Standard of Care
Mike Tyson once said that “Everyone has a plan until I punch them in the mouth”. Even the best designed financial plan must be flexible enough to deal with the evolving complexities of your wealth, and changes in your situation over time. As you grow older and your wealth grows, you will inevitably face more complex decisions about your wealth, as well as your tax, estate, debt, and insurance planning. As this occurs, an advisor’s “Standard of Care” can act as a tool kit of multi-disciplinary knowledge and expertise to help you think strategically about those decisions, and to answer the important questions of “What am I missing that could hurt me, or that I could take advantage of”?

Events, Transitions, Values and Goals
Life is a constantly evolving journey that presents your family with predictable challenges. There are normal life transitions: stages of life that we enter and leave as the years pass. Developments in each of those stages require us to adjust the plan, the portfolio and other strategies. In addition, there will be unexpected events to which every family must adapt, both good and bad. A great advisor should pay attention to what is happening in your life, observe it from the perspective of your financial plan, and make sure you get the best possible advice about how to navigate those changes.

6. Behavioral – Finance Coaching:
Research has found that investors benefit from having an advisor to act as a sounding board and as a counselor when they become distressed by volatility in the markets, or short term losses in their portfolio. A great advisor should act as a source of emotional strength, self-control, and discipline when you are tempted to over-react to market developments.

Each of these circles informs the others, back and forth, all the time, but each should be present in your wealth management relationship. More importantly, there is a reason that this model is represented by a series of concentric circles explaining each characteristic of an advisory relationship: It is to demonstrate the relative importance of each of these characteristics.

In particular, this diagram is intended to emphasize that the portfolio and the products sold within it are only one small part of a larger advisory relationship – in fact the portfolio and the products are truly the servants of the more important elements of your wealth planning, such as the financial plan, standard of care, focus on your Values and Goals, and behavioral coaching. Too many people oversimplify the wealth management process thinking that the investment portfolio is the only thing that matters. In truth, investment products and portfolio management are commodity services, and do not particularly represent any unique value. The true value in an advisory relationship is in the insight and wisdom delivered through the more advanced functions of a wealth manager.

Putting Fees in Perspective

If you think it’s expensive to hire a professional to do the job, wait until you hire an amateur.
– Red Adair

The financial services industry has become quite competitive in recent decades, and today there is no shortage of options to choose from when seeking financial advice and guidance. One result of the proliferation of advisory platforms is that fees have become much more competitive.

However it is still valuable to remember the interplay between price and value as you evaluate your options. In general, cheaper services tend to offer less extensive advice and little or no personal attention – for example the recent advent of “Robo-Advisors” is simply an attempt by financial services providers to drive profitability through automation rather than personal contact. For some families these type of cheaper services may be appropriate to their needs, but for uniquely successful families, facing increasing complexity in their financial lives, all six layers of financial advice may be a superior and necessary value.

A simple diagram may help to make this connection, and place advisory fees in the context of the value you should expect:

fee-vs-providers

The first observation of this diagram is the understanding that there is nowhere you can invest without incurring some cost, and even self-directed investors who receive no advice pay something to invest. As a demonstration of this, most automated “Robo-Advisor” platforms offer investment selection and portfolio management for a fee of 0.25% to 0.5% of your portfolio. These platforms use technology to replace human interaction, and generally do not offer services beyond the first two circles on our value diagram.

As we ascend this pricing diagram, there is another level of services which we have termed “discount advice”, which cost a little more, but which provide a fuller service offering. Discount brokerage firms such as Vanguard, Fidelity, and Charles Schwab have developed advisory services which are generally offered for a fee of 0.35% to 1.5% of assets, in addition to the fees on the underlying investments recommended. These services offer the availability of human contact, as clients are assigned to be served by a team of trained advisors – however employee turnover may limit the ability to develop a long term relationship with an advisor who understands your goals and values. Generally, these services offer the first three levels of service described by our diagram: Investment products, portfolio management, and your financial plan. However, they generally do not include the more advanced elements of wealth planning.

Finally, the most expensive option is a relationship with a full service wealth management firm such as Concentus Wealth Advisors, or other more expensive firms. Although fees may vary at this level, most advisory firms operating with a high level of skill and personal attention will cost somewhere between 1% and 1.5% of your assets, in addition to the fees on the underlying investments you may own. For this fee, you should expect a very high level of personal contact and a relationship with an advisor who knows your family over many years. At this level, you should also expect your advisor to deliver on all 6 levels of service in our Value diagram, effectively helping your family to navigate the complexities of your wealth over many years, or even multiple generations.

Clearly, fees relate to services in a logical way: the lower the fee, the more limited the service. In order for a highly experienced and capable advisory firm to provide all of the value depicted on our circle diagram, clients must be prepared to pay a little more than they would using a discounter or Robo–Advisor. Given what is at stake when dealing with the more complex elements of your family’s long term wealth plan, it may be valuable to consider this higher fee rate as an investment in the family’s ongoing financial success.

Conclusion

There is an old saying that “You get what you pay for”, which is simply a way of saying that there is a natural relationship between the price you pay for something, and the value that you will receive for your money. In evaluating your family’s use of financial advisory services, you may think about the price you must pay, for assistance in answering your most complex questions:

At a basic level, you should expect to pay a highly discounted fee for help with questions about Managing your Portfolio:

  • Will I be OK?
  • How Should I navigate current market conditions?

For families who need additional help managing the complexity and unknown nature of their planning, you should expect to pay a little more for help with questions about Your Financial Plan:

  • When Can I retire?
  • How much can I spend?
  • Should I take more risk?
  • Can I take less risk?
  • What if I work longer?
  • How much can I give away?
  • Should we pick a less expensive college?
  • What are the consequences if we buy a vacation home?

For families who experience a high degree of complexity in their planning, and wish to access the wisdom and insight of an experienced advisor, you should expect to pay a premium price for help with questions about Your Planning Standard of Care:

  • What am I missing from my financial strategy that could hurt me?
  • What am I missing from my financial strategy that I could take advantage of and benefit from?
  • How can I best express my goals and values in the implementation of my financial plan?

At this highest level, the delivery of financial advice is an iterative process: the portfolio, the financial plan and the Standard of Care must constantly evolve and inform one another. Staying current with each client is an important aspect of the value an advisor delivers.

As financial services evolve, innovation in asset management, tax law and industry regulations will require adapting the portfolio, the plan, and the Standard of Care. As clients transition into new life stages, values and goals often shift, and the type of advice needed will change. As wealth increases, new strategies become available that will benefit the client, and new hazards arise that require protection. As clients experience new levels of wealth or setbacks, values evolve and goals change – a plan that was an accurate reflection of a client’s deeply held values in her 40’s will likely be obsolete by the time she is in her 60’s.

Hopefully, this model for the delivery of advice is helpful in understanding the interplay of price and value in the delivery of financial advice, and provides a useful guide for your family in evaluating the appropriate platform for you, and what you should pay for that platform. Ultimately, it is most important to take advantage of a service level which is most appropriate to your needs, and to feel comfortable paying a fair price for those services.

scorecard_screenshot

[Click on image to take Scorecard]

At Concentus, we have developed a self-discovery tool called the Advisor Right Fit Scorecard to help people embark on the process of selecting the very best financial advisory platform to meet their needs.

You can use this tool to evaluate your own mindset and expectations, and to help you discover what is likely to be the most effective type of advisory relationship for you and your family. It may also help you avoid making a poor choice, and the bad experience of making this realization too late.

We hope you find it helpful. Good luck!

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About the Author:

Erik is one of the co-founders of Concentus Wealth Advisors and currently serves as the Chief Executive Officer of the firm. With over 25 years of industry experience, Erik guides the firm’s overall strategy.

After graduating from Amherst College in 1991, Erik spent a year working with Rittenhouse Capital Management, before joining Gerald in 1992. Erik currently holds his general securities registrations and insurance licenses, as well as CERTIFIED FINANCIAL PLANNER™ and Chartered Financial Consultant designations.

In addition to his formal designations, Erik has appeared on CNBC’s Worldwide Exchange, Fox News’ America’s News HQ, Live Well’s Mary on Money, CN8’s Money Matters Today and The Real Estate Connection.

In 2012, Erik was one of thirteen advisors named to Main Line Today’s Top Financial Advisors list.

Erik lives in Bryn Mawr, PA with his wife and three children. He serves on the boards of the Philadelphia Chapter of the Salvation Army, Acting Without Boundaries (serving young people with disabilities) and The Holy Child School at Rosemont. In addition, he is on the financial advisory board of the Sisters of St. Francis in Media, PA.

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