By Victoria Reuvers
Households across the globe are increasingly expected to be responsible for more financial decisions, such as determining how much to save for retirement, how to invest savings, how to be tax-savvy and when to retire. It’s a tricky one – especially, if no one in your household is a trained financial planner and/or adviser.
Within that reasoning, you might as well also be in charge of doing the plumbing and electrical installation for your home. While you might be able to fix a simple leak, it’s not as easy when your geyser bursts and floods your entire house. Ironically, it’s for this exact reason that you are also expected to have the correct financial planning and insurance in place.
So, why is everyone expected to plan their finances when it is such a specialised task?
It’s actually scary how underrated, misunderstood and undervalued the value of quality financial advice is. Just because we’re taught basic maths at school, it most certainly doesn’t mean everyone can understand, manage and maintain their own financial planning needs. Maybe that’s why so many people are hesitant to seek financial advice – because the assumption is that everyone should know how to do it.
The fact is that long-term financial planning and investing is much more than a mathematical analysis of risk and return. It’s a struggle with ourselves: to tune out irrelevant information, to have the strength to stick to the plan and to resist the urge to follow the herd. This is undoubtedly the most important role and value-add of quality financial advice.
The industry consensus on why financial advice is valuable is different than it used to be. While advisers used to be simply be measured on their ability ability to beat an investment return benchmark, it’s now understood that their value is far better measured by the impact that their services can have on investors’ long-term financial outcomes.
New metrics and research findings show that the interpersonal aspect of advice hase more impact on a person’s finances than anything else. This outlook favours services like behavioural coaching — helping clients mitigate their biases and stay the course — and personalised advice versus traditional selling points like maximising returns and asset allocation.
When it comes to generating positive investment returns, investors arguably spend the most time and effort on selecting “good” investment funds/managers and asset allocation. However, these elements, known as “alpha” and “beta”, are just two elements to consider among a myriad of important financial planning decisions for the average investor, many of which can have a far more significant impact on investment return.
“Gamma“, a metric introduced by Morningstar’s David Blanchett and Paul Kaplan, measures the additional expected retirement income achieved through wise financial-planning decisions, and many of these decisions are made with an adviser’s assistance. Morningstar’s Gamma research demonstrates that making sound financial planning decisions in five areas — asset allocation, withdrawal strategy, guaranteed income products, tax-efficiency, and portfolio optimisation — can generate 29% more income on average for a retiree.
Vanguard’s Advisor’s Alpha measure is similar. It measures the value added, in basis points, by seven best practices in wealth management: asset allocation, cost-effective implementation, rebalancing, behavioural coaching, asset allocation, spending strategy, and total-return investing versus income investing. This research suggests that behavioural coaching is the single most impactful thing an adviser can do.
In the past, the financial industry’s tendency was to over-emphasise returns and benchmark relative performance. However, research shows that the interpersonal side of advice, which includes personalisation and behavioural coaching, can be the most valuable aspect of professional advice, and the industry needs to better articulate that.
As investors, emotions can be our own worst enemy. The best advice as the new year approaches, is to ensure that you partner with a good financial adviser to ensure you stay the course, and rest assured knowing that your long-term financial plan is being implemented and on track. Returns aren’t the be-all and end-all — modern advice is more coaching than stock-picking, and the short-term returns are only part of the picture.
Victoria Reuvers is Managing Director, Morningstar Investment Management.