Life + Wealth Insights: Part Two

The Hidden Cost of DIY Investing

Can a financial advisor really add 3% per year?

That's the question we left you with at the end of our last article.

It almost sounds too good to be true.

If an advisor could consistently add 3% to your investment returns every year, you'd expect them to have some incredible secret investment strategy.

Maybe they're finding investments the rest of us don't know about. Maybe they're timing the market. Maybe they have a crystal ball.

They don't.

And that's actually the most interesting part of Vanguard's Advisor Alpha research.

Vanguard isn't arguing that a good advisor can consistently beat the market by 3%. Instead, its research suggests that an advisor who consistently applies good wealth-management practices can potentially add up to, or even exceed, 3% in net returns through a combination of investment management, tax efficiency, financial planning, and behavioral coaching.

The potential value varies significantly from investor to investor—both in the amount of value and where that value is found.

To put it another way:

The value isn't necessarily in finding better investments. It's in making better decisions.

And sometimes, it's helping you avoid a very expensive bad decision.

Where does the 3% come from?

Vanguard's framework identifies several opportunities to add value, including appropriate asset allocation, investment selection, rebalancing, behavioral coaching, asset location, tax-efficient retirement strategies, withdrawal strategies, and tax-loss harvesting.

These aren't additive guarantees. You don't get 3% simply because you hired an advisor. Some strategies may provide little or no incremental value for a particular investor, while others may provide significant value.

But the framework illustrates something important:

There are a lot more ways to add value than simply picking investments.

Build the right portfolio

The goal isn't to find the portfolio with the highest expected return. It's to find the portfolio that makes sense for you.

A portfolio that is too aggressive may produce excellent returns—right up until the moment you panic and sell. A portfolio that is too conservative may feel comfortable—until inflation and longevity become the bigger risks.

The right portfolio is one you can live with when markets are doing well and when they're not.

Rebalance instead of react

When stocks are going up, we tend to want more of them. When they're falling, we tend to want less.

Rebalancing creates a systematic process for bringing a portfolio back toward its intended risk level rather than allowing markets—or emotions—to make that decision for you.

Manage taxes, not just investments

Where investments are held, when gains are realized, which accounts fund spending, and how withdrawals are coordinated can all affect what you ultimately keep.

Vanguard estimates that asset location alone can add around 0.3% annually in after-tax returns for certain well-diversified investors.

That's not as exciting as finding the next hot stock. But we believe it's more useful: rather than trying to predict which investment will outperform, you're finding ways to keep more of what you've already earned.

We'll take a deeper dive into tax planning in Part Three.

Create a thoughtful withdrawal strategy

Accumulating wealth and distributing wealth are two different practices.

Once you retire, the question changes from "How should I grow my money?" to "How should I use this money to sustain my lifestyle?"

Which accounts should fund spending? When should you claim Social Security? Should you consider Roth conversions? How much can you comfortably spend?

A good withdrawal strategy considers your investments, taxes, income needs, longevity, and legacy goals together.

That's financial planning—not just investment management.

And then there's the biggest one: behavior

This is where the Advisor Alpha research gets particularly interesting.

Vanguard identifies behavioral coaching as having the greatest potential value within its framework—up to 200 basis points (2%) or more in its 2022 analysis.

Why?

Because even a great investment plan doesn't help if you abandon it when your bias or emotions take charge.

Consider what happens during a major market decline.

You turn on the news. Your portfolio is down. Your neighbor says they're moving everything to cash. Someone online is confidently explaining why the market is about to fall further.

Suddenly, a portfolio that felt perfectly reasonable six months ago doesn't feel reasonable anymore.

This can also be true in the inverse: when things go really well, that doesn’t mean you ought to abandon lower-risk assets to go “all in” on the market.

That's when behavior becomes expensive and our biases work against us.

Vanguard describes behavioral coaching as helping clients separate their emotions from their investment decisions and temper natural reactions during periods of uncertainty.

Simply put: An advisor can be an emotional circuit breaker.

Not someone who simply tells you, "Don't worry."

Someone who helps you determine whether there's actually something to worry about.

What changed?

When a client calls us during a difficult market, one of the first questions we want to ask is:

What changed?

Did your goals change? Your retirement date? Your spending needs? Your family situation? Your ability to tolerate risk?

Or did the market change?

Those are very different things.

If your life hasn't changed, a market decline may not require a change to your financial plan. And if something has changed, that's important too.

The point isn't to blindly stay invested.

The point is to make sure you're making a decision because your circumstances changed, not simply because your emotions did.

That's behavioral coaching.

And sometimes, the value of advice is measured by the decision you didn't make.

The hidden cost of doing it yourself

We don't believe the biggest risk of DIY investing is choosing the wrong index fund.

You can find an excellent low-cost ETF in about five minutes. You can build a portfolio you’re comfortable with. You can automate contributions and rebalancing. Technology has made many parts of investing incredibly easy.

The harder part is managing everything around the portfolio.

It's knowing when to make a change—and when not to.

It's understanding how an investment decision affects your taxes.

It's coordinating investments with retirement, spending, estate planning, and the rest of your financial life.

And it's having someone in your corner when the right decision isn't obvious.

So, can an advisor really add 3%?

Yes—but possibly not in the way you think.

Vanguard's research suggests that following its Advisor Alpha framework can add up to, or even exceed, 3% in net returns.

That doesn't mean an advisor will outperform the market by 3% next year. It doesn't mean every client will receive 3%. And it certainly doesn't mean an advisor can predict the future.

It means there are many places throughout your financial life where good advice can potentially improve your outcome:

A better portfolio. A better tax strategy. A better withdrawal strategy. A better financial plan.

And, perhaps most importantly, better decisions when it matters most.

That's a very different value proposition than:

"We'll beat the market."

We don't believe that's what our clients need from us.

Our job isn't to make investing exciting.

It's to make your financial life clearer. To help you make better decisions. To help you avoid mistakes that can derail long-term success. And to be there when the market—or life—makes those decisions harder.

Because sometimes the greatest value an advisor provides isn't an extra 3% of return.

It's helping you keep the 100% of the return you were already on track to earn.

For those interested in reading more from Vanguard, you can find their Advisor’s Alpha here.

Next up: We'll take a closer look at the relationship between financial planning and tax planning—and how thoughtful tax decisions can create real value for investors.