Trust Your Advisor to Separate Your Wants from Your Needs

The title of a slide from one of the breakout sessions at the TD Ameritrade Conference in January caught my eye. It read, “Re-direct clients’ interests from wants to needs.” The long list of common wants on the left side was translated into a list of more specific needs on the right side. For example, while clients tell advisors they want a “predictable income stream,” the advisor translates that to the need for an “inflation-sensitive cash flow.” Similarly, when clients want to pay less in taxes, advisors know they need a diversified asset allocation coupled with an asset location plan that places investments according to how they are taxed in either taxable or tax-deferred accounts.

The most important example of the difference between want and need was tucked in the middle of the list. Clients want “superior financial performance,” but advisors understand that the real need is “attainment of financial goals.” That is, investors need more than solid returns. Accordingly, today’s trusted advisor must provide comprehensive wealth management advice that addresses financial planning and investment policy, as well as decision-making discipline and guidance. Outperforming the market is not the goal, nor should it be the measure of value.

This is how I think about our primary goal as your financial advisor: to help our clients move beyond the returns they want in order to identify what they really need, which is what distinguishes the advisory relationship from the “robo-advisor” experience.

Robo-advisor is the catchy name for the spate of companies that provide portfolio management via a technology-based platform that automates the investment process. Here’s how it works: Instead of working with a financial advisor in person, the investor answers questions, such as his or her investment risk tolerance and age, via an online questionnaire.  A computer algorithm then spits out an appropriate portfolio.

Robo-advisors may be grabbing headlines, but according to a new Spectrem study, the business model is still new to most investors.  When asked to rate their familiarity with various investment terms on a scale of 0 to 100, where 0 is not at all familiar and 100 is very familiar, wealthy investors rated their knowledge of the term “robo-advisor” at just 15.47. The younger the investors were, however, the more familiar they were with robo-advisors.

On the plus side, robo-advisors democratize financial advice. With a robo-advisor, there are no investment minimums; anyone can use the programs. While that sounds convenient and beneficial, there are dangers in providing “expert” advice for everyone. Who will help the clients of robo-advisors distinguish wants from needs? Yes, the robo-advised portfolios may benefit investors by decreasing investment costs and diversifying their holdings. However, there is a more significant problem that robo-advisors can’t solve. Robo-advisors can’t counsel clients to ensure that they don’t bail out of the market at precisely the wrong time during a bout of market volatility. As we know, thanks to the market research firm Dalbar’s 20 years of Quantitative Analysis of Investor Behavior (QAIB) studies, individual investors tend to sell low and buy high, which results in lower returns when compared to institutional investors. Dalbar’s 2014 QAIB report showed a 20-year return of 9.22% for the S&P 500 compared to the average investor’s return of 5.02%.

Studies like Dalbar’s QAIB also help us quantify what an advisor is worth. For example, a trusted advisor adds value through relationship-oriented services such as wealth management and behavioral coaching. In a recent white paper, Vanguard moved beyond important intangibles and quantified advisors’ potential positive impact on clients’ net annual returns at “about 3%.” The paper states, “For some clients, [the advisor] may offer much more than 3 percentage points of increased returns. For others, less. The 3 percentage points come after taxes and fees. This return is not added over a specific time frame but varies each year and according to client circumstances. It can be added quickly and dramatically, especially during periods of market decline or euphoria. It may be provided slowly. It will not appear on a client’s quarterly statement but is real nonetheless.”

Vanguard acknowledges that services such as estate and succession planning, or advice on long-term care insurance or charitable giving contribute real value to the advisory relationship, even if they are not absolutely quantifiable. However, they have quantified the value of other services, offering these estimates expressed in basis points (a unit equal to 1/100th of 1%, i.e., 50 basis points is 0.5%): cost-effective implementation (choosing low-cost funds): 45 basis points; asset location (dividing assets appropriately between taxable and non-taxable accounts): 0 to 75 basis points; rebalancing: 35 points; and developing a spending strategy (withdrawal order in retirement): 0 to 70 basis points.

I’ll conclude by noting that the value we deliver to our clients comes from focusing on what we can control–product costs, portfolio diversification, and tax efficiency. While some of those decisions can, indeed, be automated, sound decisions depend on more than just evaluating the numbers. For example, how can you maximize your Social Security benefits? Are you ready to retire? Do your children understand your estate plan?

In short, we deliver value by helping our clients set clear goals and monitor their progress throughout inevitable life changes and market swings. And, especially in today’s fast-moving, volatile market, our work is both an art and a science.

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