The value of proper independent financial advice could be 10% each year!

There appears to be a perception that independent financial advice is expensive and unnecessary.  In a recent article in our Long And Winding Road series, B&Q and Financial Planning, I discussed the implications for independent financial advice given the rise of the DIY investor.

In a recent report KPMG  highlighted a significant rise in the number of execution-only stockbroker accounts among the larger portfolio sizes targeted by Private Banks and Wealth Managers. At the end of 2010 there were over 18,000 DIY portfolios valued between £250,000 and £1m; an increase of 122% since 2008. Over the same period, the number of portfolios valued between £1m and £10m increased by 73%. A study by the online investment broker Hargreaves Lansdown  suggested 84% of investors plan to go it alone and fore go advice. However, there is a significant body of independent academic research which suggests this may be exactly the wrong thing to do.

A recent paper from the Goethe University Frankfurt examined the actual trading accounts of 8,621 investor portfolios from an online execution only broker and found that 89% exhibited “negative skill” before charges (91% after charges). And where investors did outperform there was no evidence this was anything more than luck? The fact that so many DIY investors performed poorly was no surprise; the vast body of research tells us to expect this. What was surprising about this study was the magnitude of under-performance. The authors found that on average investors underperformed the returns they could have expected by luck alone by -7.5%pa before charges (-8.5%pa after charges).

There have been many similar studies in other markets including the UK and US which show that investors consistently under-perform the market and the more they trade; the worse they perform.

We are all familiar with the notion that investors should buy when prices are low and sell when they are high. However, history tells us that, left to our own devices; we will do exactly the opposite. A rough and ready reference for this might be to compare the inflows and outflows of Equity and Bond investment funds against the movement of the stock market.  The level of net sales/redemptions from UK domiciled Unit Trust and OEIC funds can be found on the Investment Management Association website. I have plotted the proportion being invested in equities and bonds since 2003 against the movement of the FTSE All Share index below.

Net retail investment fund sales relative to FTSE performance

The general trend is certainly clear. In 2006 and 2007, when the UK Stock Market was at its peak after 5 years of strong returns, almost no money was invested into bond funds. However, in 2008 after the stock market collapsed investors withdrew nearly £1.2bn from equity funds and invested nearly £3bn in bond funds.

Carl Richard, author of Behavior Gap sums it up perfectly with his sketch “Repeat Until Broke!”:

The value of independent financial advice
The true value of independent financial advice is in helping investors overcome their natural human instincts.

Another recent study by Morningstar  attempted to quantify the true value of comprehensive financial advice for retirees rather than simply measuring investment returns (a similar study could be designed for pre-retirees). Morningstar identified 5 distinct ways in which good advice adds value;

1.    Total wealth asset allocation – taking account of “human capital” rather than just financial assets. This requires consideration of risk capacity as well as risk preference; something which is fundamental to proper financial planning.

2.    A dynamic withdrawal strategy – regularly reviewing the sustainability of withdrawals and making changes as required.

3.    Annuity allocation – giving due consideration to the pros and cons of securing a guaranteed income for life through annuity purchase. Morningstar quote an Allianz study which found the greatest fear among retirees is not death (39%) but rather outliving one’s resources (61%).

4.    Tax efficient investment allocation decisions – if it is possible to hold assets in different ways, some more tax efficient than others, it makes sense to maximise tax efficiency.

5.    Portfolio optimisation that includes liabilities – asset allocation methodologies commonly ignore the funding risks with an investor’s own goals. True financial planning will attempt to quantify the impact of such risks and address these accordingly. A personal lifetime cashflow forecast is a good starting point.

The authors developed a formula to quantify the impact of the 5 factors and estimated the “added value” through proper advice to be 1.8% annually.

It is often said that there is now so much free information available online that investors can do their own research quickly and easily without the need for advice. Unfortunately, life is too short. The real problem may be “information overload”. There is no longer much value in selecting the best funds or executing trades but there is value in investment coaching and filtering out the distracting noise.

Taking all of the above into account it seems that the value of good financial planning and investment advice combined could be as much as 10.3%pa (8.5% + 1.8%). Then again, perhaps Master Card would sum it up as; Investing money 1.5%, tax planning 0.5%, lifetime cashflow forecasting 1%, liability matching 1%, investment coaching 2%, the ability to enjoy your life and sleep at night – priceless.



(The percentages in the Master Card example are ficticous and purely random numbers plucked from thin air and are not meant to imply specific values in any way shape or form)

2 Responses to “The value of proper independent financial advice could be 10% each year!”

  1. Brett Davidson

    Brilliant article Alan. I’ve suggested for years (as have all good financial planners) that we are great value even in a 1%pa fee world. But who knew how valuable we can be. I love the Master Card ending. The greatest value of all (which is obviously >10% pa) is still the ability for people to really live & not have to worry about their money.


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