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Advice has a price, but what is its value?

Asset growth is one measure, but far from the only one.

Rudy Luukko 25 November, 2016 | 6:00PM
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The value of advice can't be measured according to any universally accepted standards or benchmarks. But that hasn't deterred investment researchers, including Morningstar, from developing ways to quantify it.

While some investment calculations are simple and straightforward, determining the value of advice definitely isn't one of them. After all, advice-giving is very much of a personal nature, or at least it should be. Unlike a barrel of crude oil or an ounce of gold bullion, advice is not a commodity.

Studies that seek to quantify the value of advice are based on the collective experience of all investors. Individual situations may, of course, vary widely from the collective norm. Depending on the individual investment professional, advice may add a little or a lot of value to the investor experience, or conversely may have zero or negative impact.

The most recent value-of-advice calculations of the collective investor experience are presented in an updated study this year, entitled The Gamma Factor and the Value of Financial Advice, by the Montreal-based Centre for Interuniversity Research and Analysis of Organizations (CIRANO).

Co-authored by Claude Montmarquette and Nathalie Viennot-Briot, the 2016 study is based on data from an Ipsos-Reid survey. In 2014, the opinion pollster provided responses from 1,584 households, consisting of 487 with advisors and 1,097 without. Individual respondents were at least 25 years old, with at least $1,000 in household assets and household incomes of less than $250,000.

In their latest study, the CIRANO researchers didn't consider all households who used advisors. Instead, they restricted their analysis to households that had chosen a financial advisor. This screening eliminated advised households who were first directly approached by an advisor.

This more selective approach differed from the original 2012 study, which analysed all households with advisors. The original study drew criticism that households who employ advisors are wealthier because they are targeted by advisors.

The updated CIRANO study's key conclusion, which is consistent with its earlier survey-based findings, is that investors who use advisors are better off over time.

The headline number for the advice industry, cited enthusiastically by trade organizations such as the Investment Funds Institute of Canada (IFIC) and Advocis, is a 290% wealth difference in favour of advice-givers. That is, the 487 households who had chosen and retained a financial advisor accumulated 290% more assets, on average over 15 years, than the 1,097 households who did not have an advisor.

This was much higher than the 173% difference calculated in the 2012 study, which the authors attribute to a combination of better performing financial markets and refinements in their methodology.

As measured by the CIRANO researchers, the advisor impact was much less over shorter multi-year periods, but still significant. Over four years, according to the study, households who had an advisor accumulated 69% more in assets, on average, than non-advice households.

The 2016 study also examined 282 households that were contacted for both the current and previous study. The researchers found households that dropped their advisor between 2010 and 2014 experienced declines in their investment assets, while those who kept their advisors saw the value of their assets increase.

In a Nov.7 presentation in Toronto to an industry audience, CIRANO's Montmarquette cited higher savings rates as a key attribute of households that employ advisors. Put simply, retaining an advisor leads to higher savings rates, which in turn results in greater wealth accumulation over time.

It should be noted that the relationship between advice and savings rates is not a universally held view among researchers into investor behaviour. As noted in Do Financial Advisers Influence Savings Behavior?, a 2015 report prepared for the U.S. Department of Labor by the California-based RAND Corp., an alternative explanation is that investors who choose to receive advice are already more inclined to save than those who don't want advice.

Secondly, the study found that advisor-served households also held, on average, a larger proportion of their savings in non-cash investments. Over time, greater allocations to longer-term investments result in greater wealth accumulation.

In his remarks to the IFIC-sponsored event, Montmarquette did not draw any relationship between the use of advisors and superior risk-adjusted investment performance, known as alpha. This makes sense, since advice was defined very broadly for the purpose of the study, and the methodology did not differentiate on the basis of advisor qualifications or proficiency.

The CIRANO study's goal was to provide one measure of "gamma" -- denoting the value of advice as opposed to market returns (beta) or market outperformance (alpha).

First used by the CIRANO duo in their updated 2016 study, gamma is a term that Morningstar researchers previously came up with three years ago in the research paper Alpha, Beta, and Now … Gamma. Co-authored by Morningstar's David Blanchett and Paul Kaplan, the study has been published in the Journal of Retirement.

The Morningstar authors' methodology was simulation-based and focused on the advice needs of retirees. It identified five important financial-planning decisions or techniques that contribute to creating gamma:

  • A total-wealth framework to determine the optimal asset allocation;
  • A dynamic withdrawal strategy;
  • Incorporating guaranteed-income products;
  • Tax-efficient asset-allocation decisions;
  • Portfolio optimization that considers the investor's liabilities.

Though the methodologies of the CIRANO and Morningstar studies are completely different, there was in the broadest sense a similar conclusion that advice can add value for the investor, independent of market returns or market-beating performance.

Blanchett and Kaplan estimated that a retiree can expect to generate 22.6% more "certainty-equivalent income" by using a gamma-efficient retirement-income strategy. They calculated that such a strategy has the same impact as an increase of 1.59 percentage points in annual return.

This, of course, represents a significant value-add to the investor. But it will be true only for relationships that involve much more than gathering assets and providing asset-allocation advice.

Having someone to convince you to save more money and to avoid panic selling can certainly help you in fulfilling your investment goals. But to get the most value out of an advisory relationship, you should also receive expert financial planning.

Advice-seeking investors should ensure that the advisor they choose has the skills and experience to meet all their financial needs, not just securities selection and asset allocation. Importantly, the best advisors are those who are willing to act in their clients' best interests, during both the asset-accumulation stage and when it comes time to draw down on savings.

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About Author

Rudy Luukko

Rudy Luukko  Rudy Luukko is a freelance writer who contributes to Morningstar.ca on topics involving fund industry trends and regulatory issues. He retired in May 2018 from his position as editor, investment and personal finance, at Morningstar Canada, where he had worked since 2004. He has also worked as an editor and writer for various general, specialty and institutional media, and he has co-authored courses for the Canadian Securities Institute. Follow Rudy on Twitter: @RudyLuukko.

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