In the last decade or so, there has been a fundamental shift in the personal finance industry, moving away from product sales and towards holistic planning involving one or multiple financial goals. Decades ago, the financial advice industry was designed to be great for the stockbroker. Today, it is far better for the investor. With less of a focus on asset management and more on honest, unbiased advice, it is becoming more about helping clients understand the best ways to save, spend, and invest their resources than it is about selling financial products.
Holistic financial advice provided by fiduciary financial advisors not only helps clients better understand their overall financial picture, but it also helps them breathe easier during periods of uncertainty. If you have a meaningful understanding of how much money you need to accumulate, by when, and for which goal, you are far less likely to make an impulsive reaction during a volatile market cycle or in the midst of a major life event that could have otherwise done more harm than good.
Most outdated research and academic publications tend to focus on the value of financial advice solely as an increased investment portfolio and its numerical returns. When the stock market is performing well, there is naturally a lot of conversation between clients and advisors around getting more money invested. And when markets are falling, the conversation is almost always about getting that money out. It is the advisor’s job to help keep that conversation balanced. Good financial advisors will steadily and repeatedly lead clients away from worry by emphasizing the importance of sticking with their financial plans and focusing less on short-term market fluctuations.
Not all the potential benefits of working with an advisor are about enhanced returns and increased wealth. In fact, some planning strategies recommended by a financial advisor tend to reduce short-term returns. For instance, rebalancing a client’s portfolio between stocks and bonds is intended to reduce risk, but it is generally a return-reducing strategy. Also, financial planners are great at helping clients understand the value of a diversified portfolio and how to achieve it. Even so, diversification generally focuses less on enhancing near-term returns and more on smoothing out longer term performance.
In addition to asset management, financial advice can consist of a variety of services. These include helping clients avoid overpaying taxes, helping them determine when to retire and helping them avoid overspending while in retirement. Financial advice can also assist clients with determining the appropriate levels of insurance and asset protection to have at each stage of life, and helps ensure they have the appropriate and necessary estate planning documents in place. Many of these services provide an intangible value that is ultimately invaluable.
While financial advisors are generally not in the business of giving tax advice, there are always tax implications for planning strategies that an advisor might recommend. For some planning strategies, the tax benefits are simply restricted to whatever dollar limits the tax code itself permits and thus makes it easy to quantify the hard dollar impact of that advice. But for others, the effects are less clear.
For instance, an advisor who works with high-income clients to take advantage of a back-door Roth conversion opportunity is implementing something a bit more complex and thus is not as easy to quantify. Although the client would not be able to take an immediate deduction and attach a monetary value to that advice, the true benefit would come far down the line once that person has retired and has begun to take tax-free distributions they otherwise would not have. The value is thus not the outright tax savings but the growth on the taxes that were deferred.
For many pre-retirees, the biggest benefits of seeking professional financial advice tend to focus more on figuring out when, or whether, they can actually retire. Additionally, it is important to know how much can be safely spent during this period as one’s retired life can sometimes extend longer than their working life. Another area a financial advisor demonstrates value is in retirement planning. For example, one of the most impactful decisions a pre-retiree will make is when to begin claiming Social Security benefits. A well-timed claim of benefits can earn a person hundreds of thousands of dollars over a twenty- or thirty-year retirement.
While most financial planning strategies help to enhance a person’s wealth, good insurance planning includes guidance around risk management to avoid financial disasters. Be that as it may, insurance planning does nothing to enhance financial outcomes. What this means, from the perspective of measuring the economic benefits of financial planning, is that while obtaining proper insurance coverage may reduce the risk of disasters, it is not expected to increase one’s overall wealth.
After all, from the insurance company’s perspective, the total premiums collected should exceed the total claims paid. Which, from the consumer’s perspective, means that over time, insurance premiums will cost more than the average claim is likely to be. From another standpoint, this is simply the recognition that good insurance planning is good risk management, turning potentially destructive and highly uncertain large expenses into predictable expenses that are small and manageable.
Estate planning is about the orderly disposition of assets after death, ideally utilized in a manner that helps to continue the family’s values and ensure the financial success of future generations. Some of the biggest benefits of successful estate planning are not financial at the outset. In some cases, the best estate planning may even restrict the passage of certain assets to future generations to safeguard against potential creditors or the beneficiaries’ own fiscal irresponsibility. In other words, it is hard to put a price on the value of simply ensuring that an inheritor does not squander his or her inheritance in the first place, even though that may be the most valuable estate planning advice a financial planner can offer a client.
When it comes to hypothetically measuring the benefit of financial advice, the answer is not so straightforward. While it is possible to quantify the financial outcome of any recommended strategy, it is not so clear how to quantify what would have happened in the absence of the financial planner’s recommendation altogether. What would the individual have done in the absence of the advisor? When evaluating the benefits of a financial planning strategy in general, the value will always vary depending on the measuring stick used.
Quality financial planning is designed to simply give clients back the time it would take to effectively manage their household finances themselves. It is ultimately up to the clients to determine whether that time is worth more to them than the hard dollar costs of paying a professional to do the job instead.