Coming off one of the worst market downturns in our lifetime has brought much needed scrutiny to the financial advisory relationship. The question, which Wall Street never answers reasonably, is whether all of the fees associated with managing your money have resulted in any value added. The answer is “rarely.”

Value Added Result

A value added result doesn’t mean you should expect your account hold its value no matter what. Virtually everyone has lost significant money in the last year. It can simply mean losing less money than other portfolios that took the same level of risk. Needless to say, it’s one thing to have this idea in your head. It’s quite another to understand it when your feelings are at the panic stage. The typical measure of valued added is the amount by which advisor selections beat their appointed asset class benchmark. As you know, investors are likely to be disappointed about 70 percent of the time.

The AssetBuilder approach is different. Rather than chase index beating returns, we accept market returns knowing those allow us to do better than 70 percent of all managed portfolios. Instead, we focus on maximizing return relative to risk. Our expectation is that our portfolios will, over time, provide higher returns for the amount of risk that was taken. That’s value added.

Let me give you a concrete example. Recently we did a portfolio analysis for a prospective client. He was unusual in that he was already using a Dimensional Funds advisor. We found that our model portfolio that had a virtually identical level of risk as his provided an annualized return that was 1.69 percent higher than his current adviser over a long period1. The advantage held short term, as well. In the first 5 months of this year his portfolio had provided a return of 9.80 percent (period return). Our comparable risk portfolio (Portfolio 9) had provided a return of 12.5 percent (period return) over the same period. That’s quite a difference.

Similarly, measured against all “moderate allocation” mutual funds in the Morningstar database, our portfolio 9 was in the top 3 percent over the same period, well ahead of the category average of 6.12 percent. This was done at a slightly higher level of risk (13.13 percent vs.11.61 percent standard deviation). This could, of course, be a statistical fluke. But we don’t think so. We think it is our value added— more return for a given level of risk. It’s something that can be seen on the upside, but it is psychologically invisible on the downside.

Fees

Since fees are guaranteed and return is not, discriminating investors are taking a hard look. Fees can take a significant bite out of an already dwindling account balance.

Financial advisor fees vary, but can be grouped by fee-only or fee-based. A Fee-only advisor is compensated entirely by the investor. A Fee-only advisor typically pays close attention to the long-term cost of what he/she is recommending. A Fee-based advisor may be partially paid by fees but is also paid commissions. These commissions are part of the food chain for the legacy investment services industry. Sometimes, the commission drives an investment strategy contrary to investors’ best interests.

AssetBuilder Difference

Guided by Nobel Prize-winning research, we offer our clients a menu of pre-constructed portfolios that make choosing and implementing a personal investment strategy relatively simple. We believe simplicity is a virtue. It’s also a powerful tool for controlling expenses. We are committed to adding value to – and subtracting cost from – your investment decisions.

As a fee-only advisor, we believe real value is delivered not in trying to outperform the market, but in constructing portfolios that capitalize on the market’s long-term returns. That’s what AssetBuilder portfolios are built to do – at lower cost than traditional financial services firms can deliver.2

Sources:

1. The return figures used are net AssetBuilder’s advisory fee and Schwab transaction fee of 70 basis points (.70%) per year. (Calculation based on average fee impact on $50,000 invested in AssetBuilder Model Portfolio 06 rebalanced annually for 5 years. Return figures calculated using Morningstar® EnCorr® software from Ibbotson Associates


2. According to the 2008 Moss-Adams survey titled Financial Performance Study of Advisory Firms.