Danforth is founder and CEO of Family Investment Center, a full-service, commission-free investment advisory firm that serves clients in the Kansas City area and across 13 states.
Q. How much value do advisers add for the typical client?
A. Assuming the value that clients obtain from an adviser is distributed in a bell-shaped curve, the average client obtains considerable value from the average adviser—and even from a mediocre one. Harry Truman once complained that what he needed most was a one-armed economist because nearly all of them concluded their observations with “on the other hand …” before launching into an opposite argument.
Q. What does that imply for investors?
A. Name any idea or subject and there will be a range of opinions. Examples are endless; from the proper color for automobiles (black, white, and silver are most common) to complex economic theory. For most things, there is a pattern to this diversity. Most observations clump around the middle, with outliers at the extremes. In science and academia, this is called Gaussian or normal distribution and it is illustrated with a bell-shaped curve. Normal distribution and the bell curve have been tested and apply to almost everything, from human height to test scores to highway traffic speeds. I’ll skip the heavy math here, except for one fraction: Roughly two-thirds of usual observations clump in the middle, with the other third split between opposite extremes.
Q. How does that work?
A. Most sources report that the average height for an adult American male is 5’10”, with a standard deviation of around 2.9”. In terms of normal distribution, this means that two-thirds of American men are between 5’7” and 6’1” tall. The other one-third are either shorter than 5’7” or taller than 6’1”.
Q. And for personal finance, what’s the impact?
A. What factors are important to financial success? Let us pretend some combination of financial knowledge, good behavior, and good fortune (luck) are mostly responsible. Quantify each of those (or any other factors you might add), and we could create a scale and measure them. We might conclude that most people fall in the middle, while a few are extra good and a few extra bad. If a normal distribution occurs, just one-sixth are awful and the other five-sixths are better than that. Most people, of course, fall into the middle. A similar normal distribution applies to advisors. Most are decent, a few are great, and another few are terrible.
Q. What about the determining factors?
A. You decide the factors and scale: a combination of knowledge, people skills, empathy, and a client-friendly employer. You may throw in specific experience or personality traits or even height, I don’t care. The point is, no matter how you measure it, professional advisers will populate a bell curve. All this raises a very powerful question How much value is the typical adviser for the typical person? I’m thinking about the middle two-thirds of both groups. It seems to me that most people could use financial help, and that most advisers could be helpful. There are brokerage, insurance, banks, mutual funds, accountants, and independent advisory firms. All employ charming people who would love to help.
Q. Is that diversity of guidance sources an issue for investors?
A. Confusingly, there is not a lot of uniformity in products or services offered. Even worse, fee schemes range from reasonable to outrageous (probably on that same curve). Across advisers and brokers, the fee system is almost random; dictated by who they ask and the provider channel. There is a retail/wholesale structure that operates in layers of commissions, transaction fees, and product expenses. Often, smaller purchases impose higher costs, while larger buyers can enjoy substantial discounts. Cost is important to the answer.
Q. Does the value of professional help exceed the cost for most people? Sometimes products impose rigid and costly fees; if annual expenses on a mutual fund or unit trust are high, that works against value an adviser might bring. If products impose high sales commissions, too, it is going to be hard to overcome that hurdle. A recent industry study by the Russell Investments organization entitled 2021 Value of an Advisor Study affirmed the ongoing value of a quality adviser. This study (part of an annual series) pegged the value of an advisor at 4.83 percent each year.
Q. Given most fee structures, that sounds like a win for investors.
A. The methodology determined five areas where advisors add specific value: Selecting investments (0.62 percent), financial planning (0.82 percent), tax planning (1.2 percent), portfolio rebalancing (0.17 percent), helping clients avoid behavioral mistakes (2.02 percent). Although I have seen other studies, I have never seen the value added applied to a bell curve. Still, most annual fee schemes do not approach the nearly 5 percent threshold revealed above. Some of the worst advisors may approach 3-4 percent annually, but the rest are way less than that. From all this, the normal fee from the normal adviser is likely a pretty good value for the typical client.
Q. What’s your general advice to clients about finding an adviser?
A. Clients are decently served if they avoid the worst fees from the worst advisers. That’s my argument against the idea that “most” advisers are bad. Or, said another way, even decent advisers add annual value beyond the costs. Whether that amount is 1, 2, or 3 percent each year, the cumulative value over time is considerable. The do-it-yourself crowd likes to crow that going it alone saves fees each year. I would twist that around and contend that going it alone likely costs the typical person 2-3 percent annually. But bad apples taint the profession. That is true in any profession. Clients cannot be dissuaded by the bottom one-sixth that imposes overwhelming barriers. Unfortunately, clients, not advisers, bear those costs of failure. Having a great adviser is good—but having a bad one is devastating.
Adapted from commentary by Dan Danford of the Family Investment Center in St. Joseph, distributed by Adviser Perspectives of Lexington, Mass.