Research summary

Assessing the value of advice for investors

October 28, 2022

How should financial advisors determine which recommendations will help their investor clients the most? The Value of Personalized Advice, a recently published Vanguard research paper, shows that valuing or benchmarking advice recommendations against a client’s current plan helps advisors prioritize competing recommendations to establish the highest-value strategies.

“Many investors can benefit from advice designed specifically to help them achieve their personal financial goals,” said Stephen Weber, a senior investment strategist in Vanguard Investment Strategy Group and the paper’s lead author. “And thanks to advances in technology, it is much easier to tailor comprehensive advice solutions that meet the specific personal goals of investors.”

Personalized advice explained

Often called interventions, advice recommendations include measures intended to increase wealth as well as more subjective goals, such as enhancing life satisfaction. To benchmark specific advice recommendations, the paper’s authors say, it’s crucial that an advisor understand not only the investor’s personal goals but also their specific circumstances.

Personal goals may include retiring early, making bequests, or simply maintaining a stable lifestyle over time. An investor’s circumstances include their tax situation, health status, and household financial considerations. Other factors that go into modeling specific recommendations include market and inflation scenarios as well as advice fees.

“New models allow us to quantify the value of specific recommendations against an investor’s current plan,” Weber said. “We can then compare the potential range of outcomes for the interventions in aggregate with a similar distribution of outcomes for the baseline or existing plan.”

Results are based on how much additional wealth or extra annual return investors would need to achieve under their baseline scenario to produce a range of possible future outcomes equal to the advised scenario, Weber added.

“Our research shows that it is not unusual for the combined effect of advice interventions to be valued at hundreds of basis points annually and hundreds of thousands of dollars over time,” he said.¹

To measure value, compare the advised alternative to a baseline

Graphic outlines the three-step framework for valuing advice recommendations or interventions. To measure value, compare the advised alternative to a baseline. Step 1: Establish a baseline. Step 2: Model the interventions. Step 3: Add to the baseline to match value.

Source: Vanguard.

Helping to quantify the full value of financial plans

Vanguard has developed a proprietary model for measuring the value of advice interventions that takes into account each person and situation. The Vanguard Financial Advice Model (VFAM) uses 10,000 asset class returns and inflation paths generated by the Vanguard Capital Markets Model® (VCMM). By projecting across different market scenarios, VFAM can evaluate a wide range of possible financial outcomes for a client’s current portfolio approach and its advised alternative, taking into account how the distribution of outcomes changes in different market environments.

By considering taxes, advice fees, uncertain market and inflation scenarios, and variable life expectancy, VFAM takes an integrated approach to assessing the appropriate advice interventions for a particular investor and the total value of those interventions relative to the person’s current investment and financial planning strategy.

Interventions include portfolio considerations, such as investment strategies and asset allocation, as well as financial planning strategies, such as an investor’s preferences toward specific saving and spending scenarios. Investors also get emotional value and time savings, although the model does not explicitly assess the value of those.

This approach improves upon traditional metrics in several ways:

Personalization. By developing an integrated approach based on an investor’s preferences and circumstances, VFAM not only measures the value of interventions on an individual basis but also prioritizes the specific interventions that are most valuable for each investor.

Multistrategy effects. Each potential advice intervention can provide value in isolation, but by valuing all the effects together, advisors and investors can gain a more complete understanding of a recommendation’s impact on the entire plan.

Distributional outcomes. Although many advisors use Monte Carlo simulations to illustrate the range of potential investment outcomes from an intervention, VFAM explicitly accounts for each of those possible outcomes and weighs them appropriately. It also accounts for the variability of life expectancy outcomes, whereas most advice conventions simply project to a given age.

Discovering what’s important to investors

Imagine a couple who are thinking of retiring a few years early but are concerned that they may not have saved enough. A financial advisor can help reduce that risk through timely and regular interventions.

Depending on the investors’ specific circumstances, an advisor might recommend reducing their allocation to cash and home bias in their portfolio, scaling back annual spending, reducing mutual fund expense ratios, and increasing Roth conversions of their retirement accounts.

Placing a specific value on advice recommendations is critical if advisors are to discover the most valuable interventions and communicate to clients the importance of following through.

“All advice services can deliver value,” Weber said. “However, understanding an investor’s aspirations and specific circumstances and following through on a carefully tailored financial plan will deliver the most value for clients.”

Notes:

All investing is subject to risk, including the possible loss of the money you invest.

This information is general and educational in nature and should not be considered tax and/or legal advice. We recommend you consult a tax and/or legal adviser about your individual situation.

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