Costs are an issue only in the absence of value

June 14, 2018

Don Bennyhoff

Don Bennyhoff
Senior Investment Strategist

Have you read the article where someone mentioned the importance of keeping investment costs low? Of course you have, and so have many other people. Research has shown that low costs are the most reliable predictor of higher returns. And it's not just an indexing story. It’s just as true for actively managed funds. Judging by cash flows into the lowest-cost U.S. equity funds, that message has been received loud and clear (see chart below). Does that mean the cost of advice is next?

High-cost funds are under pressure

All U.S. equity funds and ETFs

High-cost funds are under pressure

Source: Vanguard calculations, using data from Morningstar, Inc.

Notes: Expense ratio quartiles were calculated annually. Shown for each quartile are the 2017 asset-weighted average expense ratios, determined by multiplying the annual expense ratios by the year-end assets under management and dividing by the aggregate assets in each quartile.

Before answering that question, I'd like to ask another: What's the value of advice? This is arguably not only a different question but also the more important question, requiring a more effective answer than many advisors are prepared to offer.

Value is very subjective and often personal, and it relies on an assessment of both costs and benefits. It's why we don’t all drive the same car or pay a CPA to do our taxes. It's also why some people prefer to work with an advisor rather than try to handle their financial matters alone. Some people see the benefit, while others see mainly the cost. The tricky part is helping people see both links in the value chain, not only the cost but the benefit as well.

When a client works with you, the costs are generally transparent while the benefits are typically more opaque. That's a tough combination, but it’s made easier if you understand our Vanguard Advisor’s Alpha® framework.

Crucial choices

There are choices you make—or don't make—that can add value and help clients improve their investment outcomes, such as wise use of asset location, tax-efficient portfolio construction, and rebalancing (see chart below). These smart choices, however, are opaque to your clients unless you make them clear.

For example, if you have carefully built an investment portfolio with lower costs in mind, take the time to explain to clients how cost- or tax-efficient the portfolio or strategy can be. Investment management fees and taxes are an asset transfer—whether to a portfolio manager or a tax collector—and your clients' wealth is usually better off when those transfers are kept to a minimum.

The value of doing nothing

Similarly, if you embrace a strategic rather than tactical philosophy, explain how that choice can benefit your clients. Too often, strategic is confused with being passive, when I'd argue it's anything but. It’s actually an active choice to maximize the probability of cost and tax efficiencies while minimizing active risk. Sometimes the hardest but most beneficial thing you can do for clients is to help them do nothing. That specific choice would fall under the behavioral-coaching facet of advice, and, as our research suggests, being strategic by doing nothing can be a very significant value-add for an advisory relationship.

A menu of value-added services

A menu of value-added services

Source: Francis M. Kinniry Jr., Colleen M. Jaconetti, Michael A. DiJoseph, Yan Zilbering, and Donald G. Bennyhoff, 2016. Putting a value on your value: Quantifying Vanguard Advisor’s Alpha. Valley Forge, Pa.: The Vanguard Group.

One last thing to consider: While you may already explain to clients what you do for them and why, do they know all you can do for them if the circumstances arise in the future? It's highly unlikely that clients can benefit immediately from all you can do for them, particularly younger clients who may not yet need the wealth management services you might provide.

Giving all clients and prospects a menu of your value-added services can give them a better sense of the help you can provide, not only now but also later. Such comprehensive communication can aid in client retention and give clients a much better sense of your full value proposition over the life of their relationship with you.

While these are just a few examples to help you complete the cost-benefit value chain for clients, the most important idea may be this: If you want your clients to completely appreciate the value of the advice you provide, make sure the benefits of your advice are as clear to clients as the costs are.


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Don Bennyhoff

Donald G. Bennyhoff is a senior investment strategist for Vanguard Investment Strategy Group.

He is a member of the group responsible for capital markets research and the asset allocations used in Vanguard's fund-of-fund solutions, such as the Target Retirement Funds. The group is also responsible for maintaining and enhancing the investment methodology used for advice-based relationships with high-net-worth and institutional clients.

In addition, Mr. Bennyhoff has authored a number of research papers on topics of concern for institutional and ultra-high-net-worth audiences. He earned a bachelor's degree from Furman University, has been in the financial services industry since 1991, and is a CFA charterholder.

CFA® is a registered trademark owned by CFA Institute.


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