False Courage

Whenever the market takes a tumble, I get a vision of a video I want to send out to clients that I have neither the acting chops nor the production budget to make a reality. I envision a bored-looking man sitting in what looks like a World War 1 trench. There’s dirt being kicked up, distant booming and whatnot. People are running around and panicking, except for the guy sitting there. Someone finally stops: “What are you doing, how are you so calm?!” They ask over the sounds of war and chaos all around them. “You must be new here, this happens all the time.” The calm man replies.

Production value aside, that always is what it feels like to be a financial planner and investment manager during scary market events. You’re a tired veteran sitting through his umpteenth shelling, and while your comrades scurry about concerned about the goings on, you know that you have no power to stop the shelling, and merely must wait for this latest barrage to cease. Yet, it turns out this “c’est la guerre” attitude is actually one of the best things you can have during market tumults; and that’s not just an attitude, that’s a measurable fact.

However, a recent study on financial planner efficacy recently tried to quantify the value of a financial planner in a manner that I think was a bit less than honest. It took a novel approach compared to many other studies, and while many studies have measured the efficacy of financial planners in helping their clients, another “latest and greatest” in the genre has been released, this time by Smart Asset. You can see a list of other entries in the genre here (1 2 3 4 5), but today, I’m reviewing the latest study of financial planner efficacy and pointing out that unfortunately, it has some problems.

Bottom Line Up Front

Research papers can be long and a bit of a drag to read, so let’s just give you the highlights first and then we’ll get into the nitty gritty:

• Despite assumptions of inflation being 2.56% and advisory fees being 0.75%-1% of the client’s investable assets, the paper estimates annual returns by financial planners as being 4.56% to 7.57% net of those fees, and calculates a 2.39%-2.78% premium above performance of retail investors.
• The compounding lifetime value of this premium, depending on the age the client originally engages the financial planner is anticipated to be 36%-212% in additional wealth over a lifetime.
• Advisor fees cost an estimated 23%-35.4% of the value surplus created, e.g., 23%-35.4% of the 36%-212% stated in the prior datapoint.
• Having summarized all that, I think they’re being overly generous in some of their assumptions, but we’ll talk about why later.

Take all of that at face value and our stoic veteran makes a bit more sense. While retail investors often scurry from crisis to boom to bust to crisis, professional investors tend to engage in long-term thinking to the tune of several decades at a time. While this doesn’t mean a retail investor doesn’t think about something like their retirement accounts the same way, the key difference is that a financial planner managing a client’s money is not so emotionally attached to the outcome of any individual account or investment, and thus does not so easily yield to the temptation to scamper for cover when the latest economic or market attack starts.

However, I regret to say it: The figures listed above are bullshit.

But, this was the summary view, so for those with a busy day, have a great one, and for those wanting to learn more about how SmartAsset came up with the absolutely fabricated figures above, read on.

The Squish Factor

Many studes on the value of financial planning give a lot of credit to a very squishy behavioral element, which is often summed up as “behavioral coaching” or “talking clients off the ledge.” I hate to say, and really, it’s embarrassing to say it: This probably is the biggest value proposition. Despite having a masters and concentrations in finance, despite being 2 weeks away from defending a dissertation in personal financial planning, despite having spent tens of thousands of hours at this point studying and practicing financial planning, taxes, estate laws, investments and markets, and so on. The most valuable thing I do as a financial planner is: Keep you from fucking it up for no reason.

Now, bear in mind, when I say that, I’m saying that knowing that many of you reading this are clients. You might frown and say “Well yes, but the financial plan model you’ve shown us also suggested we’d have $X dollars more if we did all the technical things you told us to.” And that’s all very true, all the technical stuff we’ve advised you to do is valuable to you. But. BUT. None of that technical stuff matters if you decide to cash out your portfolio and invest it in gold. None of it matters if you take a hail mary pass on leveraging up your portfolio to go all-in on Cryptocurrency. None of it matters if you don’t consistently execute and implement the plan, and stick to it over time. None of it.

So, that said, how did smart asset give attribution to this squishy dimension of “don’t fuck up”? Well, for the first time, they didn’t. Despite spending a great deal of time discussing the value of that particular function, they skipped right past that as a quantifiable value-add and skipped to actually doing better in the literal technical stuff. Huh, neat. But also, delightful in that we’re not using behavior finance squish to inflate the numbers, as is common in such studies. However, where they go on to make up the remaining difference is far worse than I’d expected.

Advisers Provide Investment Alpha?

So, being the first model on financial planner value that I’ve ever seen that skips the squish factor and goes for quantitative methods, let’s examine how they got to their calculation of 2.39%-2.78% a year.

Well, the first datapoint is… not great. To create a proxy for investment advice alpha (something that I have never once claimed to create for a client), they took a random sample of 45 analysts (not financial planners!) estimates for the value of the 15 largest US Companies, finding that the average performance of those analysts was 2.47% above the return of the S&P 500.

For non-finance nerds, let me just sum this up. Imagine you picked a random sample of 45 athletes playing their respective sports and found by random happenstance to have, on average, picked a collection of athletes that outperformed their respective leagues by an average of 2.47%. Would that then be definitive evidence that all athletes performed 2.47% better than average? Of course not. So why would we take a tiny sample, focused around analysts (again, not financial planners), and ascertain that we think their average outperformance is somehow relevant to the performance of all planners? Worse, how do we validate whether this sample was or wasn’t cherry-picked? If I drew another sample of 45 analysts and found that their performance on average was -3%, would we then assume that all financial planners produce -3%? Of course not.

So, the baseline investment alpha figure is… well, garbage. So let’s reset to 0% on the investment front.

Financial Planners are Saving Taxes?

Well, the study then goes on to talk about tax alpha. Now this is an area I can more readily agree with than investment alpha. While I think any financial planner who thinks they’re the next Warren Buffet is absolutely fooling themselves, I do think any competent financial planner can improve the tax position of their clients, most often through applying basic saving and investing fundamentals, and sometimes through more complex mechanisms.

Yet, the study lets us down here as well. The study takes a study that finds that “taxpayers who employed professional help for their taxes received $840 more than their counterparts.” Well hold on, there are some big problems with that:

• Receiving a tax refund means either overpaying on your taxes throughout the year or receiving tax credits in excess of any tax liability, or both. Getting a bigger refund is not intrinsically good.
• The study being cited is talking about professional tax preparer help, not financial planning or tax planning advice. So we’re giving financial planners credit for what the EAs and CPAs are doing?

Beyond that, they then take the $840 and apply that to the median net worth of $80,039, and use that to assume that financial planners can create 1.0495% in annual tax savings. But that’s not how this works! You can’t take an average from a survey from 2017 and then apply it to the median net worth of households from 2013?! WHO THE HELL THINKS THAT’S A VALID COMPARISON?! So not only is the tax savings being attributed to the wrong professional, but it’s also using data from a survey of people and then a population that does not necessarily include those people and the datapoints are four years apart? WHAT?!

Negative Factors

The study buffs itself up by having negative factors that cut against the potential value of a financial planner. This is good, because not every factor influencing finances is positive! The study highlights 3 things that could reduce the hypothetical client in the model being presented’s situation:

• The study uses average inflation rom 2000-2023 of 2.56%. This is valuable because all real return models should factor in inflation.
• A rate of withdrawal of 4%. This is just pulling out the Bill Bengen 4% “rule”, which is actually just a research finding, and using it as an assumed distribution rate. This is a head scratcher because the 4% rule has been changed constantly over the years by it’s namesake inventor, but also because only a portion of the population is taking withdrawals.
• The study then… *sigh* makes a classic blunder and represents AUM fees as a percentage charge against the net worth of the client, but then also describes the fee as being deducted from a portfolio. Let’s make this clear: AUM fees apply to a portfolio, which is an asset, which is on the positive side of a household’s balance sheet, which is then subtracted from by the liabilities on the other side of the balance sheet to calculate net worth. So if someone has a $1 million dollar portfolio and they were paying 1%, they’d pay $10,000. If the same person also owed someone else $990,000 dollars, then they’d still pay $10,000 for the AUM fee on the portfolio, but the fee would be equal to 100% of their net worth because their net worth would only be $10,000.

So, we have one valid factor which is inflation, we have one sometimes-relevant-sometimes-not factor which is a distribution rate, and then we have a mis-defined factor of AUM. Lovely.

The study then shows off some very unnecessarily complex math, which can be summed up as such:

• People with an Advisor Get Returns + Fictional Alpha + Fictional Tax Savings – Fees.
• People without an advisor get Returns.

You can guess, given that the study already gave 3%+ in value and is capping the potential cost at no more than 1%, that a formula of X+2% versus X is going to come out in favor of X+2%. Quel surprise. This is the inverted version of a dumb argument people often make against financial advisors: “Returns > Returns – Fees”, which of course should actually be Returns – Fees + Value. Yet, while this study includes fees and value, it’s already using absurdly un-based value calculations to stack the deck.

Wrapping it Up

The study closes out with the formulas played through to demonstrate rates of return pre and post-retirement, with and without an advisor, and shows hypothetical wealth accumulation between someone with and without an advisor, which, to no one’s surprise, suggests that having an advisor is awesome. Great, whee, whoopie, we love that. But, sorry to say, it’s bullshit.

When I envision the man in the trench, I don’t envision him there based on false plaudits and bafflingly stupid and unfounded assumptions. I envision him there as a student of his craft, battle tested and comfortable in an environment of adversity because of his experience and knowledge. As a financial planner, I’m comfortable watching the portfolios I manage lose literally over a million dollars a day because it’s the umpteenth time that I’ve seen it happen. I’ve also gotten the giddy delight of seeing the portfolios gain over a million dollars a day, but once again, it’s the umpteenth time I’ve seen it happen.

When someone goes out to argue for the value of a financial planner, I think there are a lot of things one could say. We’re a comforting hand on the tiller when conditions get tough. We have the technical expertise to ensure you’re doing your financial planning correctly the first time and avoiding errors and issues along your path. We’re here to give you time back with your family, or for more meaningful pursuits, or we’re even just sparing you from thinking about something you don’t really enjoy thinking about. Whatever value our expertise and emotional guidance can bring is what it is, varies by planner and client, and the value isn’t the same for everyone at the same time or over time.

But a study that goes out of its way to fabricate absurd assumptions, gives planners credit for things they don’t even do, and then simply asks “is 3 greater than -1” and uses that to argue that financial planners are incredibly valuable is not helping in that message. It’s the kind of lame fodder that gets torn apart just as I have here, but worse, by outside actors who stand to profit by selling people courses or coaching that they can do it all themselves. Plenty of people will be fine doing it by themselves, but to publish a “study” such as this is an embarssment, and it makes me disgusted to see a CFP® Professional’s name as the author.

Whether you’re a client of a financial planner, or of me, or off on your own today, let me sum up the most valuable message I can for you. You’ll be fine, whether the market is bad today or tomorrow, next week, or next month. In the long term, stick to your plan, whether it’s just yours or your financial planner’s. And if you don’t have one, then ask for help. But don’t assume because some website posted a lame study that anyone can magically crap out 2%+ positive value just because. With false courage lies the road to disappointment.