What to Know When Hiring or Firing a Financial Advisor

Hello, everybody. My name is Ty Bernicke, and today I’m going to be talking to you about what to know when hiring or firing a financial advisor.

How Financial Advisors Add Value

When you think about what a financial advisor does, there are really two common ways that they can add value to your financial situation. One is to help you manage your investments more intelligently, hopefully.

The second way is to make sure that you minimize unnecessary taxes. There are many other ways that advisors can help you manage your money more effectively, but I would say these are two of the more common ones that people will go to a financial advisor for.

Quantifying Advisor Value: The Vanguard Study

When you think about how much value a financial advisor could add, there’s a lot of discussion and debate on this. But there is one study that Vanguard did on this topic, and they wrote an article on it called “Quantifying Vanguard Advisor’s Alpha,” and it was written in June of 2020. Basically, what they found and what their research showed is that a financial advisor can add about 2.1% in value on the amount of assets that they’re helping you manage.

So if somebody had $1 million invested, if they can add an extra 2.1% per year, that’s some real money that we’re talking about. That’s what they quantified as far as helping with investment strategy, which would include things like how to allocate your assets, how to minimize unnecessary expenses outside of what the financial advisor is charging, how you rebalance the portfolio, and how you make sure you stay with the investment plan when times are really good and really not good.

So that’s what they came up with—this 2.1%. As far as the tax strategy, including tax-loss harvesting, asset location, and withdrawal order for client spending in retirement, what they found is that a financial advisor can add up to 1.85% in value in their study.

That’s on an annual basis based on the amount of investments somebody has invested.

So 1.85% on a $1 million portfolio would be $18,500 of extra value per year. If that’s compounded, that can add up to real money over time.

Why Most Investors Don’t Get Full Value

Now, the most important thing that I’d like to convey to you about this is, in my opinion, many investors are not getting anywhere close to this much in value, especially on the tax planning side of things.

I’m going to do my best to explain why in a very short amount of time.

The “Gap” in Financial Planning

If you look at all of our certified financial planners that work in our office and look at all the different tax minimization strategies that we employ, I would say close to 95% of the strategies that we employ—or more than that—require a lot of information that we have to gather to be able to execute, implement, and even discover the tax minimization strategies.

We call the information that we gather “the gap,” because we find that when many people come into our office, nobody’s gathering this information, and therefore they can’t recommend the tax minimization strategies in the first place. This would include things like: What are your current income sources? What would you expect your future income to be if you retire?

What are you going to need in the future for retirement? When’s your retirement date? What is your net worth? What types of assets do you have that make up that net worth? Do you still have a mortgage? How much are you contributing to charity? What are your health insurance needs going to be if you retire before the age of 65, when Medicare kicks in?

Because your modified adjusted gross income can greatly affect your cost of retirement health insurance if you’re going to be going on the exchange or a state-funded type of exchange, also known as Affordable Care Act or ACA insurance, if you’re going to be needing that insurance before retirement, which many people who do not have retiree health insurance will need.

Managing your total income can play a great role in how much you pay for that. How much are you contributing to your investments? How much are you eligible for in all the various retirement plans that you have available? Do you have any large anticipated expenses this year or coming up in future years? All of this information—these are just some of the high points.

But all of this information we need to know to implement, again, I would say over 95% of the tax minimization strategies that we use.

Why the Gap Exists

Why are so many people, when they come to see us for the first time, not executing or implementing the tax minimization strategies that are clearly available for them? Well, think about it. Many people have a CPA or a tax professional they work with.

How many times has your CPA gathered all this data that I have included in the gap? Usually, they don’t. They get compensated by completing your tax return, by knowing what your previous year’s income was, and then pushing it into a tax program that tells you what you owe this year. They’re not taking the time to ask you all of these different questions, and therefore they don’t have time to figure out the tax minimization strategies where one would need this type of information to actually make the recommendation in the first place.

Similarly, if you look at many financial advisors, they get compensated based on managing the investments. The more assets they have under management, the more they get paid. They don’t get paid to do all these different things. But in my opinion, there is no way that you can effectively manage investments if you’re not making sure that people are getting all the tax minimization advice that they can, and you need to constantly—every year—your financial advisor should be doing all of this for you.

How to Know If You’re Getting Full Value

How do you know if you’re getting this value? Well, at a minimum, your financial advisor should be reviewing and updating these things annually: your net worth, your current income streams, what you expect for future income streams. They should be looking at your tax returns or asking for your tax returns every year to be able to do an analysis if they need to.

Do you have large anticipated expenses coming down the pipeline? What are you doing for health insurance in retirement? What does your estate plan look like? There are many tax planning benefits that can be gained by knowing what your estate intentions are for the future. How much are you giving to charity on an annual basis? Again, if you’re not having these conversations at least once a year with your financial advisor, there’s no way that they can make the recommendations for minimizing taxes based on that information that is needed to collect to avoid the gap that I just mentioned.