The Value of a Financial Advisor – Asset Allocation

by | 03Jul2018 | Asset allocation, Financial Advisor, Investing | 0 comments

Last week we discussed the value a financial advisor can add and saw that Vanguard estimates it to be about 3%. In their paper, they talk about all the ways that an advisor can add value. Let’s talk about the first one – asset allocation.


What is Asset Allocation?

Investopedia defines asset allocation as:

Asset allocation is an investment strategy that aims to balance risk and reward by apportioning a portfolio’s assets according to an individual’s goals, risk tolerance and investment horizon. The three main asset classes – equities, fixed-income, and cash and equivalents – have different levels of risk and return, so each will behave differently over time.

Read more: Asset Allocation

Vanguard defines it as:

the percentage of a portfolio invested in various asset classes such as stocks, bonds, and cash investments, according to the investor’s financial situation, risk tolerance, and time horizon

Essentially, it is taking all of the investable assets that are serving the same purpose (retirement, college savings, emergency fund, etc.) and deciding what percentage of each asset class you want to own. For example, my asset allocation right now for my retirement money is 80% stocks and 20% bonds. The asset allocation for the money I’ve save for my kids’ education is different because it serves a different purpose.


How Does an Advisor Add Value With Asset Allocation?

Many do-it-yourself investors don’t create a written investment plan and just wing it. A proper financial advisor will create a comprehensive plan that serves as the basis for the rest of the client’s financial house. In the plan will be an asset allocation that is appropriate for the investor’s timeline, risk tolerance, and goals. They’ll help their clients stick to this plan despite all of the mostly irrelevant financial news they’ll hear on CNBC. This is where much of the value is added.

One other relatively recent development when it comes to asset allocation is that people’s portfolios have become more complex than they used to be. While I hold a fairly traditional portfolio composed of only stocks, bonds, cash equivalents, and my primary residence as my only real estate holding, nowadays people are tempted with all sorts of alternative asset classes – real estate in various forms (REITs, crowdfunded real estate, etc.), peer-to-peer lending, commodities, and innumerable other things.

In their paper, Vanguard compared a simple 60% stock and 40% bond portfolio against the performance of institutional endowments that hold more diversified and complex investments. In other words, they have more complex asset allocations. Here’s the result of their comparison:

a portfolio constructed using traditional asset classes—domestic and nondomestic stocks and bonds—held up quite well, outperforming the vast majority (90%) of these endowment portfolios

Despite its relative simplicity, a 60/40 portfolio usually beats large institutional investors and exposes the investor to about 9,000 stocks and 12,000 bonds. A comprehensive asset allocation made up of low cost, diversified mutual funds or exchange-traded funds (ETFs) can meet most investors’ needs.


How Much Value Does an Advisor Add with Asset Allocation?

Experts believe that asset allocation is the largest determinant of how volatile an investor’s portfolio is. That said, while value is definitely added with the proper allocation, everyone’s individual situation is so different that the value added is hard to quantify. If an advisor sets up an asset allocation for you and, most importantly, gets you to stick to it through the ups and downs of the market cycle, the value they are adding to your investment portfolio might not be quantifiable but is critically important to your overall financial success.


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