The world of financial advice is incredibly diverse. From mutual funds to holistic financial planning, the options for consumers are many and varied. Yet, across all of this diversity, one thing remains the same: financial advisors do not provide enough information about their performance.
Existing reporting is simple. Too simple. What were your investment returns, and how did they compare to your benchmark index? If you have a self-directed brokerage, this reporting might be sufficient. If you’re using a full-service financial advisor, it’s woefully inadequate.
That’s because this returns vs. benchmark calculation is a mere fraction of the value that a financial advisor should provide. It doesn’t touch the impact of tax planning, relative fee savings, or advice on government benefits, all of which can be equally or more significant than investment returns when determining your wealth over time. These are the three things your advisor should be telling you, but isn’t:
How have your actions affected my taxes?
It’s no secret that taxes have a significant effect on total wealth. Our entire retirement savings system in the U.S. is built around tax-advantaged accounts, after all. Yet, if asked to quantify this effect, or the tax consequence of an investing decision, most advisors and consumers will struggle.
Calculating taxes is complex. Doing the calculations by hand, even with a spreadsheet, is extremely time-consuming. Fortunately, a huge number of software applications can do these calculations for you, with only a few simple inputs. This technology is so ubiquitous that advisors should be able to tell you exactly how much their advice saved (or cost) you in taxes relative to a typical strategy.
Anything less affords far too little attention to the effect of taxes on wealth building.
How do your fees compare to others in the industry?
Much attention has been given to the subject of investment fees in recent years, and with good reason. They’re easy to quantify, and a large fee cut can mean a significant chunk of change retained by the consumer over time. In a recent paper, United Income calculated that a typical retiree in an average market would generate about $40,000 in extra wealth over the course of their retirement if their investment fees were lowered by 100 basis points.
While the SEC requires reporting returns net of fees, the actual fees themselves are usually hidden behind layers of math, forcing consumers to work out exactly how much they’ve been charged by isolating returns from fees in the reports they receive. At best, advisors will have a single line of text on fees buried deep in their statements.
This shouldn’t be the case. Advisors should not only be transparent about their fees, they should also say how they compare to the industry average, and how this difference in fees might impact your wealth over time. Only then can consumers have a good idea of whether the fees they’re being charged equal or exceed the benefit provided.
Have you increased my government benefits?
Although far from the most generous in the world, government benefits in the U.S. play a significant role in people’s financial lives. This is particularly true of seniors, who have to decide when to claim Social Security, a choice with huge financial consequences. For example, a person who earned an average of $60,000 per year and lives to age 85 would see an extra $53,000 in lifetime Social Security income by claiming at 70 instead of 62.
Like taxes, doing this optimization by hand is complex. The actual decision depends on spending needs, life expectancy, spousal benefit, and several other factors. Luckily, like taxes, technology exists that can help. Several financial planning tools (some more accurate than others) allow a person to compare the outcomes of different Social Security strategies over a lifetime. Consumers should demand that their advisors take advantage of this technology, and report back the results.
The solution: total wealth return
Despite the large impact on total wealth of the three factors above, I would wager that most readers won’t find a trace of these metrics in their performance reports. The technology exists to quantify and optimize all of the above, but industry standards and regulations are slow to adapt, leaving most consumers with an incomplete picture of their advisor’s effect on their wealth. For now, consumers should ask their advisors how they can quantify the taxes saved, fees saved, and benefits increased. If they won’t make an effort to do so, it may be time to find a new advisor.