Investment Performance Is a Bad Measure of Advisor Value

Sometimes, people apply mental mathematics in evaluating advisory fees.m"Let's see," they'll muse, "If I can get 5% by myself and you charge 1% a year, then you'll have to get 6% or more for me to come out ahead."

This simple logic is not only counterproductive, it's dead wrong.

First, performance isn't the only measure that counts. If performance were all that mattered, we'd all drive Porsches or Ferraris. Truthfully, we also care about safety, reliability, comfort and cost. When considering all factors, we almost universally choose something different than the highest performance available.

So, mentally charging a professional fee against just one of these variables—performance—is a distortion of what you really want and also of what you should expect from a quality advisor. (For more from this author, see: Determining a Financial Advisor's Value to You.)

Here's another way to think about it. Looking back, two separate portfolios earned 8% last year. One was invested completely in the common stock of a single local company, the other in a diverse mix of blue-chip stocks. Does it matter which one you own? From a pure performance standpoint, the answer probably is no (that year, anyway). But any solid advisor would tell you the comfort, safety and reasonable expectations from these two portfolios are dramatically different.

Advisor Value Outside of Investment Performance

If an advisor makes your situation safer, more reliable, more comfortable and/or less expensive, then he or she has provided something you didn't have before. He or she has added value, even if he or she didn't add "net" performance. Millions of very smart people understand that's worth paying for.

Sure, hiring an advisor is an added cost, but there are added benefits, too, and the value of each benefit isn't directly tied to performance. So, mentally, it's a terrible mistake to use performance as the only evaluation criterion.

There are other points, too. It's entirely possible that a good adviser will create additional performance, not by being smarter or by "figuring out" the market (a fool's game) but by suggesting newer products, lower fees or ideas beyond your personal experience. The advisor may broaden your portfolio in ways you've never even considered. There's no guarantee, but most observers believe added expertise adds performance over reasonable time horizons. (For related reading, see: What Do Financial Advisors Do?)

A Financial Advisor Knows How to Handle Risk

Another important factor is not so obvious. Risk is a key component of investing, and many individual investors don't have a clue. An advisor brings experience, knowledge and risk measurement tools to each situation. This expertise may not seem important, but it's critically important during market turmoil. Again, it's added value apart from performance.

A good advisor has worked with hundreds of clients, many with circumstances like yours. They’ve seen what works, what doesn’t, what offers the best odds for success. Those are valuable insights. Good performance is important, but it won’t mean a thing unless you accomplish your family's goals and objectives.

Millions of smart, successful people gladly pay advisors for assistance. They don't have money to burn, they simply perceive the comprehensive value that overrides the fees paid.