A good financial advisor can increase clients’ after-tax investment returns by about 3%, and a big component of that is helping them avoid costly mistakes during scary markets like this year’s, says Fran Kinniry, head of the Vanguard Investment Advisory Research Center. “Whether it was during the Covid crash, or 2008, or the internet tech bubble, or now, without a coach, we’ve seen investors really lagging the returns,” says Kinniry.
Speaking with Barron’s Advisor, Kinniry explains how advisors’ value proposition has transitioned away from market timing to financial planning to an increasing focus on human psychology. He also defends target-date funds, a big business for Vanguard, which have recently come under criticism. And he argues that the question of whether the market has bottomed is irrelevant for long-term investors.
How did you get your start in the financial industry? After business school at Drexel University, I worked at an RIA firm, a multifamily office dealing with ultrahigh-net-worth families. Delivering advice as a registered investment advisor was a great foundation for me to understand the value proposition of advice. I was very lucky that Vanguard recruited me in the late ‘90s to start our advice offering (the predecessor to Vanguard Personal Advisor Services). Up until that point, Vanguard was self-directed best-in-class mutual funds, and we were realizing the value proposition of advice: Clients did need and want help.
What’s your current role at Vanguard? We have a business known as Financial Advisor Services. The unit calls on registered investment advisors, broker-dealers, bank trust departments. We have somewhere around $3 trillion of intermediated assets, meaning that the investment professionals serve their end clients and use Vanguard ETFs and mutual funds. I’m in charge of the thought leadership that comes out of that group through its Investment Advisory Research Center, which I run.
Tell me about creating Vanguard’s Advisor’s Alpha content. I developed it in 2001. At the time, most of advisors’ value proposition was on investments, with much less emphasis on wealth planning and behavioral coaching. It was mostly a transaction business. We’ve been on the journey with advisors of moving the value proposition to fee-based and away from just investments toward wealth planning, tax planning, financial planning, behavioral coaching. It’s been amazing just to see the industry evolve.
For those who are not familiar with the Advisor’s Alpha research, can you sum up what you found in terms of how advisors provide value? A lot of what I’m about to say almost seems elementary today. But we were kind of on the front edge of this journey back in 2001.
The common value proposition then was, “Hire me, the investment advisor, and I’ll outperform a 60/40 or 70/30 benchmark.” It was a myopic, singular value proposition, and we know just how hard it is to actually do that, especially when you add a 1% fee. So I tried to broaden that lens, because advisors were doing a lot more than just investing. They were doing wealth management, financial planning, and behavioral coaching—but none of that ended up on the annual statement.
So we encouraged the advisor to take credit for many of these things, like what they saved the client in taxes, what they saved the client through estate planning. Did the client want to bail out of the market in 2008 or in 2022? What were their real returns if they were either self-directed or working with an advisor who was not as disciplined? And collectively, we showed that the advisor, outside of investments, added about 3% relative to the dollar-weighted assets in the marketplace.
This year’s market turmoil has certainly provided advisors with an opportunity to exercise the value proposition that you quantified. Absolutely. Of the 3% in added value, the behavioral coaching component is the largest component, at about 1.5%. And that’s about helping clients stay the course.
I have so much research that shows how much money goes into money markets in episodes like this. Whether it was during the Covid crash, or 2008, or the internet tech bubble, or now, without a coach, we’ve seen investors really lagging the returns. Investing is emotional. It’s hard for an investor to stay the course if they’ve just lost $100,000 and you’re asking them to reinvest into the stock market after it’s down 20% or 30%.
How has this research evolved over the years? Every three years we update and enhance the research. We just came out with the 2022 version this July. We also have a paper that came out in August that’s another iteration of this. It’s called “The evolution of Vanguard Advisor’s Alpha: People with portfolios.” We intentionally put “People” first because a lot of times within the advisor community, some forget that this is not just numbers, that are people behind this. And these people have dreams, aspirations, goals, and objectives. Given technology, we think the next iteration of (financial advice) may be less about quantitative portfolio management and more about people and psychology: What families want, why they’re saving the money, what keeps them up at night. The people part of it, we think, is going to become front and center.
Can you provide some examples of how you’ve expanded your research since 2001? Vanguard introduced the concept of Advisor’s Alpha more than 20 years ago. Then, in 2011, we published a paper encouraging advisors to broaden their value proposition beyond a primary focus on seeking to outperform the market. In 2014 we were able to quantify the value of working with an advisor who offers behavioral coaching, financial planning, and wealth management. Our 2022 updates have expanded on the initial quantification by introducing seven related but distinct modules: asset allocation, cost-effective implementation, rebalancing, behavioral coaching, asset location, spending strategy, and total-return versus income investing.
I imagine some consumers would view your value-of-advice research with skepticism, perhaps seeing it as self-serving. I agree that there could be a sense of cynicism. I would offer two things: We’ve been doing this research publicly since 2001, so it’s stood for 21 years. It is audited by Vanguard compliance and Finra. We would not be able to put out a number like 3% unless the regulators felt really good about it. The research is pretty rock solid.
What kind of impact do you think your research has had on the advisor industry? The body of research has over eight million downloads. It’s gotten testimonials from some of the kingpins in the RIA space; Barry Ritholtz and others have said very nice things about it. I think it’s led the advisory community to what I would call a better way to advise portfolios. It’s not about market timing, which hasn’t really worked well. The investment space is a zero-sum game. Everything we’re talking about in the research—asset location, rebalancing, financial planning, estate planning, behavioral coaching—they’re all positive-sum games. So we think it’s really made the advice business better.
Let’s pivot to investing, which is also in your wheelhouse. There seems to be disagreement right now about whether the market has seen its bottom or will resume its slide. Your thoughts? We would say that trying to predict the market in the short term or even intermediate term has been very challenging. We’re having this conversation in October of 2022. A lot of people were calling the bottom back in June and July. So I think you have to be cautious about saying the bottom is or isn’t in.
How should advisors allocate the portfolio of, let’s say, someone who’s 15 or 20 years away from retirement and has the typical needs and goals of so many clients? The most important things in portfolio construction are the client’s goals, objectives, risk preferences, and time horizon. The investor you mentioned has a contribution horizon of, let’s say, 20 years. That means they’re adding to their portfolio until they retire. But they may have, let’s say, a 40-year total horizon with life expectancy. So we’d have that kind of investor very aggressively postured; they would probably be somewhere between 60% and 80% high-risk assets, which would be equities.
Our research shows that the longer you hold risk assets, the higher the probability of having a real inflation-adjusted return. You start to see the probabilities in the 90th percentile over 10 years, and they get all the way to about 100% over 20 years. The market is a noise machine; it distracts clients from their long-term goals and objectives. The best advisors we see try to tune out the noise and get back to what they are trying to accomplish for clients.
What about an older investor who is on the cusp of retirement, or maybe retired a bit early only to find their nest egg at the mercy of a bear market? This current bear market has hurt more conservative investors, meaning investors who had lower risk appetite and shorter duration. The most important thing, I would say, is not to turn unrealized losses into losses just because it’s a sunk cost. Let’s say this investor was 30% equity and 70% bonds. Just back of the envelope, they’re now off about 14%. But think about if they just stay the course.
Bonds are now yielding 4%. And stocks look a little more attractive from forward price-to-earnings and other metrics. Even if they get 5% a year, which is not asking a lot if the bonds are at 4%, this investor is going to be back to where they were on a nominal basis in about two and a half years. And if they have a five-year horizon, in five years they should almost be up 15% from before this bear market ever happened. So I would highly recommend they stay the course.
Target-date funds have recently come in for some criticism based on their long-term returns and the protection they offer against market declines. Are you still a believer in target-date funds? We always will see the Monday-morning-quarterback criticisms. We saw them in 2008 and are seeing them again here. I would say that target retirement funds have probably been the single greatest innovation for investors who are saving for retirement. If you think about what was there before target-date funds, you were leaving 401(k) clients to make decisions on their own. A lot of times what we saw was disengagement; clients would be 100% in money markets or in their company’s stock. You saw a lot of chasing performance, buying three-year or five-year winners.
I’ll go back to what we talked about earlier, of the client’s understanding how long they’re going to be in contribution mode and how long they’re going to live. Behind all that is inflation. So keeping risk very low doesn’t do much good. These allocations have to keep up with purchasing power. It’s easy to say that you should make these funds more conservative. But I think that would be the wrong answer for investors.
Thanks, Fran.
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