A recent survey conducted by Fidelity Investments found that only 57% of clients felt their advisor provided value during "recent market conditions." Clients who felt their advisor provided value, unsurprisingly, expressed much greater trust and loyalty. What did advisors do to create a perception of value and loyalty? They focused on long-term goals and provided comprehensive financial advice.
According to Michael Laine, a financial planner in California, "what most clients are looking for is financial peace of mind. Money is often a very stressful issue for people as it is still very much a taboo subject that is not well discussed. As such, having a trusted advisor who makes sure their financial house is in good order is invaluable."
Unfortunately, peace of mind isn't easy to quantify. Financial scholars tend to only deal in research questions that can be answered with numbers. Some recent studies have tried to quantify the benefit of professional financial advice. The results aren't pretty. Another new study by David Blanchett and Paul Kaplan of Morningstar provides a much more thorough estimate of the benefits of sound advice.
How do most financial economists view the value of advice? I should first note that the investment performance toolkit is basically a single hammer, although a relatively advanced one. Financial researchers estimate risk-adjusted returns as the most objective way to determine whether any market input enhances efficiency. If they want to know whether Ivy League-educated fund managers are more effective, they calculate whether they can consistently achieve alpha. So what benefit could financial advisors provide to a client? Obviously, they could provide alpha compared to non-advised investors.
Unfortunately, some notable published examples of advised account comparisons find the opposite. Investors with advisors tend to do worse, or at least perform no better, than investors who do it on their own.
A 2009 study by Harvard professors Daniel Bergstresser and Peter Tufano, and John Chalmers from the University of Oregon, compared the performance of broker-sold to direct-channel mutual funds. Since broker-sold funds are selected by an expert advisor, the authors hypothesized that they might outperform (not including fees) if the advisors recommended higher quality funds or talked emotional clients out of investing in today's hot fund.
Not only did the direct-channel funds outperform, but it appeared that broker-sold funds were even more prone to the "hot hand" effect by following recent strong performers. They also tended to respond to changes in fund commissions by steering clients toward more expensive funds. The authors concluded that brokers didn't seem to provide much value for the $15 billion they were paid by their clients.
A more recent study of actual investment performance among a large group of German bank customers comes to a similar conclusion, but with some bright spots. University of Goethe researcher Andreas Hackethal and his co-authors tracked a group of bank customers who were matched with free advice from commission advisors. They found that the portfolios recommended by the advisors did not outperform, but they did find evidence that the portfolios were better diversified. Net risk-adjusted performance was lower than among self-directed investors, although it would have been slightly higher if clients had done a better job of following the exact recommendations of advisors. 
A knowledgeable advisor should be able to help a client avoid investment mistakes. If a client's inexperience makes him or her biased, the advisor can guide that client toward a more rational investing approach. According to Joe Bantz, a financial advisor at Foster Group in Des Moines, "I often refer to the value of our services as, in part, helping you avoid costly financial mistakes."
There may be situations where incentives get in the way of reducing client biases. In one of the most damning studies of broker-recommended investments, Sendhil Mullainathan of Harvard University and his co-authors recruited 284 auditors to visit about a hundred different financial advisory firms in Boston for investment advice. The auditors were assigned one of four initial portfolios before seeking advice—all cash (baseline), index funds, a large percentage (30%) in company stock, and a large percentage in hot sector funds.
One of their goals was to see whether an advisor would suggest a more diversified, de-biased portfolio by selling both company stock and hot sector funds. The researchers hypothesized that compensation incentives would lead advisors to favor shifting company stock into mutual funds, but not to shift money away from hot sector funds. They were right. Since they were commission compensated, advisors didn't like company stock but really didn't like index funds. But they did seem fine with a return-chasing strategy—evidence that they don't de-bias, and might actually encourage, bad investing behavior.
Most of the auditors (70%), who were randomly assigned their advisor and unaware of the purpose of the study, liked the advisor enough that they'd be willing to give them their own money even when the advice was self-serving. This is a problem identified in another study published in 2012 by Santosh Anagol of Wharton, who found that advisors who could benefit from bad client decisions didn't try to talk them out of it. If the client wants a bad fund and you get paid either way, why stop them? After all, you may lose a client if you try to talk them out of something they really want to do. How many advisors who believed in value investing lost clients in the late 1990s to other advisors who followed the pied piper of Internet stocks?
An interesting new paper by professors Nicola Gennaioli, Andrei Shleifer and Robert Vishny of Harvard and the University of Chicago provides a defense of lower-performing advised fund portfolios by describing why consumers can be better off with commission advice than without. What advisors give inexperienced, fearful investors is the peace of mind to participate in the equity market. Advisors are like doctors who guide their patients toward the correct treatment, in this case equity investment, and the client is more likely to take the medicine because they trust the wisdom of the expert. Trust helps investors by allowing them to take more portfolio risk than they would on their own. It also reduces the anxiety of periodic volatility in their portfolio. 
More than half of Americans don't own stocks, according to the Federal Reserve's latest Survey of Consumer Finances. Still fewer invest in stocks outside of the mutual funds in their retirement account. Behavioral finance literature documents the extreme response investors have to experiencing a loss. In fact, a paper by Richard Thaler attributed the high premium provided by risky investments to loss aversion and a short-run time horizon. The welfare gains from some stock market participation can be significant—but only if the client is able to stick with their portfolio allocation.
A new manuscript by David Blanchett and Paul Kaplan recognizes the increase in equity market participation as just one of the many sources of added value provided by advisors. For most of us familiar with what advisors actually do, their approach makes a lot more sense. Rather than relying on alpha to determine added value, they propose a new measure—gamma—which captures the multiple dimensions of quantifiable planning value. These include tax efficiency through strategic asset location and timing strategies, appropriate lifecycle asset allocation (greater stock investments while younger), matching financial strategies to specific goals, and choosing a more sophisticated withdrawal strategy in retirement. These improvements alone could improve total welfare by 30%.
This is where advisors can really earn their fees by accurately assessing risk tolerance, making portfolio recommendations, and helping the client focus on long-run goals. "In my opinion, the investment returns, while important, are of limited value ultimately," notes Bantz. "Nearly everyone benefits from having an advisor to guide them through decisions, helping them identify obstacles and prepare for the unexpected." Gennaioli and his co-authors conclude that it likely exceeds the cost of obtaining advice.
Many of these studies focus on advice that is tied to commission financial products. Since we're all governed by economic incentives, advisors respond predictably by selling more of the product that will put food on the table. The commission or fee is the price of the advice. It shouldn't be surprising that net returns are lower within advised accounts if markets are efficient and the client is receiving value from seeing an advisor. This value can include a more efficient, better diversified portfolio, psychological benefit in reducing the anxiety of market fluctuations, and a knowledgeable source of insight into general financial issues unrelated to investments.
helping the client implement those choices, outcome measurement would have to expand greatly to include: Is the use of human capital optimal? Is the spending pattern well-matched to circumstances and goals? Is there appropriate risk-sharing, e.g. through the smart use of insurance? Is there effective and comfortable communication about financial issues within the client's inner circle of family and friends? Is the client becoming more literate with respect to financial issues and more self-aware about financial values, habits, and circumstances?"
