The question of financial advisor value, answered

Financial advisors asked about the material value they could add to a client's wealth through their services can increasingly answer that question with specific figures.

An advisor's mix of behavioral coaching and technical planning with investment and tax strategy generates a 2.39% to 2.78% higher annual rate of return, net of fees and inflation, for their clients above the yearly gains of self-directed households, according to a study released last month by advisor matchmaking and lead generation service SmartAsset. When compounded over the long term, the estimate suggested that advisors' services tack on hundreds of thousands or even millions of dollars to their clients' wealth.

To be sure, that number could vary widely, based on client income, net worth and the number of years they work with an advisor — as with any statistical model using numeric assumptions and attempting to project across an entire population. SmartAsset's finding came close to the 3% in higher after-tax returns calculated by Vanguard in its often-cited "Advisor's Alpha" study. More importantly, advisors should be prepared for a prospective customer's valid query with qualitative and quantitative proof of their case for comprehensive planning and advice.

Since "the vast majority of consumers are not even exposed to these ideas and concepts," the study "helps lay out the total package that advisors bring to the table," said Jaclyn DeJohn, a certified financial planner who is SmartAsset's director of economic analysis and the author of the study. 

"One of the main objectives here is to really help consumers quantify the unknowns," she said. "There's a plethora of financial topics that consumers are just totally unaware of, and that includes both behavioral and technical areas. Folks have a hard time understanding the cognitive and emotional biases that will affect their decision-making."

Advisors can get more particular to each client's case by identifying their goals and tracking progress toward them. They should then ask themselves, "'Am I serving that greater purpose of my role as an advisor?'" said Shauna Mace, head of practice management at custodian, technology and asset management firm SEI. To answer that question in a numeric way by citing their own performance measures, advisors can use statistical tools such as SEI reports that calculate clients' tax savings and account values compared to their fees. 

"You can start to understand as an advisor, are you actually adding value from a return perspective?" she said. "[Advisors] should be using this sort of research to challenge themselves to deliver value in the right ways. … Those sorts of things become really powerful ways to reinforce the value of the advisor as well as the value of that relationship."

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The value of a financial advisor: The numbers

Based on SmartAsset's study, that figure could amount to anywhere between 36% to 212% higher net worth, depending on the length of the relationship and the beginning value.

"Quantifying the value of a financial advisor is complex due to the diverse and personalized nature of financial advice," DeJohn wrote in the report. "Given the impracticality of gathering comprehensive data from all advised and non-advised individuals, we use available data to make reasonable projections, mirroring how advisors themselves forecast financial scenarios for their clients. This model employs proxies and assumptions that reflect the key areas where advisors typically add significant value for most clients."

"The myriad ways in which financial advisors add value can largely be distilled into two primary categories: optimizing investments (offensive strategy) and minimizing tax liabilities (defensive strategy)," the report continued. "Both behavioral finance and technical finance limitations impact these main value drivers. While the connection between smaller and more varied financial choices and these themes may not always be readily apparent, they ultimately all make their way to a client's bottom line." 

The findings stemmed from earlier estimates. Using a random sampling of the performance of equity analysts' recommendations as compared to the S&P 500 and a wealth management firm's estimate of strategic tax savings, DeJohn carried out sophisticated projections tied to age and net worth, with inflationary adjustments and fees of 1% for those below $1 million in assets and 0.75% for households above that level. Here's what the study found:

• A 35-year-old investor with annual income of $125,000 and a starting net worth of $250,000 would reach a final net worth of $2,230,826 with an advisor and $990,844 without one, for a lifetime value-add of $1,239,981 (or 125%), net of lifetime fees of $397,793, or 24% of the surplus from hiring a planner.
  

• A 45-year-old investor with annual income of $175,000 and a starting net worth of $750,000 would reach a final net worth of $2,951,540 with an advisor and $1,475,892 without one, for a lifetime value-add of $1,475,648 (or 100%), net of lifetime fees of $657,106, or 31% of the surplus from hiring a planner.
  

• A 55-year-old investor with annual income of $220,000 and a starting net worth of $1,500,000 would reach a final net worth of $2,937,167 with an advisor and $1,656,019 without one, for a lifetime value-add of $1,281,148 (or 77%), net of lifetime fees of $702,819, or 35% of the surplus from hiring a planner.
  

• A 65-year-old investor with annual income of $80,000 and a starting net worth of $2,000,000 would reach a final net worth of $2,215,343 with an advisor and $1,581,639 without one, for a lifetime value-add of $633,705 (or 40%), net of lifetime fees of $189,656, or 23% of the surplus from hiring a planner.
  

READ MORE: How emotional intelligence is at 'The Heart of Finance'

The upshot on advisor value

Fees represent a key area of concern that may dissuade prospective clients or simply confuse them. Those in SmartAsset's statistical model comprised between 23% and 35% of the added value generated by working with an advisor, displaying that the relationship "isn't just an operation to line an advisor's pockets," DeJohn said.

The report outlined examples displaying how advisors deliver value through behavioral or technical methods. One investor has a job in renewable energy leading her to fail to "anticipate the impact of trade wars and tariffs on imported materials essential for solar panel production," while another invests in short-term rental real estate without taking a city's strict regulations into account, the report said. A third who has an advisor sets up a Roth IRA that builds after-tax savings for retirement and a fourth who hires a planner as well uses some complex 401(k) and other retirement-account strategies to begin penalty-free withdrawals at 55 years old.

"A financial advisor strategizes both offensively to grow wealth and defensively to protect it, navigating through external factors such as market dynamics, regulatory policies and technological innovation, as well as internal factors such as psychological, emotional and circumstantial nuances that could derail financial success for a client," DeJohn wrote in the report. "Such obstacles, often unrecognizable by the layperson, can cost individuals hundreds of thousands of dollars over their lifetime — or more."

Advisors can present this kind of information to prospects without overwhelming them with jargon or complicated formulas. And that process ought to take off "when advisors are interviewing with clients," where it's "important to demonstrate knowledge and expertise," DeJohn said. 

"A lot of advisors are afraid to, so to speak, 'Give away their secret sauce,'" she added. "Be forward, offer value right from the get-go, so consumers can really see and understand what you're going to bring to the table over the long term."