Gamma in Action Financially Sound Households Get Advice From

Spotlight: Financial Planning Reprinted from Morningstar magazine February/March 2019 household is behaving optimally. (For example, Gamma in Action adequate life insurance may reduce available savings, but it is a vital component of Financially sound households get advice a sound financial plan for most households.) from financial planners. Financial Planners Lead the Way Of the four sources of financial information we studied, we find that households working with a financial planner made the best overall financial decisions. Meanwhile, those households working with a transactional advisor made the GAMMA better services to households than others. To do worst financial decisions of the group. David Blanchett this, we use the six most recent reports of the Survey of Consumer Finances (from 2001 Because of potential selection bias, we cannot to 2016) to explore how financial decision-making be sure that the financial planner was the In 2013, Morningstar researcher Paul Kaplan and varies for households that use different types only—or even main—reason these households I introduced a concept we called gamma.1 of sources of information. We concentrate on five made better planning decisions. After all, better Gamma attempts to quantify the potential value decision-making domains: portfolio risk level, decision-makers might choose to use a of financial planning. As U.S. households savings habits, life insurance coverage, revolving financial planner, and not the other way around. increasingly become responsible for more financial credit card balances, and emergency savings. However, our findings do at least suggest financial decisions, such as determining how much to And we look at four information sources: planners are adding the most value among save for retirement, how to invest those financial planners, transactional financial advisors, the information sources we considered, especially savings, and when to retire, and yet typically friends, and the Internet. By dividing financial compared with transactional advisors. lack financial acumen, financial advisors advisors into two types, we can better are well-positioned to help improve household understand if any differences exist by the type We also find that households using the Internet financial decision-making. Indeed, a growing of the advice engagement. as a source of information scored second to body of theoretical research, including our gamma those using financial planners on overall financial research, has noted the potential value of The analysis focuses on the soundness of household soundness. This is noteworthy given the low advisors in a variety of financial domains; however, financial decisions versus more outcome-oriented cost of Internet information (relative to empirical evidence on the topic is mixed and variables. Therefore, for example, we want many financial advisors) and the growing use of generally suggests households that use financial to know whether a household carries any revolving the Internet as the primary information advisors do no better (or even worse) than credit debt as opposed to the household’s level source for households included in our analysis. those who don’t, especially when it comes to of wealth or savings. In 2001, only 3% of households used the investment-related domains. Internet as their primary source of financial Focusing on financial decisions allows us to: information. In 2016, 40% did. However, the better These findings may be explained in a variety of outcomes associated with the Internet ways. One explanation could be that the gCapture differences between decision- declined from 2001 to 2016, so it is not clear to empirical research, which is largely investment- making domains. what extent this relation will persist. focused, has not captured value created in other domains such as improved savings rates or gReduce issues associated with reverse All financial advice is not the same, nor are life insurance coverage. Another reason could causality (because clients with more wealth advisor types. Thus, we shouldn’t expect the value be that certain types of advisors, such as financial become increasingly attractive to financial of advice to be uniform; research that does planners, provide valuable services that advisors and it may be difficult to determine the not attempt to control for advice type may likely are not consistently captured in a relatively broad role of the financial advisor with respect to the produce biased results. financial advisor description. wealth creation). How We Conducted Our Analysis In this article, we examine this last point— gControl for the fact that higher wealth (or more Determining the soundness of financial decision- whether some types of advisors are providing savings) doesn’t necessarily imply the making for a household is obviously subjective. For 1 See Alpha, Beta, and Now... Gamma, available here in Morningstar Cloud ©2019 Morningstar, Inc. All Rights Reserved. Morningstar, the Morningstar logo, and Morningstar Advisor are either trademarks or service marks of Morningstar, Inc. Spotlight: Financial Planning Reprinted from Morningstar magazine February/March 2019 our analysis, as we mentioned above, we focus holistic services are referred to as financial savings accounts, money market mutual funds, on household decisions instead of outcome- planners while advisors that are less holistic in and money market demand accounts, oriented variables. nature, and likely more transaction-oriented, by average normal income. The goal is to have are transactional advisors. at least three months’ income set aside in The analysis uses data from the 2001, 2004, 2007, emergency savings. 2010, 2013, and 2016 waves of the Survey of Decision-Making Domains Consumer Finances. To be included in our analysis, As we mentioned above, we considered five Each household in each survey has five different the respondent had to be between the financial decision-making domains: portfolio risk observations, or implicates. Each of the five ages of 25 and 55, have children, have a minimum appropriateness, savings habits, life tests are conducted for each implicate (25 total income of at least $25,000, and have at insurance coverage, revolving credit card debt, tests for a household). The results of the test least $5,000 in financial and retirement assets. and emergency savings. These are briefly for each implicate are combined, based summarized here: on implicate weights, to get a “pass rate” for the A question in the survey asks respondents about respective domain. Pass rates ranged from their source of financial information: Portfolio Risk Appropriateness 0%, where none of the implicates passed, to 100%, This test determines if the household’s retirement where all the implicates passed. The scores “What sources of information do you (and your assets are invested in a portfolio that has at the individual domain level are then averaged family) use to make decisions about saving and a risk level that would be considered prudent given to get the aggregate financial soundness score investments? (Do you call around; read the respondent’s age. For this test, the equity for the household. Demographic control variables newspapers, magazines, material you get in the allocation of the investor’s retirement assets is (for example, total financial assets) are also mail; use information from television, compared with the Morningstar Moderate Lifetime created using the implicate weights (that is, the radio, the Internet, or advertisements? Do you Index. If the equity level is within 25 percentage weighted average of the implicate values get advice from a friend, relative, lawyer, points of the index, the portfolio is deemed to be for that household), so that each household has accountant, banker, broker, or financial planner? appropriately invested. a single set of values. Or do you do something else?)” Savings Habits EXHIBIT 1 provides insight into the percentage of We use a household’s response to this question For this test, households that have some type of households that pass the respective tests to determine the financial information source savings plan are considered to have good savings for each of the six Survey of Consumer Finances for the household in our analysis. If the respondent habits. We focus on the savings habits, instead of data sets included in the analysis. provided multiple sources, we assume the the amount of savings, to simplify the analysis and first response listed is the household’s primary because of survey data limitations related to In EXHIBIT 1 , most of the tests (except for savings information source. savings variables. habits) have approximately a 50% pass rate, which suggests there is a large potential benefit We classify financial advisors into two types: Life Insurance for financial advisors to help the households financial planners and transactional advisors. This test focuses on whether the household has make better financial decisions. If “banker” or “broker” is mentioned, the face-value life insurance at least equal financial advisor is deemed to be transactional. to the total wage income of the household. All The Results We don’t include lawyer or accountant in households in this analysis have children; To determine whether financial soundness either financial advisor group because these are therefore, it is reasonable to assume that some varied by information source, we perform not professions typically associated with level of life insurance would be desirable a variety of ordinary least squares

Load more