The investment advisor industry would like you to think that advisors are as trustworthy as family.And of course, many are both honest and competent. But all advisors live in a world of temptation: They can easily focus on gathering client assets rather than managing them well; they can focus on selling the investments that pay them the best commissions—regardless of whether they’re best for clients—and they can hide poor investment performance.
So how do you tell the folks with integrity from those without? In an industry that’s short on transparency, it can be difficult. We want to help: We’ve consulted with several experts, and crystallized their suggestions into four rules of thumb. Our list is not exhaustive, of course. But if your advisor fails to measure up in any one of these areas, you’ve got a red flag on your hands.
1. The investment advisor doesn’t focus specifically on investment advice
Some advisors practice much like the country doctor of old, promising to provide everything from investment advice to financial planning to tax advice to insurance products under one roof.
This is a certain red flag. The fact is that it’s rare for a single firm to do all those things well—and it’s still rarer for a single advisor.
Now, a good investment advisor will want you to get good tax advice and the proper insurance. She might well direct you to outside experts to provide the expertise she lacks.
But her main focus will be helping you earn returns on your money, and she’ll have the skills required to develop a customised plan of asset allocation, as well as a strategy for finding the best investment products in those asset classes.
2. The advisor does not speak openly about returns
If your advisor doesn’t speak openly and proudly of the risk-adjusted returns he’s earned for clients, run for the door.
“I would be wary of an advisor that is unwilling to share his or her past returns,” says Kristi Kuechler, former president of the Institute for Private Investors, a membership group of high-net-worth investors.
Some advisors will say that because they customise portfolios, they cannot provide a composite return. If you hear that, ask for returns on similar portfolios.
“Given how advisors typically customise client portfolios, that may require sharing a broad set of individual returns,” Ms. Kuechler says.
Of course, what you should be bringing to the table is a reasonable expectation of what good returns look like, especially when a portfolio has been designed to minimize risk. We’d all like a compounded, risk-free 8%-to-10% return. But that’s not reality.
By the way, advisors whose investment performance isn’t something to brag about may try to cover up their results with a focus on handholding and service. And bedside manner may well be important to you. But is it really worth the high fees—from 1% to 3% of assets—that many advisors charge? What you really should want to pay for is a skill that will help you earn a good return on your money.
3. The advisor pushes products in which he or she has a vested interest
In the Byzantine world of financial service fees, it’s sometimes hard to tell how and how much an advisor is getting paid. Advisors who receive their compensation from mutual fund companies may be biased to sell more funds to you, just as advisors employed by a financial institution like a bank might be more likely to sell that company’s products, even if they cost you more. A fee-only advisor’s incentive might be to take too much risk, so that your assets grow faster and he earns more in the short term.
You’ll need to equip yourself to recognise these signs of a bad advisor.
Take steps to understand how your advisor gets paid, says Linda Leitz, a fee-only financial advisor. That way, you’ll be aware if the advisor is subtly, or even not so subtly, pushing you to buy investments that will cost you more – and pay them more.
Ron Rhoades, professor and financial planning program chair, Alfred State College, suggests that advisors should inform you of all of the fees and costs of your investments—in writing—including an estimate of the transaction costs such as brokerage commissions and bid-ask spreads within mutual funds or other pooled investment vehicles.
4. The advisor promises to customise a stock portfolio for you
An advisor who tells you that she customises a stock portfolio for her clients is selling you a bill of goods. Instead, advisors should customise an asset allocation for you, and then be focused on buying the best managers for each asset class.
Consider what a customised portfolio might mean: An advisor who favours one client over another with “better” stocks would be acting extraordinarily unethically toward less-favoured clients. The stock-customisation sales pitch is especially a red flag if the advisor is selling herself as both a financial planner and an investment advisor.
“I personally doubt whether one person can be a stock picker (it takes so much time to analyse corporation’s financial statements, etc., if done correctly) and be a financial planner to retail clients,” says Mr. Rhoades.
Especially when markets are uncertain, investors are apt to reconsider their relationships with their advisors, or reconsider their status as DIYers. Whether you end up making a move or not, it’s a good idea to look with a critical eye at whether your advisor has your best interests at heart.
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