The right advisor

Selecting the right financial advisor is one of the most important decisions you will make in your life. The right advisor can be an invaluable ally as you navigate a financial world that is becoming increasingly complex and dangerous. But how do you find the right advisor for you?

After more than 25 years as a professional investor, 20 years as the client of various advisors and now 8 years running my own advisory practice, I have gained some insight into what makes an advisor effective. I hope the following will help you in your search for the right advisor.

In a nutshell, your financial advisor should be:

  • qualified
  • independent,
  • free of conflicts of interest, and
  • focused on your needs.

Is this advisor really qualified?

Make sure your advisor knows what he or she is talking about. Advanced degrees and professional designations can give you a clue to the advisor's knowledge base, but they are only a starting point. Remember Long Term Capital Management? It was a hedge fund run by some of the brightest Ph.D.'s on Wall Street. But ultimately, the eggheads knew less than they thought they knew and when it blew up in September 1998, it nearly brought down the entire world financial system. Don't let a well-credentialed but ultimately unqualified advisor blow up your financial life. Interview potential advisors to learn more about their real-life experience. Simple, open-ended questions will yield the most relevant information. Here are some examples:

  • How long have you been in business?
  • What has been your experience with clients like me?
  • What is the core philosophy that underlies your advice?
  • Describe some of the more complex situations you have encountered.
  • What do you do to keep your firm relevant with changes in the market place?
  • How do you stay current with industry developments?
  • What are you doing to improve your firm and your practice?
  • What was the most recent change you made to improve the quality of advice you provide?
  • When did you make that change?

After you listen to your advisor's answers, ask yourself:

  • Did the answers make sense?
  • Do I trust these answers?
  • Were the answers well thought out, or were they "off the cuff?"
  • Is this advisor really qualified to help me with my problems?
  • Can I trust this advisor to keep my financial life current with the best thinking available?

If you don't like what you hear, it is likely time to get a new advisor. 

Fiercely independent

In the old days, large brokerage and advisory firms had a big advantage over independent advisors. Their massive scale allowed them to purchase systems that gave them more information more quickly than small independent advisors.  All that has changed. For example, in the 1990s when I was an institutional portfolio manager, the data services I was provided cost literally thousands of dollars each month. Today that same information is available with a free subscription to Yahoo Finance. The internet has leveled the playing field and the big firms no longer have an advantage.

This is good news for you. An advisor in a big-box firm is beholden to that firm's senior management. Advisors who don't fall in line with the established order don't survive. The independent advisor, on the other hand, is able to stay responsive to the client. When you work with an independent advisor you set the pace and the agenda.

Follow the money

How your advisor gets paid for his or her services tells you a lot about how the advisor approaches your relationship. Some advisors get paid for selling financial products such as stocks, mutual funds or insurance. When advisors get paid to sell a product, they naturally focus on selling that product and they have an incentive to sell you the product whether or it makes sense for you or not. In fact, their organizations demand that they sell. After all, without a sell there is no revenue to meet the firm's overhead and the firm cannot survive.

You should also remember that commission-driven financial services firms are rife with embedded conflicts of interest. First, products that pay a higher commission tend to get more attention by commission-based advisors. Second, the entire advisor/client relationship is viewed in the context of how many commissions can be generated. If there is no prospect for a commission, there is no incentive to service the account.

On the other hand, a fee-only relationship avoids these conflicts of interest. A fee-only advisor gets paid only for offering advice. Usually the fee is calculated based as a percentage of assets under management. Because her revenue stream flows only from the advisory fees paid by the client,  the advisor has no incentive to act unless it is in the client's interest. There are no sale quotas, no hidden agendas, no preferred products. The relationship is based squarely on providing the best advice for the client. Instead of a conflict of interest, the advisor's desires align with those of the client. If the client account increases in value, the advisor's fee revenue increases. If the the account value drops, the advisor's revenue declines. The advisor is therefore incented to act in a way that will help the account grow without exposing it to too much downside.

A note about fee-based advisors

Some advisors follow a hybrid revenue model. They charge a fee for advice but they also get paid a commission. Often these types of advisors are found in brokerage firms trying to upgrade their image without making a clean break from the conflict-riddled commission habit. Personally, I dislike this model even more than the straight commission approach. At least with a straight commission advisor you know what you are dealing with.

The power of being a fiduciary

To say someone is a fiduciary means that person is legally required to put your interests first. It is a very high legal standard and most financial advisors do not qualify. For example, a broker is not a fiduciary because her first duty is to her brokerage firm, not to you, the client. A financial planner with a big-box firm is not a fiduciary because his primary duty is to the firm that employs (and pays) him, not to you, the client.

However, a fee-only registered investment advisor is a legal fiduciary. As such, she is legally required to put your interests above her personal interests or the interests of her firm. In a nutshell, working with an advisor who is a fiduciary means you have a legal right to trust that the advisor is really working for you. Why would you settle for anything less?

Watch out for labels

Let me conclude with one final caveat: be careful about labels. There are almost as many labels put on financial advisors as there are flavors of ice cream. Some labels are merely marketing hype. For example, in an attempt to upgrade their image, several major brokerage firms now call their brokers "financial consultants." But they are still just brokers. These firms' are still sales machines driven by production quotas and preferred product lines. So when you are shopping for an advisor, be careful. Look beyond the label at the way the advisor operates. Remember, if it walks like a broker and talks like a broker, then it probably is a broker -- no matter what label is attached.