Affluent investors hungry for advice have their pick of wealth managers to advise them. I should know, I’m in the business and it’s a crowded field. However, I’m also able to see what a lot of my counterparts are doing and some of it concerns me. I’m going to make a broad generalization here, but in my opinion there are a lot of things that some (not all, of course) wealth managers avoid discussing.
While these topics are all in black and white in advisors’ disclosure documents, I’d like to highlight the three I think are the most important for investors to be aware of.
1. Wealth managers are experts in relationship management, not investment management.
Most investors seek out a wealth manager to get help building an investment portfolio geared to specific financial goals. Therefore, they assume when they speak to one that he or she is an investment expert.
In many cases they are exactly that. But not always. Consumers need to be aware that some advisors are primarily relationship managers. They manage the relationship with the investor, respond to client requests, and recommend and sell products.
Their primary job is to bring in a lot of new assets, to build up a book of clients. They are not judged internally on how well their clients’ investments perform; they are judged on how many new clients and additional assets they bring into the company.
This brings up an important distinction. Did you know that brokers are under no obligation to suggest investment vehicles that are in your best interest – called the fiduciary standard? By regulation they only need to recommend “suitable” products based on factors consistent with your age and risk tolerance. They are not required, for instance, to compare the cost of their recommendations with alternatives. In other words, “suitable” does not mean the cheapest.
A registered investment advisor (RIA), on the other hand, is legally required to act in a fiduciary capacity and to put your interests first. CERTIFIED FINANCIAL PLANNERTM practitioners, while not bound by law, often adhere to similar professional standards.
Solution: Ask your wealth manager if they are bound by law to act in your best interest in a fiduciary capacity.
2. Beware the power of compounding fees.
Since the investor is paying a fee for advice, they might assume that fee covers everything. Not so. You have a right to know all the sources of your advisor’s income as it relates to your accounts.
First of all, third-party incentives can color a wealth manager’s advice – and could cost you more. For example, some insurance companies pay advisors commission based on the first year’s insurance premium for selling equity-linked insurance policies. In some companies managers are paid bonuses for moving certain products.
Second, some wealth managers sell managed accounts, also known as controlled or discretionary accounts, which are professionally managed by someone or an institution which is also paid a fee. These active managers take 1% or more of your money. If they’re recommending alternative investments you could be paying even higher fees, if the managed account involves them.
Third, while many advisors are upfront about detailing precisely how they are paid, some rely on lengthy disclosure documents.
Starting in 2011, the SEC required firms to publish the “Form ADV Part II” which explains their compensation in plain language minus the jargon. You can look up many advisors’ list prices on the SEC website and you can request the document from your advisor. It will explain if your advisor is paid a commission from the investments he sells, charges a flat fee or a percentage, or is paid in other ways. Nevertheless, this form doesn’t always tell the whole story.
Solution: Request the Form ADV Part II and, in addition, have the advisor walk you through the disclosure documents to uncover hidden fees.
3. There are more important things than portfolio composition.
There are a broad range of variables that affect your financial life including taxes, insurance, retirement income planning, estate planning, and more. These are all tied to your goals, core values, objectives and risk tolerance. Moreover, balancing all of these components is an ongoing process.
In other words, it’s not always about getting the best possible return. It’s about how you define wealth at each stage of your life. Real wealth management goes far beyond a colored pie chart illustrating a “diverse” portfolio. It’s about the hard conversations. Are you saving enough to meet your goals? Are you budgeting properly? Are you making too many assumptions?
In estate planning, for instance, are you sure that your assets are being securely passed down to your beneficiaries? Estate taxes must be paid in cash within nine months of death and before the distribution occurs. Many families don’t have that kind of cash on hand, which forces them to sell assets at less than market value. However, life insurance can help you offset some of these costs. As you can see, such a conversation is far, far away from portfolio construction.
Overall, this is a highly regulated industry with several agencies watching over it. And there are good – and great – advisors out there working every day in their clients’ best interests. However, it never hurts to be aware of some of the things that a wealth manager might not tell you.
