Why And How To Choose A Financial Advisor

This article was written with Jim Cahn, the Chief Investment Officer at Wealth Enhancement Group. It was part of a series of articles developed under an agreement with Forbes to work with a variety of contributors and assist them in delivering actionable investment ideas each week. The site forbes.com is one of the top 500 sites in the world with nearly 10 million subscribers and nearly 100 million page views a month.

In many areas of our lives, self-reliance yields positive results. You could say our country was built on this principle. Unfortunately, successful investing seems impervious to this rubric, despite online and discount brokerage pitches that make investing seem easy. And, certainly there is lots of free and low-cost financial information available from various blogs, TV shows and guys like me.

While do-it-yourself active trading can be fun and give you a sense of control, it may not translate into profits. This isn’t just me shilling. Fact: Individual investors tend to underperform the market. Many studies have been done on this phenomenon, but I consistently return to Brad Barber and Terrance Odean’s published work. These professors have devoted well over a decade to studying how individuals invest. One of their most well-known studies, “Trading is Hazardous to Your Wealth: The Common Stock Performance of Individual Investors,” concluded that the average individual investor underperformed a market index by 1.5% a year. The same study also demonstrated that active traders underperformed by 6.5% annually.

When investors do decide to seek out an advisor the question becomes how to choose among the over 316,000 financial advisors in the United States [data: Cerulli Associates].

Alas, not all financial advisors are equal and I recommend investors use four criteria to choose the best one for them: Value, Responsibility, Resources and Rigor.

Ask yourself if you are getting (or will get) value from working with an advisor, given your specific goals. Typically investors look for an advisor to maximize their returns, leverage specialized knowledge and help them devise a strategy that helps reduce emotions. Many advisors charge the industry standard, 1% fee. For that fee, some advisors will provide you with access to tax and estate planning specialists, investment strategists and financial planning experts, while other advisors will take you for a round at an expensive course. Same fee, but a very different value proposition.

Next you need to determine responsibility, literally to uncover whether your advisor is dedicated to your best interests and worthy of your trust. As I’ve noted in Three Things Your Wealth Manager Doesn’t Want You To Know, depending on the type of advisor you choose, he or she may be bound by either fiduciary or suitability standards – or they may be licensed to operate under both, depending on your needs. When operating with fiduciary responsibility, the advisor is legally required to act in a client’s best interest. By comparison, the suitability responsibility means that the advisor is legally required to make recommendations that are “suitable” for a client’s objective.

Generally speaking, fiduciaries charge a fee and non-fiduciary advisors charge a commission, but there are exceptions to the rule. Where people usually decide whether or not to use a fiduciary versus a non-fiduciary revolves around cost and the future of their relationship. The fees charged by an Registered Investment Advisor (RIA), for example, might be higher than the commissions one faces with a broker. And maybe that’s OK with you – maybe you’re not looking for a long-term partnership with an advisor that gives you continuous advice; maybe you just want some one-off advice. In that case, it may be more reasonable to go with a broker. Either model may be right for you, based on your investment objectives.

Next you want to determine whether or not the advisor has the resources that meet your needs. These would include trained specialists in many fields (such as tax strategies, insurance and estate planning), portfolios that follow the science of investing, and access to alternative investments. Some advisors provide comprehensive financial planning services above and beyond investment management.

Finally, you want to determine rigor. The types of questions you should ask to determine this include:

  • How do you apply academic and industry thought leadership?
  • Do you have specialized staff to monitor the complexity of world financial markets?
  • What process does your investment management team follow to ensure due diligence and to offer the most appropriate products?
  • Do you have accredited/certified/licensed professionals with years of experience in various areas?

Be sure that when you take the step from DIY investing to seeking out a financial advisor that you find one that will do the best work for your situation, whatever it may be. Investing in work up front to pick one well-suited to your needs can pay dividends in the end.

Click here to see the article on Forbes.

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