Choosing an Advisor
Here are the appropriate steps you should follow when considering a financial advisor:
- Define your objectives
- Decide what services you need
- Make a list of candidates
- Conduct interviews
- Check credentials and references
- Choose an Advisor
Define your objectives
- Assessment of your relevant financial history, such as tax returns, investments, retirement plan, wills, and insurance policies.
- Identification of areas where you may need assistance, such as building up a retirement income or improving your investment returns.
- Determination the appropriate level of risk and manage a portfolio at that risk level.
- Discussion, preparation, and explanation of a personalized financial plan based on your situation.
- Implementation of your financial plan, including referral to specialists such as lawyers or accountants, if necessary.
- Minimization of tax and transactions costs.
- Review of your situation and financial plan and suggestions for changes in your program.
Decide what services you need
Before contacting potential advisors, it's a good idea to know in advance what you're really expecting from an advisor. Make a list of expectations to go along with your financial goals. An advisor may not be able to help you if they don't know what you want. It's your own responsibility to make sure you've provided an advisor with the information they need to advise you appropriately. When asked what they most want from a financial advisor, 83% of consumers listed education first, according to a survey of 4,000 households by Dalbar Inc. Eighty percent said minimize taxes, 70% said highest returns, 68% said protect assets from loss, 68% said prevent mistakes, 64% said a written plan, 63% said help defining possible goals, and 58% said change investments. (Source: http://www.latimes.com/LA Times October 13, 1996)
Make a list of candidates
There are many types of advisors. Banks, Brokers, Stockbrokers, Money Managers/ Registered Investment Advisors, and Financial Planners are all potential advisers for your investments.
Conduct interviews
The following is a collection of questions you may want to use in evaluating advisors and their organizations. You can choose any you feel are relevant to your needs (or you can ask all of them if you're looking for weaknesses or trying to get rid of an advisor that will not leave you alone).
- How long have you been providing advisory and planning services?
- In what area(s) of financial planning do you specialize, if any?
- What continuing education courses have you taken, or are you taking?
- Do you have any advanced degrees, certificates or advisory and planning credentials?
- How often have you performed similar services in the past?
- How are you compensated for your services?
- What type of advisory and planning service(s) do you think I need based on my concerns and goals?
- On average, how long have your clients utilized your services?
- How do you intend to help me implement my investment/financial plan?
Check credentials and references
Investigating Advisors in Texas
You can contact the Texas State Board of Public Accountancy (http://www.tsbpa.state.tx.us/) to check on license and disciplinary record of Certified Public Accountants. Call (202) 737-0900 to get state securities commissioners' phone numbers. You can contact the Texas State Securities Board (www.ssb.state.tx.us/)to see if an advisor is a licensed Registered Investment Advisor. For information on an advisor outside of Texas, please contact the appropriate state agency.
The ABC's of CFPs, PFSs, Etc.
CFA: Chartered Financial Analyst. The CFA is a prestigious credential recognized worldwide and held mostly by institutional money managers, investment advisors, and stock analysts.
ChFC: Chartered Financial Consultant. ChFC is held by financial consultants who must pass an extensive, rigorous exam relating to insurance and investments.
CLU: Chartered Life Underwriter. CLU is held primarily by life insurance agents.
CPA: Certified Public Accountant. CPAs must pass a rigorous test administered nationally and receive state accountancy board approval.
CFP: Certified Financial Planner. CFPs must pass a 10-hour exam and agree to abide by a code of ethics.
PFS: Personal Financial Specialist. A PFS is a designation granted by the American Institute of Certified Public Accountants (AICPA) which requires extensive experience and education in the following practice areas: estate, investment, retirement, tax and personal financial planning.
MBA: Master of Business Administration. An MBA is a graduate level degree generally seen as a solid background. Education is generally in finance and investments but will depend on school and major field.
Registered Representative: Stockbroker. There is no explicit financial planning component to the testing.
RIA: Registered Investment Advisor. RIA means an individual or a firm has filed with the SEC and paid a modest fee. They are required to present a copy of the filing.
Choose an Advisor
When you choose a doctor, you want someone with the appropriate credentials as well as good bedside manners. Likewise, when choosing a financial advisor you should select an advisor with whom you feel comfortable, personally and professionally. You also should be confident in the advisor's morals and ethics. In that regard you should be aware of how they are compensated. Money management clients typically pay a percentage of assets under management. The manager's compensation is not based on the commissions generated on trades. The manager has no incentive to churn but does have an incentive to grow the assets, thereby growing his own income. The manager's incentive is therefore in line with the clients and in the client's best interest. Less than ethical practices that do exist include accepting kickbacks from brokers for using the broker's products, and undisclosed self-dealing with an affiliated broker. Stockbrokers are generally compensated by commissions. Financial planners can either be compensated by commission, fees, or both.
Behaviors by managers you may want to avoid include:
- Choosing investments not suited to goals and constraints.
- Failing to diversify and failing to move to an efficient portfolio.
- Reacting to short term, not long term market movements.
- Reacting emotionally.
Behavior that can work against the client is behavior that is likely NOT to lose the business of a client. A manager may be excessively risk adverse and liquid by not allowing enough risk, therefore resulting in lower returns. By simply matching the market or not straying far from a benchmark, a manager can reduce the risk of significantly underperforming and getting fired. This behavior can occur typically when an advisor has performed well in the recent past. An analogy can be drawn to a football team with a large lead near the end of a game. They play a "prevent defense" which prevents big plays but allows short and medium gains that will run the clock out. Likewise a manager is unlikely to be fired for slight under performance; therefore, taking few risks may reduce the likelihood of losing an account in some cases.
In contrast, a manager that has significantly underperformed may also exhibit behavior that is not in the client's best interest. What does a quarterback do when he's trailing at the end of a game and his back is against the wall? He throws the bomb. Similarly, managers that have underperformed will be tempted to take additional risk in an effort to catch up. A manager on the verge of getting fired may take larger risks since he/she is likely to get fired anyway. Throwing the bomb may be his last chance to keep a client.