Tips for Finding the Right Investment Advisor Part I
Markets got you down? Now may be a good time to team up with a good investment advisor.
Andrew Horowitz
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Tips for Finding the Right Investment Advisor Part I
Part I: Advisor Basics
Part I: Advisor BasicsSome tips on how to find a good investment advisor, ripped right out of Chapter 9 of my book, The Disciplined Investor. This is such and important topic that we have split it up into two episodes.
Part One will cover Advisor basics…what you need to know. And part two will provide tips to finding the best advisor to work with.
Working With an Advisor
Protecting your assets from all the potential pitfalls can be a rather trying matter. For many people, enjoying money is much more rewarding than constantly searching for ways to improve the bottom line. For others, it may make better financial or personal sense to focus daily attention on their career, their family, or retirement, and let a paid professional handle the kind of painstaking research it takes to maintain a profitable portfolio.
Fortunately, for the many people out there who do not like the idea of braving the waters alone, there is an entire fleet of financial professionals willing to help. The degree and quality of that advice varies greatly, and as this book has stressed again and again, it is important to do your homework.
Financial professionals come from many different backgrounds, biases, skill sets, and influences, and have varied levels of experience. Therefore is it imperative to assess the kind of investment strategies you are looking for as well as the kind of person you would like to work with. It is critical that you take the time to size up the benefits and drawbacks of dealing with a particular financial advisor as if you are looking to buy and test-drive a car.
During your evaluation, there are a few easily recognizable key indicators that The Disciplined Investor must pay attention to. The following two segments conveniently lump them into two categories: what to avoid and what to look for.
Shopping For An Advisor: You Get What You Pay For
At the grocery store, most people comparison shop. They are not likely to buy a $2.00 can of corn from one reputable brand when another equally reputable name is selling for $1.50. Unless, of course, you are dealing with a canned corn connoisseur. In that case the discerning consumer would more likely buy the $5.00 can that was imported from Europe. Choosing an advisor is a similar process and carries many of the same potential influences. Know this: when looking for an advisor, you usually get what you pay for.
Getting what you pay for, in this case, has a rather complicated connotation, especially considering that you are not just dealing with varying price tags. This time you are also dealing with varying pricing structures. It is true that highly regarded, experienced advisors tend to charge more than lesser known or inexperienced advisors. It is also true that the method of payment tends to complicate things. Financial advisors earn their income by charging their clients in one of the following manners:
- Pay-per-trade
- Fee-only
- Fee-based
- Commission-based
Pay-Per-Trade : This is a term that refers to any advisory practice that charges a rate for the simple act of trading a stock or other investment. The term “pay-per-trade” actually refers to the kind of online, self-directed investment approach covered in Chapter 8. Some companies employ advisors who may receive a base salary. In addition, bonuses may be based on the many thousands of flat-rate trading fees that the company earns every day from the clients that use their services. For the most part, this type of advisor is considered a “broker” and merely assists with your trades rather than providing advice.
Fee-Only : This term refers to the type of advisor that charges a standard hourly fee, a flat fee, or a percentage fee for his or her advice. Think of the way in which one pays a lawyer or psychiatrist. This sort of pay structure may also come with an annual fee associated with the types of investments that you and your advisor agree on. Most often, you will pay a percentage of the assets managed for ongoing advice and support beyond the initial consultation.
Fee-Based : This is probably the loosest term in the entire group. Fee-based advisors may charge a flat hourly rate plus a fee for managing your portfolio. In addition, investments purchased may pay a commission to the advisor. The degree of those commissions varies greatly between advisors and some firms will actually work in a manner closer to the category of fee-only than others. With this arrangement, clients will have the broadest range of investment options available to them.
Commission-Based : Anyone who has ever gone into a shoe store or car dealership knows that salespeople who live exclusively off of commissions are nothing short of relentless when it comes to their advice on products or services they represent. If they do not get you to “pull out the old checkbook” they do not make any money. It is essentially the same with commission-based advisors, who are paid only when you implement suggestions that they make on stocks, loaded mutual funds, insurance, or annuity products.
Which Investment Advisor Pricing Structure Is Best?
In summary, you can determine what to avoid in an advisor by following a few basic rules. The first is that while the online, self-directed advisory firms may be great for those who wish to maintain some degree of control over their own portfolios, when it comes time to offer expert advice, they tend to fall short. Basically, it is pretty easy to figure out that the advisors working for one of these services (with no commission, a base salary, and little motivation to perform well for the client) may not exactly be the “cream of the crop.”
The second point is that when dealing with a fee-only advisor (specifically those that charge by the hour) you may find yourself paying for some services that you do not really need. Look at an interior decorator analogy: it may happen that your new decorator takes a look at your entire home and tells you that everything is perfect and no changes are needed. More probable though, he or she will suggest all of the things that need to be updated and improved. Of course this service will be provided for an hourly fee. Even with that analogy in mind, the fee-only advisor is still an excellent choice if you are looking for ongoing investment management.
Then there are advisors that are primarily commission based. Imagine for a moment that you are in a mall shopping for shoes. You walk into a well-stocked retail establishment and find that it only sells brown shoes. The pleasant salesman walks over and asks if you need help. Let’s agree that you are most assuredly not going to walk out of there with a brand new pair of black shoes. No matter how badly you may want a black pair, the benefits and beauty of the brown shoes will be extolled.
Now, with that in mind, think about the commission-based planner. If you are working with an advisor whose income is based on the commissions from selling specific investments, how can you ever be certain that what you are buying is not a membership at the country club for that advisor?
At what point does adding a mutual fund to the portfolio or jumping on a stock become an action that is less in your interest and more in theirs?
By process of elimination, the best pick out of the group is the fee-based advisor. Typically, these advisors employ a nice blend of all the fee structures. Basically, you will be able to choose which pay structure is best suited for you and the advisor. This gives you the greatest flexibility and control.
Investment Advisors Help You Maintain Objectivity
In some capacity, it is important to seek counsel of some kind. Bear in mind that old saying: The man who represents himself as an attorney has a fool for a client. Nobody—not even an experienced advisor—has the answers to all of life’s (or Wall Street’s) questions. Furthermore, almost no one can completely separate their emotions from their own portfolio. This happens to be one of the most important lessons to be learned when dealing with your own money.
That is why advisors have a decided advantage. If they gain or lose $5,000 in a day for your portfolio, they are less likely to lose sleep over it. Of course this is not something to be taken lightly, even with a very large portfolio. Yet the simple fact of the gain or loss is less likely to dictate the advisors’ next move. This is what separates the successful investor from the rest of the pack.
In short, the greatest benefit of utilizing an investment advisor, in some capacity, is to gain objectivity. Portfolio decisions that are based on logic, rather than emotion, will be much more consistent with your long-term goals.
Cha-Ching, and that is ALMOST all for now…Next episode we will explore what you need to know to find an Investment advisor that is a good fit. I’m Andrew Horowitz, your guest host for this episode. Check out my regular Quick and Dirty Tips podcasts under The Winning Investor. Don’t forget to come on over and subscribe to my other weekly podcast – The Disciplined Investor available on iTunes and if you want to become more disciplined with your investing, pick up a copy of my book or audio-book, The Disciplined Investor – Essential Strategies for Success.
In a future episode, Laura Adams, your new Money Girl, will cover some investment strategies for those of you who want to go it on your own, or want to keep an eye on your investment advisor.
As always, everyone’s situation is different, so be sure to consult a tax or financial advisor before making important financial decisions. This podcast is for educational purposes only and is not intended to be a substitute for seeking personalized, professional advice.
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