Seeking an investment advisor isn't easy. Advisors vary widely in their training, backgrounds, experience and approach. And they have different levels of competency. The reality is that many advisors routinely fail to add value to your holdings in amounts that exceed their fees.
But having the right advisor can produce returns far superior to what you'd earn when left to your own devices. The key is to avoid choosing the wrong advisor. Clients of Bernard Madoff, whose Ponzi-scheme of an investment firm bilked them out of billions, are ruefully aware that choosing wrong can be hazardous to their wealth.
So how can you choose the right person? There are myriad ways to go about this, and none of them is a glass slipper for finding a princely advisor. But there are some rules of the road to keep in mind:
It's not what they're called, but what they do. You'll encounter various labels: financial planners, wealth managers, portfolio managers, financial analysts. These labels are generic, and don't tell you much about a person's background, training or approach to investing. So no matter what it says on the shingle, you need to find out precisely how they propose to make money for you.
Look past the alphabet soup. In their bios, advisors often list abbreviations for various titles after their names. Academic degrees aside, these impressive-looking abbreviations are known as "designations." They indicate that the holder has completed a course of study in a financial specialty.
Some of these courses are extensive and the examinations, demanding – for example, the requirements to be a Certified Financial Planner. But many designations mean only that the holder has passed an easy test after a course lasting a couple of days. Most designations are little more than sales tools.
Check up on them. If advisors earn commissions selling securities (stocks or bonds), they should be be registered with the Financial Industry Regulatory Authority (FINRA). On its website, FINRA has a search function consumers can use to check up on an advisor's background, training, education, disciplinary history and income sources.
If advisors earn fees from clients, they must register with the Securities and Exchange Commission (SEC) or with the comparable agency in the state where they practice. Investors can check up on these registered investment advisors using the advisor-search function on the SEC website. Both sites carry a history of complaints against advisors. Just because there has been a complaint doesn't mean you should forget about a candidate. But multiple complaints – or one that's particularly troubling – might be a red flag.
What's an advisor's "minimum"? Advisors usually require a minimum amount of assets that they will handle for a client. Often, it may be more than $500,000, but many advisors take $250,000 or less, especially from younger clients whose wealth is likely to grow as they age. You can save time by simply calling the advisor's office and asking what the minimum is.
Conduct an interview. You're the employer, so act the part. Ask advisors about their backgrounds, philosophies of investing, approach to risk and above all, how they get paid. If their answers make it seem as if they're not getting paid, be wary.
Advisors get paid in two basic ways: fees charged for services (usually a percentage of the assets under management--often about 1 percent), and commissions from investment companies for selling products. Some consumer advocates maintain that commission arrangements are an inherent conflict of interest, but many advisors who earn commissions produce excellent results.
Some advisors earn both fees and commissions. The challenge in these cases is to understand when advisors are wearing the commission hat and when they're wearing the fee hat.
Regardless of how an advisor gets paid, you want one who puts your interests first. Fiduciaries have a duty to do just that. A fiduciary is someone whose legal/regulatory status exposes them to significant legal liability and government sanctions if they don't put your financial interests above their own. (All advisors registered with the SEC and comparable state agencies are fiduciaries.) Regardless of an advisor's status, be sure to ask about any scenarios that might pose a conflict of interest.
Also ask about any complaints you found in their backgrounds on the FINRA or SEC sites. These complaints may be insignificant because any client can get miffed. What counts is how the candidate advisor answers your inquiry – the light he or she sheds on the issue.
Screen for hubris. Some advisors are too egotistical to be reliable. A good way look for this is to ask them to discuss a mistake they once made. If they seem irritated or can't come up with an example, disregard the advisor. You want an advisor with some degree of humility.
Pursuing this line of questioning with an advisor is comparable to job interviewer's asking a candidate: What are your weaknesses? This is a classic question for a reason: People lacking humility tend to be over-confident and inflexible.
Of course, Bernard Madoff might have met all of these criteria. But Madoff's epic fraud wouldn't have been possible if clients had questioned his uncanny investment returns. In investing, as in all endeavors, be skeptical of anything that seems too good to be true. Question everything.
Ted Schwartz, a Certified Financial Planner®, is president and chief investment officer of Capstone Investment Financial Group (http://capstoneinvest.net). He advises individual investors and endowments, and serves as the advisor to CIFG Funds. Because Schwartz has a background in psychology and counseling, he brings insights into personal motivation when advising clients on achieving their wealth management goals. Schwartz holds a B.A. from Duke University and an M.A. from Oregon State University. He can be reached at firstname.lastname@example.org.