Many investors can capably manage their own
portfolios. Others need advice from a competent
practitioner. But not all advisors are high-caliber
professionals who conscientiously put the best
interests of their clients first. Some operate like they
are selling shoddy used cars: They'll put you into any
vehicle that will turn a quick profit and then quickly
move on to their next victim. How can the uncertain
investor make a wise choice?
Quality professionals can be identified by their
emphasis on policies and procedures that promote
the continued well-being of their clients. Here are
some of the more important.
Develop a Plan
Investing without a plan is like driving without a
destination in mind or road map in hand. Instead of
a bucolic countryside, you could find yourself
passing through industrial wastelands, and who
knows where you will end up or whether you will
simply run out of gas? If you don't know where you
are going, you are not likely to get there. Serendipity
has its place, but for best results, don't substitute
luck for an investment road map.
The first job of an advisor is to develop an
investment plan specifically designed to meet a
client's goals and objectives. These may include
retirement funding, inheritance preservation, tax
reduction, charitable gifting, and more. Once the
destination is known, the investment advisor can
determine if there's enough gas in the tank to reach
it, and select an efficient route to get there.
This must be a collaborative effort, by the way. The
advisor is just that, an advisor. The client needs to be
involved in the process too, and must assume
responsibility for clarifying goals, understanding the
plan, getting comfortable with the route, and letting
the advisor know when problems arise.
As I have written in previous newsletters, the road to
reaching your investment objectives is littered with
costs. Although these costs may appear insignificant
-a percent here or a percent there'they can
become serious impediments to reaching your
One niggling problem is the way fees are presented
(if they are presented at all). A mutual fund's
expense ratio may be 2%, for example, which may
seem like an insignificant part of the total amount
invested. A different picture emerges, however,
when we compare fees not to the total amount invested,
but to the expected return.
Let's be generous, for example, and assume that a
well-diversified investment portfolio is expected to
return an average of 8% over the long term. (You
might pick a different number, but if your
expectations are well into the teens or higher, I
suggest you get a grip on reality.) At 8%, a $1 million
portfolio will return $80,000 a year on average.
Now consider this: That 2% mutual fund expense
ratio mentioned above is actually one-fourth, or
25%, of the 8% expected return. That $80,000
return has suddenly shrunk to $60,000.
The lesson for investors? When evaluating fees,
compare them not to the amount you are investing,
but to your expected return, and you will get a better
idea of the impact costs could have on your
anticipated investment success.
Another problem is frequent but unnecessary
trading in a client's account. Some people call this
'increasing the velocity,' or increasing the number
of transactions over a given period of time. For
investment brokers, increasing the velocity also
increases their income, because they usually get paid
a commission or other fee for each transaction.
These brokerage commissions and fees are deducted
from the client's portfolio. Unfortunately, the new
investment often performs no better than the
previous one, and the costs of frequent trading
reduces the client's return.
There are times, of course, when trading is
necessary. Trades in a new account may be required
to bring the portfolio asset allocation in line with the
investment plan. After that, as some assets perform
better than others, the overall allocation may drift
away from the plan. Trades may again be needed to
rebalance the portfolio according to plan.
Investment expenses are unavoidable. But a quality
investment advisor will work hard to reduce fees and
trading costs - and minimize taxes as well.
Yes, investing is often difficult, but contrary to what
many in the industry will have you believe, investing
need not be overly complex. It really boils down to
setting realistic goals, and then developing and
executing reasonable investment strategies to reach
The industry, as you may have noticed, is constantly
reinventing itself by creating new investing
"solutions" (these used to be called "products") -
solutions that often go seeking a problem. Some
catch on for a while. For example, hedge funds and
separately managed accounts are currently the buzz.
But more often than not, these investment vehicles
are not truly solutions to the problem of how
investors can increase their returns or reduce their
risk. Instead, they are solutions to the problem of
how brokers can increase their fees.
The quality advisor will avoid complex investment
strategies where possible, not only because they
generally cost more, but also because he wants his
clients to understand their investments and how they
relate to fulfilling the investment plan. The quality
advisor, then, will steer towards simplicity and
Many investors look at their brokerage or mutual
fund statements and don't really understand what
they own, why they own it, what their returns are, or
how much they are paying in fees. Sadly. many
people in the investment industry like it that way.
This makes it easier to look like an "expert" ("Yes,
dear client, it's all very complicated") and to obscure
things they'd rather clients didn't know.
A quality advisor, however, works hard to inform
clients and to increase their awareness and
understanding. Every quarterly report from Cascadia
Investment Consultants, for example, clearly
presents the portfolio's asset allocation, quarterly
return, and quarterly management fee.
Again, it's a collaborative relationship, and clients
need to be informed and involved as much as
possible. Moreover, since the quality advisor is also
working hard to reduce expenses and avoid
complexity, she is proud of her work and welcomes
side-by-side comparisons with other professionals in
"The only certainty is change," the saying goes. The
conscientious advisor will initiate regular
communications with clients to stay informed about
changing life circumstances that may call for
reworking the client's investment plan.
Even without change, however, the advisor still will
review each client's investments periodically to
ensure that the plan makes sense and that assets
remain allocated according to plan. The review
might, depending on the advisor's policies, also
prompt the advisor to take advantage of perceived
misvaluations in the market.
For their hard work and expertise, advisors might be
paid in several different ways, but some of these
ways present serious conflicts that put the interests
of the advisor and his affiliated broker ahead of the
interests of clients. Some advisors, for example, are
under pressure to generate sales, commissions, or
other fees by pushing expensive proprietary
"solutions" onto clients with only token regard for
the client's well-being.
One way that quality advisors get around this
pressure and maintain independence is through feeonly
business practices. Fee-only advisors refuse to
accept commissions. Instead, clients pay these
advisors directly. This is usually better for clients
because then they know what they are paying, and
fees paid to fee-only advisors are usually lower than
the combined commissions, loads, and other fees
paid to commission-based advisors. Moreover, feeonly
advisors are not restricted to certain
"approved" investments but are free to select from
the full universe of investable assets.
Better advisors, then, are not beholden to any
financial institution. This enhances independent
judgment and promotes unbiased advice that puts
client interests first.