Ruminations on Selecting an Advisor

Ruminations on Selecting an Advisor

It has been my experience that people struggle to know how to select an advisor and once they have one, to know whether he or she is the right one. To answer that question I suggest looking at the 5 P's: People, Philosophy, Process, Performance, and Pricing.

The primary quality your financial advisor should have is integrity, and - in spite of the sensational press stories about some advisors - I believe that most advisors are ethical and do have integrity. However, in my view, those with problems fall into one of these three categories:

  1. They are consciously trying to swindle you. Fortunately this type of person is rare and there is a criminal justice system designed to accommodate them.
  2. They just want to make you happy. This is the largest problem I see. The advisor isn't "evil", he or she just doesn't want to tell you bad news and make you unhappy. The advisor attempts to smooth things over or cover things up - just until things get better. But frequently it doesn't get better, it snowballs out of control. Does your advisor contact you with bad news immediately Quality advisors contact clients quickly, while poor advisors avoid the situation (and the phone) hoping it will somehow go away before the client notices. You want an advisor that is proactive, not reactive. If you always have to initiate contact with your advisor, that is a bad sign.
  3. They live above their means. Some advisors get into trouble (particularly in poor markets) because they are straining to keep up appearances. Truly successful people, advisors or not, live well within their means and see their wealth merely as a tool to better their families and communities.

One last aside on the topic of integrity - as we have seen in the news lately, large firms are frequently conflicted in their relationships with their clients and sometimes don't have your best interests at heart. While many quality advisors work at those firms and try to do what is right, increasingly they are leaving for smaller companies or starting their own firms. Make sure your advisor has the ability to serve you properly.

The second main quality your financial advisor should possess is competence. While I think most advisors are ethical, I do not think that most advisors are competent. Today, tax laws and investment products are complex, and it is important that your advisor be well informed. Generally, advisors succeed because they are nice, personable, and well-connected. Unfortunately, it is almost impossible for a client to determine whether or not they also know what they are doing. While there is not a perfect solution to this problem, I would look for an advisor who has professional designations and advanced degrees.


Top financial advisors may have a Master's Degree in Business Administration, Finance, or Financial Planning. In addition, if they practice comprehensive financial planning they should be a CFP (Certified Financial Planner), or a ChFC (Chartered Financial Consultant). If they are investment managers, they should also be a CFA (Chartered Financial Analyst). All of these designations not only took years of study and testing to attain, but also require continuing education.

The third quality you want in your relationship with your advisor is rapport. A successful advisor recently told me he sometimes feels more like a financial therapist than an advisor. I believe that is one of the reasons he is successful. In our culture money is a very sensitive subject, but if you haven't had open and candid conversations about your hopes, fears, dreams, and aspirations with your advisor, he or she can't do what is best for you.

While advisors may have differing philosophies, quality advisors will have a philosophy. Incidentally, "We try to make you a lot of money!" is not a philosophy.

A quality advisor will have an identifiable process. For example, the investment process should look something like the following: 1) Identify the specific goals of the client. 2) Select asset classes in which to invest. 3) Create strategic allocation best suited for the individual client. 4) Implement the allocation using the most efficient and effective vehicles. 5) Monitor performance. 6) Adjust to changes in the situation. If the advisor starts by explaining which product you should own without going through an in-depth analysis of your goals, he or she does not have an adequate process.

Overall, your investments should perform like their asset classes. If your investments are performing dramatically different from the market, that is a red flag. It may seem odd that good performance is a bad sign, but in an effort to outperform, the advisor is frequently taking sizable risks. Research has shown that there is no persistence to superior relative performance. Therefore, good performance will often be followed by poor performance.

Price is an important factor. Typically, you get what you pay for, and a good advisor should be well compensated. On the other hand, the specific products he or she uses should be relatively inexpensive. Most advisors continue to use products that have high fees in spite of the fact that research indicates this does not lead to improved performance. In addition, many advisors do not pay adequate attention to (or are ignorant of) tax implications and transaction costs of their decisions. While these costs are not obvious, that does not make them any less real.

It is also important to note how an advisor is compensated. While no compensation method is perfect, we believe a fee-only approach is the optimal way to align the advisor and client toward mutual goals. Many good advisors still work on commissions, but they face conflicts between what is good for the client vs. what is good for them and their firm. One way to evaluate advisors is to note whether they use more than an incidental number of products managed by their firm. Most companies in-house products have relatively high fees and poor performance, but advisors frequently get additional compensation for using them. Good advisors generally avoid these proprietary products.

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