Not Created Equal: Putting the Interests of Clients First

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.

Minimize Costs
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 destination.

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.

Reduce Complexity
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 those goals.

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 transparency.

Report Clearly
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 industry.

Review Periodically
"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.

Maintain Independence
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.