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What to Look For When Choosing An Advisor

What to Look For When Choosing An Advisor


  1. Is this a person you can trust?  This is the most important factor in trusting someone with your money.  If you aren’t comfortable with the person managing your investment portfolio, you won’t be comfortable with your investments.  If a potential advisor can’t explain what he is doing and why, you should be cautious.  The Advisor should not take possession of your assets, but should use a third party custodian.

  2. What is the advisor’s business model?  There are two basic approaches.  One is a Broker-Dealer model, where a Registered Representative makes recommendations on what to buy and sell, and receives a transaction-based commission.  This is generally non-discretionary, so the client ultimately makes each decision.  Registered Representatives are required to only recommend investments that are suitable for the client.  The other model is the Registered Investment Advisor (RIA).  This model is generally fee-based, and discretionary.  The RIA is paid an agreed-upon fee, often tied to assets, to manage the portfolio in accordance with a plan agreed upon by the client.  The RIA is a fiduciary of the client, meaning all investments must be in the client’s best interest.  (See links below for explanations of the models.)

  3. What are the fees?  There are two considerations here.  First, what is the total amount of expected fees?  Future investment returns are difficult to predict, but fees are quite predictable.  Over time higher fees can cut into potential gains.  Second, how are the fees structured?  Incentives matter, so they should be aligned with what is in the client’s best interest.  A commission-based structure rewards brokers who make transactions or sell products that have high commissions attached.  A fee-based structure rewards advisors who grow the assets.

  4. What is the background of the advisor?  Many people who are looked to for investment advice are actually financial salespeople.  They know enough about the products they sell to be able to speak intelligently, but their background and skills are in sales.  They have probably passed some exams, like the Series 7, which require a few weeks of studying.  Look for an Advisor who has a strong financial background.  Inquire about education, experience and credentials.  While no degree, work history or credential is a guarantee of ability, they are helpful indicators.

  5. What services are being offered?  Is the Advisor making a comprehensive financial plan or simply managing a slice of your portfolio.  Make sure the services offered match your needs.  Financial success involves more than just picking a few stocks.  Clients should have a comprehensive financial plan, with objectives, needs, means and risk tolerance considered.  Clients may also want to do tax, estate and philanthropy planning.  A client may choose to split these services among multiple advisors, but should make sure each need is met.

  6. What is the investment approach used by the Advisor?  If the Advisor is making investments, he should be able to articulate an investment philosophy he follows and why that approach works.  Make sure you are getting diversification, particularly across asset classes (e.g. US and International stocks of different sizes, bonds, etc.)  Asset allocation is the most important factor, as some studies have traced around 90% of returns to asset classes.  Evaluate whether the Advisor truly has the resources to execute on his investment approach.  Be careful of approaches that rely heavily upon very hard to execute tactics like market timing and short-term trading.  In general, well-developed, disciplined strategies are more likely to yield positive long-term results.

  7. Is the Advisor starting with your unique situation and crafting a personalized service or starting with products and selling them to the masses?  If you are paying for personal financial advice, you should not settle for a canned solution.  Ask any potential advisor about his process for getting to know you and tailoring a plan to your situation.


RIA vs. Registered Rep

This explains the difference: http://investorjunkie.com/24051/difference-ria-broker-dealer/

This fun whiteboard illustration graphically explains the difference between an RIA and a Broker.  https://www.youtube.com/watch?v=Dg5RRMAc1GY 

This whiteboard illustration is a little more detailed, but also offers an easy to understand explanation of the difference between an RIA and a broker. https://www.youtube.com/watch?v=0tgQxvWfi0c