Financial Advisor Rating is an Art

Financial Advisor Rating is an ArtHow do you develop a financial advisor rating for a professional who does not have a track record? You have no way to determine if the advisor has produced competitive returns in the past. And, since you have no way to validate what the advisor says, you run the risk of selecting the financial advisor with the best sales pitch versus the highest rating.

CPAs & Attorneys

When you think about it, you also select other types of professionals without any form of documentation. How do you know you selected a high quality CPA or attorney? You don’t. You make your selection decisions and retention a function of your experience with that professional. You retain CPAs and attorneys if you believe you are getting high quality advice. The same is true for financial advisors.

Why No Track Records?

So why don’t financial advisors who generate performance reports for their clients have track records? Their argument is all of their clients are different, so unlike money managers, there is no one track record. It is true money managers provide the same service to multiple clients so it is easy to produce a track record. Advisory services vary by client so it is difficult to produce a track record. But, it is possible to segment clients into categories, young–middle-aged-retired, and develop track records for each segment. However, very few advisors have taken this approach. They don’t have to if investors are willing to hire them without any documentation for past results.

Substitute Track Records 

Some advisors, in particular the more aggressive ones, use fake track records to convince you to select them. They may show you a few hot performing mutual funds and claim they selected the funds before the performance occurred – knowing full well you have no way to invalidate this sales claim. This is not a track record. There is a 99% probability the advisors selected the funds after the performance occurred. Anyone can do that.

References

Some advisors will refer you to clients and professionals who will make positive statements about their performance. In my opinion, references are worthless because no financial advisor will give you a bad one. In fact, most references are carefully selected, advisors may have coached them, and there is a good chance they are friends. Talk to references if you want to, but don’t put any credence on their remarks about performance.

How to Determine Competence

It takes years to become an investment expert so select advisors who can document years of financial advisory experience. High quality certifications, such as CFA®, CIMA®, and CFP® are a great way to obtain specialized financial knowledge. College degrees, in particular advanced degrees, can be a plus. Membership in associations can also increase advisor knowledge if the associations have continuing education requirements. Be sure to ask advisors to document answers to your questions about their investment credentials. If you ask multiple advisors the same questions it will be easy to compare their responses and select the one with the best qualifications.

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