by Jack Waymire
This happens more than you’d think: Three guys are having lunch after a round of golf and they start to talk about their investments. One thing leads to another, and one of the men recommends his financial advisor. This might come as a blessing – no extra work for you; if your friend trusts them, you should too. But beware: The traits that make someone a good friend don’t necessarily make them a good financial advisor. In actuality, good friends could be bad financial advisors.
As we dig deeper into this seemingly harmless conversation at the golf course, let’s see what went wrong.
Here’s how the conversation may go:
Golfer #1 isn’t happy with his current advisor and tells his friends that he’s thinking about working with someone else. “You should talk to mine,” offers one of the friends. “He’s a great guy.”
“Oh yeah? the golfer says. “What do you like about him?”
“He’s smart, he’s funny, he really knows his stuff,” his friend shares. “He’s a scratch golfer and went to Stanford. You’d like him.” He may share old college fraternity stories and the advisor’s family makeup. “My wife really likes his family,” he might add.
“Sounds like someone I could work with. Give me his number and I’ll give him a call.”
Did you notice that the friends did not discuss the advisor’s credentials or education? They didn’t even talk about the types of services the advisor focuses on.
In these kinds of conversations, what you don’t typically hear is how long advisors have been in the business, what they specialize in or what certifications they have. All the friend finds out is that he or she is a likeable person. But many salespeople are great people too. They just might not be the person you want handling your money.
Something else to consider: When people talk about their investments, they tend to share successes. Talking about their losses highlights their mistakes. When you hire a financial advisor to take care of your hard-earned money, the negatives can be just as important as the positives. The stock market might be doing very well, and the friend is earning the credit for positive investments.
The sad truth is Wall Street knows that people inherently trust people they like. So they put a big emphasis on salespeople with strong people skills. Making assumptions can be very dangerous.
When most investors select a financial advisor, they then follow his or her advice more than 90 percent of the time. They don’t typically question the advisor’s recommendations, just like they wouldn’t question the advice of a CPA or an attorney – they are the experts and you pay them a lot of money for their knowledge, advice and services.
But again, Wall Street knows this, and some advisors use sales tactics to convince you they are experts – that is the key to the sale.
Instead, when you select a financial advisor, you should remain objective and do your research.
There is a certain irony when you select a financial advisor. The best may have less than stellar personalities, whereas bad financial advisors can be very relatable. That’s because many of the really good advisors are intellectual, quantitative and analytical by nature. They may be better with numbers than they are with people. While these qualities might not make them very fun to hang out with, it can make them excellent financial advisors. The likeable advisor may tell you what you want to hear. The quantitative advisor will be more inclined to tell you the truth, even if it is not what you want to hear.
What Really Matters
We encourage investors to use the Internet to gather information about advisors. What should an investor really be looking for? That information falls into four categories:
- Credentials (education, experience, certifications)
- Ethics (licensing, fiduciary, compliance)
- Business Practices (compensation, communications)
- Services (planning, investment, insurance, tax, legal)
Let’s break them down:
When finding the best advisors, you should always evaluate their education, experience and certifications. Remember, while some firms require a certain level of each, the industry itself has no required amount of education, experience or certifications earned to practice as an advisor. That’s scary.
In doing your research, you may find that some advisors have college degrees, some have advanced degrees and some did not attend college. What can you learn about advisors based on their education? Well, at a minimum, a college degree shows a commitment to learning, and a career in financial services requires a lifetime of learning, because it is always changing. Degrees associated with finance, planning and portfolio management are more important than degrees that have nothing to do with financial services. Graduate degrees can also be important. There are dozens of colleges and universities that offer undergraduate and advanced degrees in financial planning and investment management. Advisors who have these degrees have made a substantial commitment to becoming a financial expert.
However, while education does create a strong foundation, it is experience that creates a real financial expert.
Remember, as we’ve stressed before, experience does not mean age. A 30-year old financial advisor may have 10 years of experience, while a 40-year-old advisor may have just entered the field of financial services. Years measure time, but years don’t tell you anything about the quality of the professional’s experience.
To determine the level of an advisor’s expertise, you should look at data such as:
- Number of clients
- Assets Under Management
- Sample financial plans and portfolios
- Results in the form of track records or actual portfolios
- Data at the regulatory agencies
Certifications, also called designations, are another way advisors acquire the expertise they need to provide good advice and high-quality services. But all certifications do not have the same value. You must do your research to weed out the bad financial advisors.
Investors want financial advisors they can trust, and the best advisors have certain characteristics that impact their trustworthiness.
Licensing & Registration Securities licenses (Series 6, Series 7) enable financial advisors to sell investment products for commissions. They are compensated with commissions by broker/dealers and third parties, for example, a mutual fund family.
Registered Investment Advisors (RIA) and Investment Advisor Representatives (IAR) are registrations that enable firms and professionals to provide financial advice and ongoing services for fees. For example, you pay an hourly or fixed fee for a financial plan or you pay an asset-based fee for investment advice and services.
We believe the appropriate way to pay for financial advice is with a fee, just like you pay other professionals you depend on for specialized advice and services.
There are also hybrid advisors who hold both types of licensing and registration. They can sell products for commission or provide financial advice for fees. In general, they sell commission products to investors with smaller asset amounts and provide advice and services for fees to investors with larger asset amounts.
A fiduciary is a person who holds a position of trust.
You should select a fiduciary advisor if you want a professional who is required to put your financial interests first. Only RIAs and IARs are financial fiduciaries. They are held to the highest ethical standard in the financial services industry.
Any other type of financial advisor is not legally bound to put your interests first. They are held to a much lower ethical standard that only requires suitable recommendations.
The best financial advisors also have clean compliance records. However, it is important to note that the longer an advisor is in the industry and the more clients he or she has, the higher the probability that there is a complaint on his or her record.
Another thing to consider is an advisor’s business practices – do they favor you or them?
Some advisors choose not to disclose their business practices to prospective clients because their practices are not investor-friendly. They use a “don’t ask, don’t tell strategy” to withhold information. For example, if you don’t ask about their experience, they more than likely won’t volunteer that they are new to the industry.
A lack of transparency creates major risk. In the above example, the advisor is practicing omission. Consequently, you could hire an advisor who lacks the experience you need to help you achieve your financial goals.
There is also misrepresentation. Some bad financial advisors have used fake credentials to support their claims. Others have said they produce superior investment returns without providing an audited track record. And if this information was communicated to you in a verbal sales pitch, you have no record of what was omitted or misrepresented. If there is a future dispute, it is your word against the advisor, and you will more than likely lose the dispute because you have no proof that you were misled.
Compensation is also an important topic to discuss. Did you know that some advisors are paid by a third party to sell investment or insurance products? Others make money from their relationship with you. For example, they may have been paid thousands of dollars in commission for a one-hour meeting and some sales recommendations.
The best financial advisors disclose how much they are compensated, who compensates them and what you receive for the compensation.
It’s also important to discuss a financial advisor’s specific services. You need to know if they specialize in things that will allow you to achieve your financial goals. Are you interested in insurance and tax and your advisor focuses on estate planning and wills? Again, make sure you conduct the proper research. A little extra time in the beginning can save you a lot of money in the long run.
If you find yourself in one of the common conversations we started out with, and a friend recommends a financial advisor, it is OK to follow-up on that recommendation, but you must follow-up correctly and conduct the right amount of research to determine that the friend is also a good financial advisor.
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