How (not) to choose a financial advisor

Last week a friend of mine asked us for help with his portfolio. His portfolio hadn’t made any money in eight years and he hasn’t made RRSP contributions for the past two years because he’s been so unhappy with the performance. He’s already switched financial advisors once (in 2008). Right now he’s feeling stuck and wondering what to do next.

When our team looked at the portfolio, it revealed that the fees are high (MERs of about 2.75%) and he has an over-weighting in small cap mutual funds – both of which have dragged down his performance. Equally revealing is how he came to choose his current advisor.

He told me: “We knew each other when we were 18 year old boys. He left for university in his 20s like I did, and ended up as a RR, eventually settling with his current firm. He had a local radio show in our home town – I even went on it from time to time thinking even if I don’t get any returns, at least it will be good for my business – but this really has not panned out.”

Now, he’s a close enough friend that I can tell him that’s a pretty poor reason for choosing an advisor. But he’s not alone. Often, people choose advisors on the basis of personal relationships, a referral from a friend or respected colleague or ‘gut instinct’ from an initial meeting. Of course we all want to deal with people we know, like and trust. That’s important. But it’s not enough. You’ve got to be clinical in your approach if you want to find a competent and professional advisor who is a good match for you .  Below are our ten criteria for choosing an investment advisor.  Hope you find it helpful. 

1. Credentials
The investment industry has a broad spectrum of professional accreditations and registrations. Start your search by deciding what specific services you need, and then determine which credentials are best suited to providing them. From a pure investment perspective, the credential held by most institutional money managers, analysts and investment counselors is Chartered Financial Analyst (CFA).

For more comprehensive advice, a Chartered Accountant (CA) or even a Certified Financial Planner (CFP) will have expertise in tax and financial planning. A Masters of Business Administration (MBA) provides a solid business background, but is no indicator of investment acumen. Some questions to ask potential advisors: Why are you qualified to advise me? What are your educational credentials and experience? How long have you been doing what you do? How do you stay current in your field? How long have you been with your current firm, and why are you there?

2. Competence
Credentials are only one indicator of the advisor’s ability to do the job you want. What about their actual results? You should ask: What do you invest in and why? What is your area of expertise? What’s your track record? How do you define risk, and how do you manage it?

Beware of individual advisors who say they do everything well. There are too many specialty asset categories for one person to know them all. And I’m especially leery of advisors who say their approach is like Warren Buffet’s. Ask if their performance is like his, too.

3. Choice
When your goal is to earn a good return on your capital, you want as many arrows in your quiver as possible . A broader asset mix is proven to deliver better returns and withstand volatility. Ask prospective advisors: How large is the investment universe you have to choose from? Do you have access to investments outside of stocks and bonds, such as real estate or private equities? If so, how are these selected? Whose expertise do you rely on to invest in these areas?

If an advisor is limited to proprietary products or an in-house investment-management team, ask how you can spread your risk. What happens if the team is in a slump? Or if their investment style or asset class goes out of favour? What independent sources do they consult in making investment decisions?

4. Consolidation
Some people spread their assets among different advisors; others like to consolidate with one advisor for simplicity’s sake. If you wish to deal with multiple advisors, recognize that it means more work for you: communicating with each, avoiding duplicate investments, comparing results. The best solution, if you can find one, may be an advisor who can oversee your entire financial picture, but accesses different investment managers to spread the performance risk.

5. Clients
One of the most important (and least-asked) questions is: What types of clients do you work with? Make sure the advisor is practiced in handling clients with your types of issues. The size of the advisor’s practice should also concern you. Some may serve 500 or 600 clients, usually with the help of a support team. Make sure you find out who on the team will manage your account, and that you are equally comfortable with their capabilities. Enquire about the rate of turnover on the advisor’s support team, as these positions are often viewed as training grounds for new advisors. If you have $1 million or more to invest, your advisor should probably have no more than 100 to 150 clients.

Finally, it’s always good practice to request a list of clients willing to provide references.

6. Contact
Research says more people leave their financial advisors due to poor service than poor performance. Most common complaint: lack of communication. Establish up front how much contact you expect and in what form. Ask: How often will I hear from you? How often will we sit down to do a formal review? How will you keep me up-to-date on the factors that are impacting my wealth? How often will I receive statements? What information will they give me? Who else will be part of the team servicing my business?

7. Comprehensiveness
Investments are only one component of your total wealth. You may feel that you need access to a comprehensive set of financial capabilities. Ask your advisor if you will receive a written analysis of your financial situation with recommendations. (See point #1 for their credentials to provide this.) Do you want someone who will offer broader advice, including non-related financial issues such as insurance, or wills and estate work?

8. Cost
Always ask, how do you get paid? There are basically two remuneration structures in the investment industry: commission and fees. Advisors may earn commissions on the products they sell, such as stocks, bonds or mutual funds. Under this structure, advisors are paid only when there is a transaction, not directly for their advice. If you plan few transactions, this may be the least expensive model. Given the possible conflict, however, be certain the advice you get will be in your best interests, and that you will get attention even when there are no transactions to be made. Check if there are any financial incentives for the advisor to recommend certain products.

In fee-based structures, advisors are paid an annual fee for their advice and investment management, generally expressed as a percentage of assets under management. As your assets increase or decrease, so goes the advisor’s compensation. Individuals with $1 million or more to invest likely shouldn’t pay more than 2% of assets under management for professional management of a balanced portfolio. Mutual funds, by comparison, are relatively expensive: the average management expense ratio of a balanced mutual fund in Canada is about 2.5% (Source Globefund.com Dec. 31/08).

9. Compliance
It may be a touchy subject, but due diligence requires that you ask about each advisor’s compliance record. An advisor with a strong compliance record generally presents less risk to clients, compared to an advisor with few or ineffective compliance controls. Questions to ask: Have you ever been disciplined by any regulator for unethical or improper conduct? How does your firm ensure proper practices and procedures are followed?

10. Chemistry
You’ve done your homework. You’ve checked the facts and asked all the right questions. Now your decision is simple: who makes you feel most comfortable? An ideal relationship may last for years, so you want an advisor you know, like and trust. Let your instincts guide you. You’ve prepared well.