Choosing an investment advisor is a very important decision that many investors rarely give much thought to. Some simply make a choice based on the recommendation of a friend or family member, while others stumble upon an advertising campaign or other flashy marketing piece.
In my experience, people spend more time researching their next TV or computer purchase than they do in selecting the professional that will steward their nest egg. This is probably because there is instant gratification in the purchase of a new toy rather than the months and years it will take for an investment advisor to prove their worth.
Over the years I have spoken to hundreds (if not thousands) of investors that are searching for the right fit in managing their assets. Below are some of the biggest mistakes I see being made in this decision process.
1. Obsession with fees.
The media and many industry experts have done an outstanding job in calling out the excessive fees that have plagued Wall Street for generations. Products like annuities, 401(k)s, actively managed mutual funds, and even hedge funds have been derided for their disproportionately high fee structures. This has led to the trend of investors swapping these products for low-cost exchange traded funds and automated investment programs with rock-bottom expenses.
While this subject has been in the spotlight for years, the pendulum has now shifted to an obsession with every basis point of embedded expense. Now things like the difference between an $8 trade and a $9.99 trade are considered huge controversies for investors considering two different online brokers. Similarly, the difference between an advisor charging 0.90% and an advisor charging 0.80% can often sway an investor to pick one over the other.
I'm going to let you in on a little secret. In the long run, neither of those decisions is going to matter as much as the securities your money is invested in or the advice you are given during a tough stretch in the market. Fees are important, but the continued democratization of the industry is leading to some of the lowest overall expenses in the history of the game.
Don't confuse cheap with value. There is a huge difference between buying the cheapest car on the lot versus the car with the best value for the options that come with it. You get what you pay for.
2. Fixation on experience.
This section should really be labeled a focus on age. For some reason, older advisors are considered to be much smarter and more reliable than their younger peers. They have seen and done it all, so they must be the best choice when comparing two different professionals. A little gray hair goes a long way in creating a heartwarming sense of knowledge and wisdom.
I'm 34 years old. I was not even 6 years old during the 1987 crash. Crazy, right?
Fact: My age has nothing to do with my ability to successfully navigate my clients through the next crisis in the market. It may even provide a better perspective because I'm not constantly looking over my shoulder and making ad nauseum comparisons to the markets of old.
Every cycle in the market is different. Period. Today's market is far different from the 80s and 90s just based on the sheer speed of information and volume of trading.
The only thing that will be a constant throughout every generation is the predictable swings between fear and greed that are a function of human psychology. Market's change, people don't.
3. Preoccupation with short-term historical performance.
This is a question I get a lot - How did you guys do last year?
If I said we were up 5%, 10%, or even down 2%, how could you possibly frame that response in the context of your individual risk tolerance and expectations? In addition, it should be understood that this current year in the market isn't going to look anything like last year.
I fully understand the desire to know an advisor is at least keeping some level of correlation with the overall market. Nevertheless, there are a tremendous number of circumstances that need to be explained before performance will even make sense. In addition, every client's portfolio will be slightly different based on their unique needs, timing, risk tolerance, cash additions or withdrawals, and other exogenous factors.
In order to understand these nuances, some of the following questions may be appropriate:
- How do you construct your portfolios?
- What does your portfolio look like now?
- What benchmark do you use to gauge your performance?
- What was your max drawdown in ___ year or in the history of your strategy?
- What factors go into making changes to the portfolio?
- Who is the person or committee that makes these decisions?
- What type of macro events may lead to you changing your stance in the future?
- Is your own money invested in the same place as mine?
The responses (or lack thereof) to these questions will help you understand the level of knowledge your advisor possesses about building a sensible portfolio. This may shock you, but many investment advisors are better salesmen than money managers. Make sure that you can identify the difference between the two before you turn over your hard earned nest egg to anyone.
4. Assuming all advisors are the same.
Assumptions in investing can be costly and often lead to expectations that a current trend will continue indefinitely. I often have investors dejectedly explain their horror stories with past advisory relationships that led to ill-timed investments, high fee products, and an overall destruction of trust. This creates a sense of paranoia that the same thing will happen with the next professional they hire to manage their money.
Fear of making another costly mistake isn't something that should hold you back from finding the right person to oversee your assets. Make a resolution right now to break the cycle.
If you have had bad experiences in the past, reflect on what you learned from those moments and use them to make a more calculated decision in the future. This should lead to better interviewing of any future advisors and the ability to detect someone who is telling you what you want to hear versus someone that has a reliable philosophy.
Also, try to avoid full blown capitulation of the industry if you know deep down that you need help. I have watched people just throw up their hands at the whole group and say" I'm just going to do it myself" or "I'm just going to buy an annuity and be done with it". Investing is difficult under the best of circumstances and if you don't have the time, tools, and discipline to do it alone then you should continue to seek out a qualified professional to help.
Lastly, and this is completely anecdotal, I have never heard a single person tell me that buying an annuity was the best thing they ever did. Most quickly realize the fees are high, the guarantees are conditional, and they lock you into tight specifics with little flexibility.
5. Not aligning yourself philosophically.
Don't try to fit an advisors' belief system into your unique viewpoint if they don't match up at the outset. It's like trying to fit a square peg in a round hole. You may be able to jam it in there for a short period of time, but eventually it's going to fall out and you both will be disappointed at the results.
- If you have been an ardent buy-and-hold investor for the last 25 years, then don't seek out a flashy trading service that has shown short-term success.
- If you have always been an index mutual fund investor, then don't switch to individual stocks or options just because someone tells you "this is the best way".
- If you firmly believe in risk management or market timing, then seek out an advisor who also follows those beliefs and has developed a system to counteract volatility.
The biggest risk of stepping outside your comfort zone is that the moment the new strategy comes under fire during a difficult period, you will likely abandon it at the worst possible time. This will set back your performance and lead to the type of regret I explained in the last section.
Comfort with an advisors' investment tools, decision making process, communication, and overall knowledge of portfolio management should be critical components in your final decision.
Every strategy is going to experience periods of pain - count on it. However, being able to look each other in the eye (even metaphorically) and understand WHY something is being done will be a tremendous advantage in working together as a team to achieve long-term success.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.