How To Choose An Advisor, Part II

by: John Lohr


There are literally hundreds of types of financial advisors, with different skills and different roles. What type is yours?

Some people need an advisor just to insulate themselves from the herd mentality.

Investors bear responsibility for their choice (or non-choice) of an advisor.

"Investing based on return is like buying cattle because you like their brown eyes." -- Ian Lohr, author

I've learned a lot about investor sentiment by reading comments and articles by Eric @ SERVO and Gil Weinreich and others here on Seeking Alpha. They point out the reasons why there is a wide disconnect between sophisticated veteran investors with some experience under their belt (I didn't specifically say "old") like we see on SA and financial advisors. Specifically, I've gleaned the following:

  1. A fundamental lack of understanding among investors of the role of a financial advisor.
  2. As pointed out by Eric, education and information does not in and of itself produce better financial outcomes for investors.
  3. Some investors, even your sophisticated ones, can use some handholding to prevent a really bad investment decision.

Here are a couple actual investor scenarios we've talked about:

The well-informed DIY investor who has been sitting in cash since 2007 and is financially paralyzed now, still waiting for the "right time to invest."

Another well-read DIY investor afraid of running out of money in retirement who bailed out of the market in 2009 and never got back in.

An investor with a discretionary money manager who required his advisor to go to 100% cash in June this year because he was convinced the market was going to hell in a handbasket "any day." Still twiddling his thumbs.

Consider this about financial advisors. As Eric points out you can read a lot of complaints about paying a financial advisor 1% for nothing. Thursday Gil wrote about interviews with Santa Clara University behavioral finance professor Meir Statman who said,

Paying someone 1% a year to keep you from making 1.5% worth of mistakes can make a lot of sense.

And who also said:

Clients are their own worst enemies. They come to advisors to tell them when to buy and when to sell, and what to buy and what to sell. But that's not what advisors can do-period. Advisors cannot beat the market. But they can prevent clients from doing really stupid things."

4. Investors do not always clearly understand the actual role of the person they are referring to as a "financial advisor." Not all apples are alike in this basket. Here are a few types:

Your advisor recommends stocks, bonds, funds, ETFs, etc. for you to buy. You buy through your advisor and he/she gets commissions (and trails). You probably have a broker. Is that what you want?

You have an advisor that crafts for or with you a financial roadmap for you to follow and documents it in a plan. Maybe you even pay him/her a percentage of assets to implement the plan for you. You probably have a financial planner who calls himself/herself a "financial advisor." Is that what you want?

You have an advisor that develops an investment strategy and implements it for you with your okay. You probably have a non- discretionary financial advisor. Is that what you want?

You have an advisor who has an investment philosophy that you hire and pay a percentage of assets under management to manage your portfolio under their philosophy at their own discretion, not needing your okay transaction by transaction. You probably have a discretionary investment advisor who should be registered with the SEC or a state. Is that what you want?

You have an advisor who wants to sell you an annuity on which they will collect large up-front commissions. Run!

There are many, many different incarnations of this "advisor' scenario. But I have to point out to investors that if you did not research your advisor with the same due diligence you would have a spouse (OK, maybe more) then the fault lies with you. If you hire or fire an advisor based on investment performance, you must prefer to drive by looking in the rear-view mirror, and the fault lies with you. If you keep using an advisor who you do not trust implicitly, the fault lies with you. If you blindly believe the mainstream TV talking heads and heed every hot tip you come across, the fault lies with you. I could go on, but the point is some of you need a version of a financial advisor and some of you do not. You decide.

Here are some things I've learned in 40 years in this business. I believe them. You may not.

1. Diversification is a myth. It only works until you need it.

2. We need to know whether a mutual fund manager is a grizzled veteran of Wall Street wars or a 28-year-old MBA who has barely started to shave.

3. Active managers generally do not beat the market. In fact, you can't outsmart the market because the capital markets rapidly discount all known information and any new investing techniques quickly become obsolete by overuse.

4. Index funds are by definition assured to underperform their benchmark by the amount of their expenses and fees.

5. Buying last year's winner or last week's big hitter is like starting out in the cattle business by buying one cow and hoping it grows to 42,000 pounds so you can make a killing.

6. Not all ETFs are created equal. There are thousands, and no two S&P 500 ETFs produce identical results. Nor do they cost the same. So, buyer beware.

7. If a helper offers to actively "manage" an ETF or index fund portfolio for you, ask yourself, "What is the skill level of this helper, and is the cost effectiveness of ETFs mauled by the helper's management fees?" Do not pay 1% for any "service" like this.

8. It's not what you make, but what you keep. If you must consider performance in your evaluation, make sure to factor in taxes, fees and transaction costs.

9. Annuities are not investments; they're bets you make against the giants. Can you say Vegas odds?

10. The crooks are smarter than we are.

To wrap up Part II, this is my personal definition of a true professional financial advisor: mine. It is from my earlier Seeking Alpha article, "How Do You Quantify the Value of Advice."

I have a financial advisor who manages my money. He's my friend as well as financial confidant. I've known him for more than 30 years. I know his wife and his kids (adults now). I've stayed at their house. My kids (adults now) know him and his family. They swam in his pool and watched the fireworks at Disneyland from there. He's managed the investments that we have for most of the time that I've known him. My kids put their IRAs with him. He knew my late wife and took care of her estate issues when she died. My kids know that if something happens to me the first thing they do is call him and his son who works with him. That son is the contingent trustee on our trusts. They're smart people. I do not measure his investment performance compared to anyone or anything else. I have no idea what he charges. I simply do not care. It's not a race.

I trust him and his son with my very life.

Some investors are not that lucky.

Stay tuned.

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.

Additional disclosure: Ian lohr provided some intellectual tidbits for this article.

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Tagged: Financial Advisors, Wealth Management
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