It is a theme that serves as the cornerstone of our work at Aronson SpringReef – the safety of a family or organization’s financial future can be dramatically impacted by the financial advisors to whom they entrust their assets. And with over 350,000 registered advisors spread across hundreds of firms in the United States, selecting the most appropriate professional is often an arduous and risky process.
It is this very process, however, and the diligence with which it executed that often determines the quality of the financial advisors chosen and, in many cases, the future financial outcome for the clients involved.
Over the last thirty years, I’ve had the opportunity to participate in hundreds of presentations given by financial advisors to potential clients, an invaluable experience that has provided me with useful insight into how families and organizations go about selecting their financial advisors. While I can recall clients who displayed thorough, thoughtful search methods – they asked the right questions, made the right comparisons – the majority came into advisor meetings with substantially less-sophisticated processes that lacked the breadth, depth and insight critical to finding an exceptional advisor.
Based on this accumulated history, I am happy to offer to our readers this two-part SpringReef Insights series, a special edition that covers the five most critical mistakes clients make when selecting a financial advisor:
Let's dig into the details:
Mistake #1: Lack of a thorough, diligent process.
The disconnect between the wealth accumulation and wealth management phases has never failed to surprise me. Fortunate families and organizations often spend years of hard work and dedication applying their expertise towards achieving financial success. But when it comes to the management of that hard-won wealth, many apply significantly less effort and precision to the process of selecting their financial advisors.
To begin, let’s get this part out of the way. While we all love our families and enjoy the company of our closest friends and neighbors, at no point does this affection qualify them to be exceptional financial advisors. Your association with your advisor should always be professionally-based. Granted, it’s helpful if you like each other, but at the end of the day it should be an advisor’s ethics, experience, capabilities and performance that determine your selection. Other relationships can cloud the issues, causing you to select an advisor for the wrong reasons and stay with one who is not meeting your needs or expectations – sometimes with devastating financial consequences.
Next, define your needs and expectations and write them down. Are you looking for a complete top-to-bottom financial plan or just seeking an additional advisor for added insight? Do you need help with a specific pool of assets or in a specific area of expertise (i.e. alternative investments), or do you need help with an asset allocation for your overall wealth picture? What are your requirements for the investment process, performance reporting, and ongoing servicing? How often do you want contact with your advisor and under what circumstances?
You may find it valuable to review our SpringReef Insights piece from March 1st, 2011, “Separating Exceptional Advisors from Good Salesmen,” which provides an overview of the seventeen dimensions we focus on when selecting exceptional advisors.
After delineating your needs and expectations, cast a wide net for advisors. Exceptional advisors exist in multiple business models and across hundreds of firms and you should be sure to include professionals from several or all of these advisory models. As a general premise, your interview process should include advisors from at least two national, full-service broker-dealers, one independent broker-dealer, two to three different RIAs and perhaps a private bank or trust company. Ask your CPA, Trust and Estate Attorney and other trusted professionals for referrals. Names from family members, friends and work associates can be also be helpful, subject to my comments above and under the expectation that all recommendations, regardless of source, would be put through a rigorous due diligence process.
Next, try to include your trusted advisors in the process. We recommend including your CPA and an attorney from a relevant field, i.e. trust and estates. I’ve rarely seen a time when the outcome didn’t improve with more smart people engaged in the conversation. The hourly cost for the participation of your trusted advisors should be more than offset by an improvement in your ongoing wealth management. And as a side note, this inclusion will also improve the ongoing communication and coordination amongst your professional advisors.
Finally, keep score. As you interview each advisor team, benchmark them against one other and against your own needs and expectations. Rank each advisor on each attribute you believe is important and then provide an overall rating for each. A few notes next to each ranking will help you recall the detail behind the ratings and keep the advisor interviews from drifting together.
There are no guarantees that any process will lead to the perfect advisor. However, with a good dose of diligence detailed in the steps above, you’ll certainly increase your chances of finding a professional who will meet your needs and expectations and hopefully improve your chances for wealth management success.
Mistake #2: Failure to demand fiduciary behavior.
There is a great deal of discussion today about a universal standard of care in financial services. The reality is that registered investment advisers (RIAs) pledge to adhere to a fiduciary standard, while registered representatives from broker-dealers are only required to ensure investments offered to clients are suitable. This might come as a surprise given most people believe their advisor, regardless of firm or model, is required to hold to the fiduciary standard, or in simpler terms, required to act in the best interest of his or her clients. For the millions of clients served by the over 150,000 advisors at various broker-dealers, that’s certainly a major disconnect.
If Congress and regulators can agree, this divergence in required standards of care may be resolved by the adoption of a universal fiduciary standard. Even then, however, the resolution would only be a partial one – being required to adhere to a certain standard and actually embracing it in your day-to-day client interactions are two different things. The numbers tell the story – from January 2008 through March of this year, FINRA records indicated 10,894 arbitration cases involving breach of fiduciary duty1.
The mistake here? Assuming financial advisors will always act in the client’s best interest.
I know hundreds of financial advisors who, regardless of what their model requires, hold themselves to the core of the fiduciary standards. They come to work every day determined to do the best they possible can for their clients. The solution here is based not on what firms and advisors are required to do, but rather on what they choose to do, on their basic ethical principles and on how they behave.
The Committee for the Fiduciary Standard lists five core fiduciary principles on their website2:
I think it is both fair and reasonable for clients to require advisors to behave in a way consistent with these standards. In the advisor selection process, do not hesitate to show the five principles to the advisors you’re interviewing and ask them to commit to them – in writing.
Mistake #3: Bigger is better.
It’s no surprise that people are often impressed by numbers. As such, advisors have a tendency to boast about significant assets under management, high revenues, and lofty rankings on various national and state “top advisor” lists, all in an effort to impress potential and current clients. And while there are tremendously talented advisors who genuinely hit all these points, in many cases, big is just big.
Big doesn’t necessarily mean great, and it certainly doesn’t always equate to high-quality advice. Big can be the result of inherited relationships from terminated advisors, corporate, institutional or employee benefit assets, “self-reported” assets held away from the investment firm, several advisors rolled into one figure, or worst of all, just the result of good sales skills.
Look for your “Goldilocks” – the advisor size that is just right for you. An advisor who is big enough to demonstrate success and expertise, but not so big that you’ll get lost in the crowd.
To find this happy medium, strive to understand the advisor’s business. One of the most important questions to ask is how much experience and success they have with clients like you – people with similar levels of assets and similar levels of complexity. Assets and revenues from clients similar to you are substantially more meaningful than those from clients who are not. Be sure to also ask where you’d fall in terms of the advisor’s book of clients – in other words, would you be in the lowest tier in terms of assets and complexity, in the highest, or right in the middle? Going back to the Goldilocks concept, you want to be nearer to the middle where you know the advisor has experience and expertise.
Finding the best advisor is much more about expertise and quality of advice than about asset and revenue levels. What you’re looking for is someone who will invest your assets to add to your net worth, not theirs.
Mistake #4: Too much trust.
At its core, the financial services industry is a sales business – it screens, hires, trains and retains financial advisors based on their sales ability. The vast majority of advisors are well-practiced at this craft, and to the untrained and inexperienced eye, many sound terrific. The challenge becomes protecting yourself from the large percentage of advisors who are substantially more gifted in sales than in asset management.
Trust but verify – this signature phrase made famous by former President Ronald Reagan is consistently appropriate for interactions in financial services. There are a few simple things clients can do, particularly during the advisor selection process and early in the relationship, to ensure that what is promised by the advisor is delivered.
First, it is always beneficial to write down specific commitments an advisor makes and have them confirmed in writing or in an email after the meeting.
Second, ask the advisor for three references – the first two should be from clients who have approximately the same level of assets and complexity of issues as you. For the third, you’d ideally like to get the name of a former client who terminated their relationship with the advisor. Since most advisors won’t provide a negative reference, ask them for the name of the current client with the largest net new asset outflow over the last twelve months. Clients vote with their checkbooks, and chances are if a client is drawing down assets, they are unhappy with the quality of advice or service they’re receiving.
Finally, call the references and get feedback on matters you believe are critical in an advisor relationship, as well as on specific commitments the advisor made during your meetings. These verification steps should get you much closer to a professional capable of delivering against your needs and expectations.
Mistake #5: Failure to set expectations upfront.
There are plenty of investors who work diligently through the advisor selection process, properly identifying their needs and expectations and verifying answers with the advisor and a select group of his or her clients. However, you’d be surprised how many of these clients snatch defeat from the jaws of victory by failing to actually confirm their expectations with the advisor.
As the final step in choosing your financial advisor, you want to be certain you avoid misunderstandings that could tarnish the relationship later on.
The first item you’ll want to confirm with your advisor is cost. Make sure you know exactly what you are going to be charged for his or her services. Second, confirm who will be your primary point of contact for service- and investment-related issues. Depending on the advisor’s team, different people may handle different needs or request. Finally, confirm how often and under what circumstances the advisor is going to contact you. This should include how frequently the advisor will meet with you to review your portfolio performance and what will be included in that review (see the January 2011 edition of SpringReef Insights for more detail). Also, given the uncertainties of the markets, you should have a mutual understanding as to when you’ll be informed if an investment isn’t working out as planned.
Summing It Up
Choosing a financial advisor is rarely an easy, straight-forward road – it’s a process that not only requires a dose of self-reflection to ascertain one’s true needs and expectations, but also demands a strong hand and a critical eye. However, based on personal experience and observations, I know that the amount of work put into the process rarely goes unrewarded. Those who take the time to conduct proper due diligence and avoid the common mistakes detailed above have a higher chance of finding truly ethical, high-quality advisors who are dedicated to their clients’ financial wellbeing.
1 FINRA Dispute Resolution Statistics: http://www.finra.org/ArbitrationMediation/AboutFINRADR/Statistics
2 Committee for the Fiduciary Standard: http://www.thefiduciarystandard.org