How to Choose a Financial Advisor

Posted on April 13th, 2009 by admin in How to Invest

In our recent post:

Skill vs Luck in Money Manager Choice. How Can You Decide?

we discussed some of the research that shows that while money management skill does exist, it is extremely rare and there are no criteria for identifying individuals who are skillful. We then touched a few ideas for you to apply when choosing a money manager.

We’ll be more comprehensive and specific in this post. We’ll follow and elaborate on the points raised today in an article in the Wall St. Journal:

Seven Questions to Ask When Picking a Financial Adviser

by Shelly Banjo

13 APRIL 2009

The key assumption is that the client doesn’t have the time or expertise to manage his own investments and seeks a professional advisor to help.

In the end, it all boils down to having wise conversations for action.

1. What’s in the advisor’s background?

Investors should know the difference between advisors who have a fiduciary duty to their clients, and those, like stock brokers, who do not. Registered investment advisors have a fiduciary duty to make their highest priority their client’s best interest, even over the advisor’s own interests.

Registered investment advisors (such as your humble servant) must pass a test (Series 65 Uniform Investment Advisor Law Examination) or have certain forms of certification, such as being a Certified Financial Planner (CFP), as a necessary qualification to legally be an advisor.

A registered investment advisor must also disclose a substantial amount of detail about his business such as any formal investigations and disciplinary actions initiated by regulators, along with any customer disputes, certain criminal charges and financial disclosures, including bankruptcies, and education, address and fee structure. These disclosures (form ADV part 2) are found online at

2. What do the advisor’s clients say?

Ask for references from the candidate advisor, and try to get references not initially named by the candidate. References can give you lots of information about how the advisor actually operates.

By the way, registered investment advisors are legally forbidden from soliciting or using testimonials themselves in advertising, but of course, references are free to volunteer anything they choose.

3. How does the advisor get paid?

Advisors get paid according to what they do for you. The main issues in compensation these days are to use structures that avoid conflicts of interest (such as sales commissions on financial products) and which also reward performance. Stock brokers, whose job includes selling financial products, are often thus conflicted and should tell you so. Registered investment advisors are usually not conflicted (if they don’t sell financial products) , but they must disclose any conflicts and commissions if such exist.

Advisors are forbidden to charge a fraction of profit to any client. While paying your advisor proportionally to his profit generated seems like a good idea to align advisor interests with your own, the SEC believes such an incentive structure would entice advisors to take excessive risk to achieve high profit (even though such high risk could possibly cause losses for both advisor and client).

The usual solution is for advisors to charge a small fraction of the assets under management each quarter. Fees will rise and fall with the asset base.

4. Where are the advisor’s checks and balances?

The client should get a written description of how the candidate advisor would choose a third party money manager in any situation for which the advisor himself wouldn’t be managing the money himself.

5. What’s the advisor’s track record?

We showed how uninformative track record can be. However, clients should demand a formal description of the process by which the advisor makes investment decisions (selecting, entering, holding and closing positons). Most registered investment advisors describe this in an Investment Policy Statement (IPS). The IPS  also defines the universe of permissible asset classes. The advisor’s process must be formally constrained to support the client’s risk profile (obtained from  extensive interviews of client). Clients can use the IPS to decide if the advisor’s process suits the clients style and preferences.

6. Can the advisor put it in writing?

These days, it is fully expected that professional advisors will specify their services in a Client Contract along with their detailed fee structure for those services. This contract is a great document for client and advisor to formally define their relationship and make formal disclosures. In this context, the SEC requires the advisor to provide his Form ADV Part 2 directly to the client five days before the contract is signed.

7. What do other pros think?

Clients should get third party opinions on the advisor and his decisions from time to time.


No registered investment advisor (RIA) can reliably promise an ROI because ROI is neither predictable nor controlable. Similarly, no RIA can reliably claim to produce an ROI better than what you could do for yourself.

What we RIAs can promise by our discretionary management is to pay attention to your money and investments and to use good judgment in taking or closing positions. Further, and most imporatnat, we will engage you in wise conversation about your goals and how your investments can support them.

To read more about what we offer, go here.

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