Posted by Leo T. Ly on November 17, 2017November 16, 2017
A while ago, I penned a post to encourage my readers to take charge of their finances and to manage their own investments. One of the main reasons for writing that post was to encourage my readers to be financially literate. The second reason was to arm them with financial knowledge to help them avoid committing money mistakes. Most importantly, I wanted to help my readers hire the right financial advisor or avoid unethical financial advisors – licensed or unlicensed.
Now, I am in no way implying that the whole financial industry is unethical nor am I saying that you shouldn’t hire a financial advisor. There certainly are great financial advisors out there that are worth every penny of the fees that you paid them. Nevertheless, what I am trying to do is to remind my readers of the importance of financial knowledge, regardless if you are interested to manage your money or not.
An Investor’s Worst Nightmare
You see, from time to time, I would come across a financial horror story here and there. With the latest story, a senior claiming her trusted financial advisor unethically churned her account to make money for himself. Over a four-year period, her advisor had conducted numerous trades in her account that amounted to over a quarter of a million dollars in commissions/fees.
We are not talking about an institutional trading account with hundreds of millions in assets here. We are talking about a personal investment account. A quarter of a million dollars in commission/fees? Really? Who on Earth is willing to pay such astronomical commission/fees to manage an account that’s probably no more than $2M to start with?
So, instead of trying to analyze the court case and be the judge, it’s much better for us to learn from this incident and protect our finances and avoid the downfall of this situation. Let’s take a look at some of the important criteria for hiring and evaluating the qualities of a financial advisor that you want to hire for.
How Does The Advisor Make Money?
To evaluate if the potential advisor’s interest is aligned with your own interest, you have to know what and how he/she is charging you for the service provided. Is the advisor being compensated based on the activities on your account or the investment being purchased? From the article, this was the case. In my opinion, I don’t think that this type of financial advisor’s interest is aligned with an investor’s interest. I would avoid hiring these financial advisors.
The other methods that financial advisors make money are the fee for service model or charging a percentage of the asset under management model. Depending on how much money you have to invest and the number of accounts, you can find a balance between these two models. Your goals are to minimize your investment fees and to compensate your advisor fairly for the service provided and to design a portfolio to maximize the return based on your risk tolerance.
To find the balance, let’s take a look at two investors with identical situations except for the amount of money to invest. One investor has $200,000 to invest while the other has $800,000. If a financial advisor charges $100 per hour (or 1% of asset under management) and it takes about 25 hours (three days) of work to construct a personal portfolio, which payment method is best for each investor?
For the fixed fee service, the cost is $2,500 (=25*$100) for both investors. For the 1% asset under management fee, it cost $2,000 (=1%*$200,000) and $8,000 (=1%*$800,000) for the investors. Based on these numbers, it’s better for the $800,000 investor to choose the fee base option as that investor can save $5,500 in fees. For the $200,000 investors, I would still go with the fee base model even if it meant an extra $500 for the initial setup. Going forward, it shouldn’t cost that much to meet with the financial advisor once or twice a year to review your portfolio’s performance. The investor will save more money in the long run.
How’s Your Money Managed?
When you read stories of investment fraud victims, you usually would encounter a couple of reoccurring themes. The first is the financial advisor and the custodian of investor’s asset being the same entity. This allows the financial advisor to have full control of the investor’s investment asset and abuse their authority. This is a situation that investors need to avoid.
The second thing that you often hear about is the financial advisors having full control to conduct investment activities in a client’s account without having to consult with the client. I understand that one of the reasons that investors want to hire an advisor is to delegate the investment task to the financial advisor. But just remember one thing, “no one should care more about your money than you do.” The less attention that you pay to your investment, the more you are putting your money at risk.
How Do You Evaluate Performance?
Your main goals for hiring a financial advisor are to help manage your money and to earn a reasonable return on your investment based on your risk tolerance and asset allocation. So what’s a reasonable return? This will be a great question for your financial advisor to answer based on the portfolio that’s designed for your situation. By answering this question, you’ll also indirectly answer another question, “am I taking too much or too little risk with this portfolio?” Adjust your portfolio asset allocation to a level that’s suitable for your risk tolerance if needed. The question to ask yourself is, “if the worst case scenario happened, can I sleep at night?”
Once your model investment portfolio had been created for your personal situation, it’s prudent to ask for a benchmark or a weighted average of a few benchmarks to measure your investment performance against. If you are going to pay for a service, you may as well hold your financial advisor accountable for the service provided. I would recommend my readers to do a performance review at least once a year for both your investment and the financial advisor.
Monitoring Your Investment
Many investors made the mistake of entrusting their money to their trusted financial advisor and rarely review their investment performance or statements. Once you’ve got a portfolio designed for you and set it on autopilot, it doesn’t mean that you should forget about it. This mistake can be fatal and you may lose all your hard earned money if you trusted the wrong financial advisor.
To avoid this potential downfall, ask your potential financial advisor to provide a sample investment statement and review the statement with him/her thoroughly. If you can’t understand the investment statement, then you should either ask if there is a simpler investment statement or find another financial advisor that can provide you with a statement that you can understand easily.
My Two Cents
A financial advisor should only be an advisor, an investment mentor or an expert that you can rely on to assist you with your investment decisions. No more, no less. What you are paying for should be their advice, coaching or expertise. After all, it’s your money, your livelihood, and your success. You should be the one making the decisions, accountable for growing your savings, and the beneficiary of this wealth at some point in your life. You get what you put into it.
So readers, do you have a financial advisor to assist you with your investments? If you do, what’s your experience like when working with a financial advisor? Would you recommend your current financial advisor? If you are investing for yourself, how do you measure your performance?
