Chapter 24

Ten Tips for Hiring a Financial Adviser

In This Chapter

Knowing what services to expect and how much you pay

Hiring someone you can count on

Hundreds of millions of people worldwide have successfully invested in mutual funds on their own. Investing in mutual funds isn’t difficult; common sense and an ounce of financial sense are all you need.

You have no compelling reason to hire a financial adviser in order to invest in mutual funds. So if you jumped to this chapter first, stop! I recommend that you march back to the earlier chapters. You’ll be better able to understand this chapter after you’ve read the ones that come before it, not to mention the fact that you’ll be improving your ability to save yourself possibly thousands of dollars in financial advisory fees. But if you’ve arrived here because you just don’t want to deal with handling fund-investing or financial-planning decisions on your own, keep on keepin’ on.

Communicator or Obfuscator?

In your preliminary meetings with a financial adviser, develop a sense and opinion about the person’s ability to clearly communicate with you. Take your time and speak with prospective advisers before deciding whom to hire. Don’t rush yourself or allow an adviser to pressure you into making a decision before you’re ready and comfortable.

Consider these questions: Does he clearly and patiently explain things or use a lot of jargon and talk down to you? Is he forthright and candid or evasive?

Financial Planner or Money Manager?

As you search for help, you’ll confront a variety of people who call themselves “advisers” and who’re eager to assist you with investing and other financial matters. People who claim to be advisers but who derive commissions from the products that they sell are salespeople (Chapter 9). Keep this warning in mind as you consider the different types of people you could hire:

Financial planner: True financial planners generally provide objective help with issues, such as retirement planning, using and paying off debt, investing, insurance, and even real estate. The charge for these services should be a fee based on the time involved. A good planner should help restructure your financial situation before your money gets invested in funds. If a planner provides specific fund recommendations, implement them on your own and save yourself ongoing advisory fees.

Money managers: Money managers or financial advisers who perform money management invest your money and charge you a fee — usually expressed as a percentage of assets under management (that’s the money you turn over to them to manage). Some advisers only do money management, but increasing numbers of financial planners offer money-management services as well. Using money managers can make sense for people who’ve finished their planning and need someone to help manage their money. Money managers argue that, because they devote themselves full time to investing, they’re more adept at it.

Planner/money managers may be reluctant to recommend — and, in fact, have an incentive to ignore — strategies that deplete the money you have to invest. The more you have to invest with them, the greater the fees they earn. All the following financial moves result in less money that you can invest, so planners/money managers may not recommend these often-advisable paths:

Paying down debt of all types, such as credit cards, auto loans, mortgages, business loans, and the like

Maximizing saving through your employer’s retirement savings plan(s)

Purchasing real estate — either through buying a primary home or investing in rental property

Buying and investing in your own business or someone else’s privately held business

Another problem with planners who also manage money is that they may be short on specific advice in the planning process. Sadly, I’ve seen cases in which people paid planners thousands of dollars for a largely boilerplate, computer-generated financial plan and received little, if any, specific financial planning and investment advice. If you want to invest in no-load funds, the planner should willingly and happily provide specific fund recommendations and help you build a portfolio for the fee that you pay her.

Market Timing and Active Management?

Much of what you’re paying a planner for is the time spent reviewing your financial situation and matching your needs and goals to a suitable portfolio of funds. If your needs and situation are relatively stable and you do your homework right the first time and select good mutual funds, you shouldn’t need to make frequent changes to your portfolio.

If anything, constant tinkering with a portfolio tends to lower returns. In Chapter 20, I cover this same issue on the perils of blindly following some newsletters’ and gurus’ timing advice to switch into this fund and out of that one. Trading in nonretirement accounts also increases your tax burden.

Who’s in Control?

If you hire a money manager, you should consider if the manager requires that you turn control of the account over to him. Specifically, you’ll sign or initial a form, as shown in Figure 24-1. Here’s the outline of the form:

Line 1: Grants the adviser authority to execute trades in your account — otherwise known as granting a limited power of attorney.

Line 2: Gives your adviser power to move money out of your account. I recommend against giving your adviser this power unless you need to withdraw money from your account frequently and find it more necessary to have your adviser do it for you.

Line 3: Allows your adviser to deduct his ongoing fees from the account. Definitely do not allow this deduction to be taken from retirement accounts because it diminishes the amount of money that you have compounding tax deferred. (But, unless you’re already well into retirement and taking plan distributions, paying fees from your retirement account may be okay — you’re paying with before-tax dollars that would otherwise be withdrawn and taxed.) For nonretirement accounts, it’s up to you, although many advisers insist on this feature to make collecting their fees easier.

Line 4: Requests the brokerage firm to send duplicate copies of your account statements and trade confirmations to your adviser. That’s acceptable and to be expected.

Figure 24-1: Initialing this section gives the adviser control over investing your funds.

Almost all money managers manage money on what’s called a discretionary basis — they make decisions to buy and sell funds without your prior approval. In other words, you’re turning control over to them. You find out about transactions after they’ve occurred, usually when you receive the trade confirmations in the mail and through your monthly or quarterly statement.

At a minimum, before you turn control over to the money manager, make sure that you discuss your investment objectives with him. These overall goals should drive the way he manages your money.

Fees: What’s Your Advice Going to Cost?

If you hire a planner on an hourly basis, expect to pay at least $100 per hour — you can easily pay more; planners with the $300+ per-hour billing rates tend to work exclusively with affluent clients.

Fee-based money managers work on an entirely different basis. See this fee schedule example:

Amount You Invest Fee Percentage Annual Fee

$1,000,000 1.10% $11,000

$2,000,000 1.00% $20,000

$5,000,000 0.90% $45,000

What’s amazing to me about this type of fee schedule is that, although the percentage charge declines slightly as the amount you invest increases, look at how the total charges increase. This firm sends the same quarterly reports out to the client with $5 million invested, who pays $45,000 per year, as it does to the client with $1,000,000 invested, who pays $11,000 per year for the same service. Advisers’ fees are often negotiable. The more you have to invest, the greater your ability should be to negotiate lower fees.

Also, ask what sort of transaction and other fees you have to pay in addition to the advisory fee paid to the money manager. Most money managers ask that you establish an account at one of the discount brokerage firms, such as Schwab, Fidelity, TD Ameritrade, or with a mutual fund company. Ask who they use and why. If you’re going to consider hiring a mutual fund money manager, add up all the costs. Table 24-1 helps you do the job.

Table 24-1 Adding Up All the Costs
Cost	Annual Percentage of Your Assets
Money manager’s fee	For example, 1.0%
Operating fees on mutual funds invested in (Don’t let the adviser say that she can’t figure this amount because the funds she uses vary over time — she can base the calculation on her current portfolio or the amount she used over the past year.)	For example, 1.0%
Transaction and other fees (Your adviser can convert these dollar expenses to a percentage.)	For example, 0.2%
Total	For example, 2.2%

Over the long haul, a diversified portfolio that’s primarily invested in stocks has usually returned around 9 to 10 percent annually. If you’re paying a total of 2.5 percent to have your money managed, you’re giving away 25 to 28 percent of your expected return. And don’t forget, because the IRS sure won’t, that you’ll owe taxes on your nonretirement account profits, so you’re giving away an even greater percentage of your after-tax returns.

How Do You Make Investing Decisions?

Throughout this book, I discuss the good and bad ways people can and have invested in mutual funds over the years (Chapter 7, in particular). The process isn’t rocket science — it can be as simple as picking any other product or service. You want value — where can you invest in funds that meet your needs and that are managed by a fund company and fund managers that have good track records and that charge competitive fees. Most advisers try to factor their economic expectations and prognostications into their investment strategies. But this is much easier said than done.

The fundamental problem with some money managers is they try to convince you that they have a crystal ball. Specifically, some claim (explicitly or implicitly) that they can time the markets, that they’ll get you out of the market before it falls and put your money back in time for the next rise. Over long time periods, beating the markets is virtually impossible, even for acknowledged experts (see Chapter 20). Great investors, such as Warren Buffett and Peter Lynch, say you can’t time the markets. Believe ’em!

What’s Your Track Record?

Mutual fund companies must have their performance records audited and reviewed by the United States (U.S.) Securities and Exchange Commission (SEC). Most also provide an independent auditor’s report. Private money managers face no such SEC requirement. Few provide independent audits. Of course, you really want to know the performance facts about the money manager who you’re considering for ongoing management of your funds. What rate of return has he earned year by year? How has he done in up and down markets? How much risk has he taken, and how have his funds performed versus comparable benchmarks (see Chapter 17)? These are important questions. Getting objective and meaningful answers from most investment advisers who manage money on an ongoing basis is difficult.

Money managers play a number of marketing games to pump themselves up. If all the money managers are telling the truth, 99 percent of them have beaten the market averages, avoided major market plunges over the years, and just happened to be in the best-performing funds last year. Money managers pump up their supposed past performance to seduce you into turning your money over to them through common marketing ploys:

Select accounts: If you can get the money manager to give you performance numbers and charts, too often an asterisk refers you to some microscopic footnote somewhere. If you have a magnifying glass handy, you can see that the asterisk states something like select or sample accounts. What this term means, and what they should’ve said instead is “We picked the accounts where we did best, used the performance numbers from those, and ignored the rest.” (Interestingly, using smaller type in this way is a violation of SEC regulations.) Advisory firms also may select the time periods when they look best. Finally, and most flagrantly, some firms simply make up the numbers (such as Bernie Madoff did).

Free services: Some money managers will produce performance numbers that imply that they’re giving their services away. Remember, money managers charge a fee (a percentage of assets) for their services — they are required to show your returns net of fees [or after fees have been deducted] to clearly show the amount that, as an investor using their services, would’ve made. Because most money managers place their fund trades through discount brokers who charge transaction fees, they must deduct these fees from returns as well.

Bogus benchmarks: Some money managers make their performance numbers higher than they really are; some also try to make themselves look good in relation to the overall market by comparing their performance numbers to inappropriate benchmarks. For example, money managers who invest worldwide (including in international stocks) may compare their investment performance only to the lowest-returning U.S.-based indexes.

Switching into (yesterday’s) stars: Money managers don’t want to send out updates that show that they’re sitting on yesterday’s losers and missed out on yesterday’s winners. So guess what? They may sell the losers and buy into yesterday’s winners, creating the illusion that they’re more on top of the market than they are. (Some newsletters also engage in this practice.) This strategy, known as window dressing, is potentially dangerous because they may be making a bad situation worse by selling funds that have already declined and buying into others after they’ve soared (not to mention possibly increasing transaction and tax costs).

What Are Your Qualifications and Training?

An adviser should have experience in the investing or financial services field — generally, the more the better. But also look for someone with intelligence and ethics who has good communication skills.

Check out credentials but don’t be overly impressed by some, such as the CFP (Certified Financial Planning) degree. Too many planners with this “credential,” which you can largely earn by taking a self-study course at home and then an exam, sell financial products. Other common credentials include

CFA (Chartered Financial Analyst): This credential means that the adviser knows how to analyze securities and investments and the fundamentals of portfolio management.

MBA (Master of Business Administration): An adviser with an MBA should’ve had coursework dealing with investments and finance. Find out where he earned the MBA and check out the school’s reputation.

PFS (Personal Financial Specialist): A PFS is a credential conferred on accountants who pass an exam similar to the CFP.

CLU (Chartered Life Underwriter) and ChFC (Chartered Financial Consultant): These credentials are for insurance and carry little, if any, value in advising on mutual funds. These credentials may be a red flag that you’re dealing with a salesperson or with someone who knows more about insurance than investments.

The term Registered Investment Adviser denotes that the adviser is registered with the SEC; it means nothing as a professional credential. (Smaller advisory firms with assets under management of less than $25 million generally register with state regulatory agencies.) The SEC doesn’t require a test; however, it does require that the adviser file Form ADV, also known as the Uniform Application for Investment Adviser Registration. This document asks for specific information from investment advisers, such as a breakdown of the sources of their income, relationships and affiliations with other companies, each adviser’s educational and employment history, the types of securities the firm recommends, and the firm’s fee schedule. (Many states require passing a securities exam, such as a Series 2, 63, or 65.)

In a pitch over the phone or in marketing materials sent by mail, an adviser may gloss over or avoid certain issues. Although it’s possible for an adviser to lie on Form ADV, it’s likely that an adviser will be more truthful on this form than in marketing materials. Ask the adviser to send you a copy of his Form ADV, or visit the SEC Web site at www.sec.gov. You can also call them at (202) 551-8090 or fax your request to (202) 777-1027.

What Are Your References?

Ask other people about how the adviser benefited them. This process is one way to verify the rates of return the adviser may claim (although you’re smart enough to recognize that the adviser will refer you to the clients who’ve done the best with her). Also ask about the adviser’s strengths and weaknesses.

Virtually all money managers offer a free introductory consultation if you meet their minimum investment requirements. Planners who work on commission also tend to offer free sessions. So the “free” consultation ends up being a sales pitch to convince you to buy certain products or services.

Busy advisers who charge by the hour usually can’t afford to burn their time for a free in-person session, especially a lengthy one. Don’t let this deter you; this fee is probably a good sign. These advisers should be willing, however, to spend a modest amount of time in person or on the phone answering background questions free of charge. They should also send background materials and provide references if you ask.

Do You Carry Liability Insurance?

Some advisers may be surprised by the question of liability insurance or may think that you’re a problem customer looking for a lawsuit. On the other hand, if your adviser gets you into some disasters, you’ll be happy you have the insurance coverage. Financial planners and money managers should carry liability insurance (sometimes called errors and omission insurance). This coverage provides you (and the adviser) with protection in case a major mistake is made for which the adviser is liable.