Trust but Verify
Access to Bank Accounts…uhhh no!
The Greater Good
Big Firm or Small Firm Doesn’t Matter–Focus on the Individual
My 2 cents on how athletes can avoid the trap of fraud from bad-apple financial advisors.
Trust but Verify
Access to Bank Accounts…uhhh no!
The Greater Good
Big Firm or Small Firm Doesn’t Matter–Focus on the Individual
If you work with a professional money manager or advisor it’s possible that you have some things that you would like to know but you probably feel are “weird” to ask. It’s not that many of the things that you may want to know are secrets as much as much of the financial services world still lives by the code “don’t ask, don’t tell”. Even without increased regulation, demographic changes are causing this once sacred barrier to be broken down. I’m sure much of the mystique may have been related to an advisor’s inability to fully explain an investment or his compensation at one point in time. Regardless of why and how, it seems only natural that over time the barrier that has been erected prevents transparency from reigning in the relationship with clients. This week, I’ll attempt to correct some, although validly drawn, misplaced notions about advisors that I’ve heard clients mention before. So for the sake of investors working with financial professionals all over the globe, let’s delve into some things you may want to know.
Q. What licenses do you need to practice and how are you regulated?
A. Hopefully this was one of the first questions you asked your guy or gal before you began a relationship. Impersonating a financial professional is possible, just ask Bernie Madoff’s victims. This has the potential to be a long answer so I’ll be brief. There are two main regulatory agencies for financial services professionals: the Financial Industry Regulatory Authority (FINRA) and the Securities Exchange Commission (SEC). The former largely regulates broker-dealers (e.g. individuals that charge “commissions” for products and services they deliver), whereas the latter regulates registered investment advisers (or RIAs)–individuals that charge “fees for services”. The main difference is the standard by which FINRA and SEC regulate. FINRA uses what most industry experts believe to be a lesser standard by determination if a product or service is “suitable” for a client, whereas the SEC imposes the “fiduciary” standard. Fiduciaries are charged to operate in the best interest of the client. FINRA has several licenses that professionals can obtain with the most common being the Series 6, 7, 66–these allow financial professionals to use virtually any product to construct an investment portfolio. IMPORTANT: No licensure is required if an individual just wanted to hang a shingle and call himself a financial advisor. However, he would be hard pressed to put you in a mutual fund or stock without being affiliated with one of those two organizations.
Q. How are you better than a robo-advisor? Can’t I save on fees by using one?
A. The quintessential subject of fees is something that deserves some attention. So I will attempt to be thorough without being wordy. First, robo-advisors are platforms that allow investors to set an investment mix and leave it alone. Usually a periodic contribution can be made to the account for systematic investment. These platforms usually allow for investments as little as $1000 to get started and waive the first several thousand in fees for assets under management. The caveat is that in exchange for a more efficient investing mechanism with lesser fees, you also get less personal attention. In almost twenty years in the industry, I’ve met few clients that want less personal attention. Typically as assets grow, the more attention that is needed as choices become more numerous along with wealth consequences like taxes and estate planning. So, robo-advising seems appropriate for a certain type of client up to a certain point in life. Advisory fees should be treated like anything else. They should be negotiated upfront and discussed fully so each party (client and advisor) understands what benefit is being received. Advisors conduct difficult analysis and draw on years of experience in order to deliver consistent, meaningful solutions for their clients. Clients work hard for many years to accumulate enough savings to live a dignified lifestyle after earnings from work stop. Each should understand the benefit being received by the relationship.
Q. How often are you reviewing my investment plan?
A. I’ve somewhat covered this in a previous post, but I’ll add a bit more detail. At the relationship’s inception, each advisor should construct a guiding document for how the portfolio will be constructed and investment objectives. Length is not as important as agreement by client and advisor as to the plan’s contents. A review of this document (or at least what it expressed) should happen regularly. The frequency should be mutually agreed also, but semi-annually for individual investors and annually for institutional investors is probably the bare minimum. With everyone living more complex lives, investment plans need to be dynamic, fluid documents instead of static.
There are obviously other questions that I cannot cover in just one post. However, feel free to inbox me if you have one that you are afraid to ask!
Most people are familiar with the exquisite level of service associated with the Ritz-Carlton brand. Possibly the most definitive quote to describe that level of service is: “You can defend your price, or explain your value.” Most that have experienced the Ritz Carlton experience would agree with me that they don’t need to defend their price because the value speaks for itself. However, many investors probably don’t realized how under-served they are when it comes to the review of their portfolio. That is to say: what are you truly paying for when you pay asset management fees, commissions, or mutual fund loads? Can it be quantified? It may not be the most comfortable topic to discuss with your financial advisor, but after all he or she works for you, right?
Let’s cover some of the most likely components of the portfolio review process. (By no means is the following an all-inclusive list, however I feel they should be covered at a minimum.)
The investment policy statement (IPS) should have been written prior to your first deposit. (Check my previous posts on developing this crucial component). There can never be enough written on the topic of investment performance, so I will not try to accomplish that goal here. Suffice it to say, your standard for performance should be as it relates to your individual investment policy and investment goals, not the broad market. Unless your goal is just to beat the market (which it rarely is). That is to say your questions should be framed like the following:
“As it relates to my overall return objective, how has my portfolio performed?”
“As it relates to my overall risk objective, has my portfolio experienced more or less than I expected?”
The same exercise should be done with the other aspects of your IPS like taxes, liquidity provisions and asset allocation.
Note: Other things included in the IPS would be the frequency of portfolio reviews, and whether your portfolio will be managed with or without discretion, etc. Needless to say, you need to spend some time on this part making sure it is done correctly.
2. What market expectations does your manager(s) have?
Developing capital market expectations is a big part of your investment manager’s job. Will equities outperform fixed income? How will alternative asset classes like commodities and real estate perform? What effect will interest rate policy have on the assets in your portfolio? Is the current economic environment sustainable or is there a significant probability of slowdown? All these questions and more guide the way your portfolio is constructed and positioned to achieve your investment goals. Further, these should be part of the portfolio review discussion (to the extent you permit it).
3. Why has my portfolio performed the way it has?
This can be a touchy subject. Why? Because it introduces the “luck or skill” argument when it comes to portfolio performance. Here’s the quick and dirty version: if your financial advisor manages to a benchmark it is rather easy to see how much “extra” return was added by having them control portfolio decisions. The difference between what your portfolio actually returned and what the benchmark returned is called “active return”. Obviously the benefits of having a manager control the portfolio decisions is to have positive active return. Otherwise you could have just purchased the investment that mimicked the benchmark. (Note: Consider that once transaction costs, management fees and taxes are included, this may be true.) My point is that you should be able to quantify the “active return” your manager is delivering to your portfolio.
4. The X-Factor
I call the X-factor all the stuff you really cannot quantify. It is how you feel during an office visit or when you call and hear a person on the other end of the phone. Do you feel reassured or more nervous after you talk with you advisor? (Hint: You should feel reassured!!) One of the greatest things about what I do as an investment consultant is the comfort I give clients that their plan is working. And further, if there are adjustments that need to be made, then we will make them before it results in a detriment to the portfolio.
It is true that a subset of this list may be enough in and of itself for a lot of investors. However, in today’s world of greater overall transparency including advisory fee disclosure and cost efficiency, advisors have to rise to the occasion to deliver the best client experience–a Ritz Carlton one!
In the last few decades with the advent of self-directed defined contribution plans (versus defined benefit), it has become more necessary to engage a financial professional to assist in future spending needs. In the 2013 Risks and Process of Retirement Survey report, it states that “in 1974, defined benefit plans covered 44% of private sector workers, but today the number is less than 20%.” And like anything that you do that employs the need of a professional there should be some rules for engagement. The best physicians, attorneys and CPAs I’ve found have been through a personal referral or word of of mouth. However, the commonality that exists among all these groups of professionals is the need to have a rubric or list by which to choose the right guy or gal. This works the same way for your financial professional. Being an industry insider, I’ll share with you what you should be looking for and why. Pretty much regardless of objective, when seeking the advice of a financial professional you are looking to maximize the value you receive for what you pay. Agreed? Here goes…
1) Look for credibility. I rank this first because reputation is key with me. And this is easily done the same way I found my last physician–by talking to existing clients and/or other professionals. You probably have 3-5 people in your network that at least know someone that has heard of the person you are talking about. The point is you are trying to corroborate their credibility. What are other clients experiencing as far as service and advice? Are expectations being met or exceeded? The probability is low that an unsavory character in the financial services industry is getting a ton of glowing endorsements. There is always the Madoff exception, but it is definitely an exception.
2) Look for competency. You want someone that knows what they are doing. And probably equally as important, quickly admits to an area of little or no expertise. Someone acting like they know something that they don’t isn’t doing you any favors and can be very dangerous. The level of competency should exceed what you are comfortable searching for alone via Google or Wikipedia also. This part of the engagement process should be like an interview of sorts. Primarily, you are looking for the professional to provide you with examples of how they have handled situations involving investment and financial planning before so you can gauge their experience level. You can also begin to tell where their “niche” lies. You may be talking to a guy or gal that is great at securities selection and building a portfolio of stocks and bonds, but you actually would just prefer a really simple financial plan to organize your annual spending for some upcoming purchases or life events. This would be a terrible mis-match that you want to identify upfront.
3) Look for credentials. To stay with the physician analogy, I don’t typically walk into a doctor’s office looking for where they went to school, but then again I do want to know they went! So alma mater aside, the fact that they engaged in some type of post-secondary rigor counts for something. There is a fine line here though, because the more education and designations behind the last name could translate into higher fees (for service). At the heart of the matter though is that the professional you choose is just as good at being a teacher and explaining the topics for which you need more understanding. The financial industry has a plethora of designations that it awards and deems worthy of distinction. Hopefully though, by the time you use the techniques listed above you will be comfortable enough with an individual that this is of lesser importance.
As with any service you pay for, know what you are trying to achieve and if you don’t understand what is being offered–ASK QUESTIONS. If your questions cannot be answered clearly and concisely, it is usually a red flag.
And here is a bonus…so if you really want to look like a pro when you are interviewing, try asking these questions: