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When it comes to choosing a financial advisor there is a great deal of information out there, but it seems to be a universal problem that explaining the value of an advisor is an intangible and often hard to articulate concept. Your relationship with your advisor does not produce a tangible product that can be evaluated based on features, specifications, and functions. Thus, the natural tendency is to evaluate your advisor based on one attribute that is readily available and tangible, which is your portfolio rate of return.
Vanguard has famously conducted an ongoing 20+ year study called “Vanguard’s Advisor Alpha” wherein it has attempted to quantify a good financial advisor’s value, or alpha, to their clients in terms of adding an extra 3.0% of annualized net rate of return through relationship-oriented services such as the following:
Proper asset allocation,
Cost-effective investment implementation,
Rebalancing,
Acting as a sounding board to keep you on track,
Tax efficiency,
Spending strategies, and
Total return vs. income investing.
The Vanguard analysis is an interesting starting point, however, the problems with this analysis are the following:
It plays perfectly into people’s preconceived notions that the primary determinant of their financial success is portfolio performance, or rate of return:
It is not.
The financial choices people make are the primary determinants of their financial success.
It presupposes that the primary function of a financial advisor is portfolio management:
It is not.
The primary function of a financial advisor is to help clients make wise financial decisions throughout their entire lives.
A portfolio simply serves to fund your spending goals.
It assumes that an advisor is prepared to be judged on the basis of one number, over which he/she has no control:
The financial advisor should only be willing to be judged based on the following:
His/her ethical standards,
Devotion to his/her clients’ best interests, and
Professional competence as a planner and educator.
Unfortunately, you have no control over your rate of return either, and even if you did, it would be meaningless. Even if you got a 50% rate of return one year, that would not answer the following fundamental questions for you:
What do I need to do to retire when I want to?
How much can I safely spend in retirement on the things that bring me joy without worrying about outliving my assets?
When should I start taking Social Security, how do I maximize it, and should I pay down my mortgage?
How do I best draw down income from my portfolio and reduce my lifetime taxes?
What should I be doing to protect against inflation, rising health-care costs, or a Long-Term Care event?
How do I make sure my family is well-taken care of if I am not around?
These are just a few of the questions that can keep you up at night. A good advisor should help you answer these questions, and those decisions will lead to achieving your goals and your ultimate financial success, rather than how well your portfolio performed versus some arbitrary rate of return number you have fixed in your head.
Most advisors will almost certainly tell you that they can help you with these critical decisions, but many cannot.
So, how do you break the through the veil and discern the truth?
The wisdom of this truth can be broken down into 10 things a good financial advisor should be doing for you.
The graphic below provides some highlights to distinguish a good advisor from a typical advisor:
Financial Planning:
The first indicator of your financial advisor’s value is if he/she actually does financial planning. In other words, do you have confidence that you are making wise decisions in your ever-changing life. The financial plan will help you make decisions on investments, retirement income, taxes, insurance, and estate planning.
In order to make a proper financial plan, your advisor must have access to all of your relevant financial data. So, here is a simple clue to see the difference between a good advisor and one who is not:
Does your advisor ask for your tax returns each year, and can he/she quantify the amount of money you can save on your lifetime tax bill using certain tax strategies?
Does your advisor look at your Social Security statements, and what is his/her advice to help you maximize it?
Does your advisor have copies of your estate documents on file, run regular reports to ensure your documents are up to date, remind you to have them updated every so often, and make sure you are protecting your loved ones in accordance with your wishes?
Does your advisor keep a record of all your insurances and map out a Long-Term Care plan for you on a regular basis?
With this info your advisor can build a financial plan with dollar specific, date specific goals. The plan will help you set spending limits, determine savings limits, help you to avoid mistakes, and connect all the moving parts like a spider web, with each string representing all the decisions you will need to make in order to secure a stress-free retirement.
One of the most immense benefits you will get from financial planning is, as your life changes, your advisor can continually update your financial plan so that you always make well-informed decisions. In other words, you will know how plucking on one of the strings will affect the whole web.
Investments:
Let’s talk investments specifically. Your financial advisor should be able to provide clear and transparent information about the returns on your investments. However, the conversation is typically centered on rate of return alone. A bad advisor gets defensive or starts switching investments when rate of return is poor, hides behind industry jargon when explaining rate of return so you have no idea what he/she is talking about, or acts like a hero when the numbers show in his /her favor, whereas a good advisor explains rate of return in the context of your goals.
The following are very natural client questions and an opportunity for a good advisor to navigate a client through these concerns:
“Am I on track?”
“How’s my money?” or “How have I done against the S&P 500?”
“This portfolio hasn’t moved. Something’s wrong.”
“The money you manage has only done X% rate of return, while my 401k has done better with Y% rate of return. Why does the portfolio you manage always seem to do worse?”
“I’ve lost X amount of dollars this year. What do we need to do differently?”
“I like all your investments, except these two. Can you just get rid of these two and pick some others?”
Answering these questions solely in the context of your rate of return number makes you think rate of return is the most important factor in your financial success. It is important! Naturally, you want to be achieving enough rate of return to fund your goals and keep up with rising inflation. However, it has almost no relevance to whether you will run out of money in retirement. Your financial life is so much more than just your investments.
It may surprise you, but how well your investments are doing at a specific point in time has very little impact on your overall financial success.
The elements that do have a big impact on your financial success are:
Making a plan and
Staying on that plan so that you make consistently wise choices.
A good financial advisor should help you make those choices to ensure you reach your goals, and those goals should be funded through a high-quality portfolio, which is extremely well-suited to fund those goals. Building the portfolio is the easy part. It takes a few days. Keeping you in it is the hard part. It takes the next 10,000 days of working together.
In order to keep you in a great portfolio, it has to be measured against a financial plan. Otherwise, it can only be measured against the market, some benchmark, or another portfolio, and these are the ways clients always lose in the long run.
To measure your progress vs. the S&P 500 has NO impact on your life. If your advisor helped you outperform the S&P 500 every year, but you do not quite reach all of your goals, you are not going to be happy with your advisor. So, what is more important, performance or performance in relation to your goals?
A good advisor will help you understand that progress must be personalized to be meaningful. That is the reason a good advisor will take a goal-focused and planning driven approach, rather than a performance driven approach.
Furthermore, the funds you select have very little to do with the success or failure of your financial plan. It is the decisions that you make that will have the greatest impact on you, such as how much you can safely spend on the things that bring you joy in life (portfolio paycheck), without overspending.
Your choice of one fund with historical performance of X% over another fund with historical performance of Y% will not determine whether you run out of money in retirement. In fact, it has been demonstrated many times over that proper allocation, appropriate diversification, and regular rebalancing have a far greater impact on portfolio returns than fund selection.
In most cases rate of return is not a client’s biggest concern – it is taking too much money out of the portfolio when spending, not putting enough in the portfolio when saving, and making changes to a well-designed portfolio when things are not looking good for a period of time. A good advisor will help you put the focus on the items that matter most in your financial life, which coincidentally, are all factors you can control, whereas rate of return is outside of your control.
Tax Strategies:
Most advisors are scared of taxes. They do not understand taxes and do not take the time to study them. In fact, most advisors would struggle to explain how your Form 1040 works. Consequently, most advisors have no system in place to collect and review your taxes on an annual basis.
By the way, collecting your taxes during the initial onboarding phase and never asking to see them again, does not qualify someone to render tax saving advice over your lifetime.
You can tell much about a person’s financial profile by examining their tax return. How can you possibly expect an advisor to map out a lifetime tax saving strategy for you if he/she does not ask for your tax returns on an annual basis? This factor is a critical aspect in evaluating whether you have a good advisor or not.
Retirement Income:
Can your advisor help you make decisions on Social Security, Pensions, Annuities, and Required Minimum Distributions (RMDs)? Decisions on Social Security are the most common questions we receive. To advise a client to wait until 70 to claim Social Security (the latest age you receive delayed retirement benefits) is a no brainer. However, a good advisor should be able to craft ad hoc Social Security strategies that are best for the clients given their unique circumstances. In addition, it is important to consider all other forms of retirement income when advising on Social Security as each income stream adds to a client’s taxable income and will affect other areas of their financial life.
Insurance:
Does your advisor sell insurance? Good advisors typically do not sell insurance, including and especially annuities! Although the fact that an advisor sells insurance alone does not make him/her a good or bad advisor, it is a red flag because it creates a competing incentive. It places the insurance product at the center of the relationship since that is the way the advisor gets paid, rather than putting you, the client, at the center of the relationship. Good advisors advise the use of insurance within the context of a financial plan, explain the benefits and drawbacks of insurance, and offer alternatives to insurance products so that clients can understand the inherent risk that they could potentially be exposed to, and they have a plan to address that risk should it come to pass.
Estate Planning:
Does your advisor keep your estate documents on file and make sure you update them regularly? A good advisor will make sure your assets pass on the way you want them to. He/she will review your beneficiaries on a regular basis, advise on gifting strategies, and offer guidance on protection plans for aging and the common pitfalls that come along with it. Furthermore, a good advisor should be able to recommend and explain the benefits and challenges of certain types of trusts so that you can ensure that you protect those you love and make the estate transfer process as easy as possible when you are not around anymore.
Competencies:
Would you have someone do your taxes who is not a CPA? Would you go to a doctor who is not an MD? Would you hire an attorney who did not go to law school? It is amazing how many people are willing to hire a financial advisor with no credentials. Unfortunately, the financial industry in general has capitalized on the fact that prospective clients can get a sense of comfort from their advisor if he/she has some letters behind the name. Thus, the industry offers an array of certifications and credentials. Regrettably, most of these certifications can be awarded by taking a quick online course and paying a nominal fee.
With that being said, there are some well distinguished and qualified credentials in the industry such as the following to name a few as outlined in our previous blog, Credentials in the Financial Services Industry and What Makes Them Important:
CFP® (Certified Financial Planner),
CFA® (Chartered Financial Analyst),
CPA (Certified Public Accountant), and
CFO (Chief Financial Officer).
Regardless of the letters behind someone’s name, it is to your benefit to inquire as to the advisor’s background and experience. It is imperative that you ensure the person with whom you are working is extremely competent. A good financial advisor should have paid the price to obtain a profound knowledge of what he/she is offering and that it is unquestionably exactly what you need to make your life better.
Responsiveness:
Does your advisor respond to emails and phone calls, or do you have to wait several days or even make several attempts before you get a response? Do you have to call a 1-800 # or can you speak directly with someone who has an intimate knowledge of your financial situation? A good advisor should get back to you promptly and should be readily accessible. Even if he/she is not available immediately to give you the response you need, it is prudent to let you know that your inquiry has been received, and the advisor will get in touch with you soon to give you the guidance you are seeking. In addition, a good advisor will provide direct answers. If you get the feeling you are dealing with a politician every time you ask a challenging question, that is probably a bad sign.
Communication and Integrity:
Continuing with that train of thought, does your advisor use simple, easy to understand language or does he/she hide behind industry jargon? Trust can only be built with your advisor when you believe he/she always has your best interests at heart, and that belief is fostered by transparent, empathetic conversations where you understand the pros and cons of financial decisions you must make. If you do not understand how a course of action may benefit you, then it is likely you will not take action, and action is the only way to make progress in your financial life.
One way to gauge the quality of your advisor’s communication skills is to observe whether he/she lets you finish your sentences, or does he/she interrupt, or look as if he/she can’t wait for a quick pause so he/she gets the chance to speak.
Finally, and most importantly, does your advisor do what he/she says he/she is going to do? An easy way to confirm this commitment is to notice if the following hold true:
Meetings start on time,
Your advisor is prepared with an agenda, preferably sent out beforehand, and
You get a meeting summary after the meeting so that you can confirm what action items you and your advisor are doing to ensure your financial success.
Specialization:
Does your advisor specialize in a certain type of client or does he/she have all kinds of clients? What makes a heart surgeon an expert on hearts is that he/she does not do surgery on anything except hearts. Your advisor cannot be an expert for you if he/she serves many different types of clients.
Financial planning for 30-year-olds is much different than financial planning for 50-year-olds. The former group is concerned about getting children through school, eliminating student loans, managing credit card debt, and buying bigger houses, whereas the latter group is concerned about getting ready for retirement, doing the things they want to do without running out of money, Social Security and Medicare strategies, tax savings, aging parents, and Long-Term Care to name a few. These are all important financial areas, and they take a considerable amount of time and planning to get them right. If your advisor is distracted with financial planning topics that are not applicable to you and your peers, he/she can never provide the expertise that is required for you to sleep well at night.
Call For Action: Break Up With Your Typical Advisor:
After you have read this article if you determine your advisor is not the right one for you, it may lead you to the next question, which is, “How do I break up with my advisor?”
Here are some tips:
Schedule a meeting or call to do it:
Do not simply move your assets or send an email saying that you’re leaving.
There may be intricacies regarding your financial situation that require an expert to move your assets appropriately without causing you any financial detriment.
Make your conversation short and sweet – get to the point.
Say the following: “I’m moving to another advisor because I feel he/she is in a better position to help me with my needs. I hope you understand.”
He/she will try to convince you to stay:
He/she will tell you that he/she can do all the things you want (The reality is that if he/she had been doing these things already, you would not be leaving.)
He/she may attempt to lure you to stay by reducing your fees:
This offer is not a solution to your problem and will ultimately leave you worse off in the end because your advisor has already demonstrated he/she is incapable of or reluctant to provide the service you are looking for.
Just tell him/her relationships change over time, and he/she may have helped in the past, but you are going with someone who specializes in the type of situation you are in now, and you have already made up your mind.
Done.
Conclusion:
Your advisor is the product! A good financial advisor should bring you multiples of value beyond the cost. Many times, there is a quantitative value to working with a great advisor, but it is not based on rate of return. For instance, how much money you can save on taxes over your lifetime is a quantifiable metric. However, more often it comes down to a qualitative value, which is confidence in your decision making i.e. do you sleep better at night???
The truth is you only need to make one important financial decision in your entire life, and that is which financial advisor you are going to work with. When you make the right decision, you will know because you will sleep sounder, live longer, and make better decisions together. Working with the right advisor should help you have, “Success on purpose!” and that takes more than just a rate of return!
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