Wednesday, February 8, 2006

Chapter 9
On Your Own Or Hire An Advisor?

Jack Brennan in his book, Straight Talk on Investing says, "Remember, it's in the interest of many financial services companies to make you think that investing is difficult."

While Mr. Brennan’s statement is true, many recent news items and magazine articles have noted that Americans on average are not saving enough. And many of those who are saving and investing aren’t doing a very good job of it. Investing isn’t rocket science, but while knowing the right way to go about it is one thing, actually doing it right may be quite another.

If you are just starting out and you haven’t accumulated a large asset base, you probably do not need advice. However, if you are not disciplined, then you might need someone to keep you on track.

If you have accumulated a hodgepodge of investments in various places, you may need some help in sorting things out. There is also a large percentage of people who simply do not want to mess with finance. Before you decide one way or the other, evaluate your own situation and personality.

Jonathan Clements in a Wall Street Journal article comments “If you want to see the greatest threat to your financial future, go home and take a look in the mirror."

Jane Bryant Quinn in The Washington Post gives a similar warning “The green—in our eyes and in other peoples wallets—brings out the worst in us. I don’t mean morally, I mean our worst instincts as investors. We think we make rational decisions. More often, we veer from hope to fear and back again, with out putting our brains into gear at all.”

Investor, Know Thyself
Do you need an advisor? You now know that building a good portfolio is not difficult, but there may be unseen hazards awaiting the unsuspecting investor. Ask yourself the following questions:

* Am I impulsive?
* Do I jump to conclusions?
* What will I do when markets inevitably go against me?
* Do I have the temperament to act without panic?
* Do I second-guess myself?
* Do I have the time to oversee my investments?
* Can I view my situation objectively?
* Can I stay with the plan through thick and thin?
* Am I too competitive?
* Do I have the ability to see and adapt to life and goal changes?

Any of these traits can cause behavioral mistakes which cost money, but mistakes are generally made by investors who do not know the fundamentals. Knowing what you should and should not do goes a long way in overcoming natural tendencies.

Belsky and Gilovich in "Why Smart People Make Big Money Mistakes” suggest that when we consider important financial decisions, instead of asking knowledgeable friends or professionals what they think about the changes we are considering, ask them what they think about the process used to make the decision. It is far more revealing.

A good advisor may save an investor from making major errors, which would more than justify the added expense. So, there are very valid reason to use an advisor. But then, the investor needs to avoid another major mistake—choosing the wrong advisor.

If you decide you need professional guidance, there are two ways to get it. One is to put your assets under management (AUM). The other is to manage your own investments but consult with an advisor occasionally on an hourly basis to ensure you are on the right track.

Here are the general ways advisors are compensated:

Commission only: No direct charge for financial planning or investment advice. Recommendations consist of investments and financial products that have commissions or fees that will come out of your investment.

Fee-based or fee and commission: A fee is charged for financial planning or investment advice. Recommendations consist of investments and financial products that have commissions or fees that will come out of your investment.

Salaried: No direct charge, but incentives and awards are often provided in addition to the salary when certain financial products are purchased based on the advisor’s recommendations. Recommendations may also include investments and financial products that charge commissions or fees.

Fee only: Charges an hourly fee for consultation or a percentage of your assets if the advisor manages your investments. Recommendations consist of investments and financial products that assess few, if any, commissions or fees. The advisor receives no commissions; his or her only compensation is the fee you pay directly.

Choosing An Advisor
The great paradox of using an advisor is that you must know some basics in order to evaluate the advice, and once you do, you also know enough to consider doing your own management.

If you have gotten this far through the primer, you are already a more knowledgeable investor. You now have some sense of what proper investing fundamentals are, which means you have some defense against really bad advice. The professional advice you receive may or may not be in your best interest, but from what I’ve seen, you are far more likely to get biased or even harmful advice. Unfortunately, because of extremely loose industry standards, it isn’t easy to find an advisor who is qualified and one you can trust.

What comes to mind when you hear the terms financial planner, financial advisor, investment counselor or wealth manager? You might be surprised to learn that these titles mean absolutely nothing. Anyone can use such titles and no training, education or experience is required. The Financial Institution Regulatory Authority (FINRA), formerly NASD, does not recognize these generic titles.

Here is some enlightenment from Chartered Financial Analyst (CFA), Rick Ferri: “The financial industry plays the game like no other. Every advisor calls himself something that makes him seem like an expert, but few people are. At brokerage firms, everyone is a Vice President. If they are not a VP, they are either very new or on their way out the door. In addition, everyone calls himself or herself a Financial Consultant, Financial Advisor, Financial Coach, Retirement Specialist, or some other nonsense title that means nothing. These are all self-appointed titles, and they can change with the wind.”

In the section on costs you saw how high costs and commissions can really cut returns. The type of advisors who hold no useful credential almost always promote high cost commissioned products. These are the high profile guys. They're the ones who advertise heavily and aggressively look for your business. They promote through “free” seminars, dinners, mailing campaigns and cold calls. Friends and business acquaintances frequently recommend them simply because they’ve met them through business associations, and they don’t know any better. You don’t have to look for these advisors; they will find you!

High costs and commissions are to be avoided as they are silent wealth killers. But, an even greater danger is getting advice that can wipe out your assets. Poor recommendations and uncontrolled risk often result from a combination of lack of skill and self-interest.

I have painted a pretty bleak picture of commissioned and fee-based advisors, so it's only fair to say that there are some advisors who have high ethical standards, are knowledgeable, and try to provide fair service. You can greatly increase your odds of finding a good advisor, though, if you look for CFP or CFA credentials.

Bruce Miller, CFP clarifies, Real Certified Financial Planners (CFP) are bound by something called the 'brochure rule', that requires us to immediately disclose lots of information to a prospective client...including from whom and how much we are paid, even if by commissions. This is done by contract before any data collection or advising is done.

Brokers and other salesmen are specifically exempt from this rule as described in the 1940 Investment Advisors Act, unless they received direct compensation for advisory services, which they never do. In addition, the advisors ADV II form should be clean (no present, pending, or past disciplinary actions). The prospective advisor must offer you a copy of his/her ADV II, as required by the SEC.”

What Mr. Miller said about brokers was true, but recent changes have improved things a bit. Now, any advisor who has discretionary power to trade (the normal contract set up in fee-based managed accounts) must be a registered investment advisor (RIA) and must carry fiduciary responsibility.

That’s an improvement, but the RIA certification is a far cry from a CFP certification. The RIA requires only a home study course with one final test.

Advisors who manage accounts without full discretionary power (need the client’s approval for trades) are held to a lesser standard. And those using commission are only held to what’s called suitability standards. That standard clearly is not fiduciary responsibility.

One major point to all this is commissioned advisors still hold no binding commitment of fiduciary responsibility to their clients. The new ruling has shifted fiduciary duties from the individual to the type of account held. It’s confusing, but still better than it was.

And this is what AARP had to say in their July 2006 online magazine:
"Fiduciary” means that the person working for you owes you the highest possible duty of care and loyalty, so that a relationship of trust and confidence exists between you and the planner. While you may think that this sort of trust and confidence will naturally exist, a fiduciary relationship usually depends on the facts and circumstances of a particular situation.

Most brokers do not want to accept fiduciary responsibility and many are now converting discretionary, fee-for-services accounts to other types. That usually means if you are in another type of account you are truly in a “buyer beware” relationship because you are assumed to be knowledgeable enough to watch out for yourself when it comes to investments.

This situation also means that by using brokers and the wrong kind of accounts you are not only opening yourself up for expensive, biased advice, you are also giving up an element of protection. In a dispute, you will receive almost no help—you have no leverage—when using a broker unless he clearly carries fiduciary responsibility. With CFPs, you do have leverage against flagrant mishandling of assets. Here is an article on a recent court ruling concerning advisors, brokers and fiduciary responsibility:

This link provides the definition of fiduciary responsibility as defined by The National Association of Personal Financial Advisors (NAPFA):

Author Larry Swedroe sums up the advisor dilemma this way, “Sometimes you get what you pay for, and sometimes you pay for what you get.”

In the strictest sense, there is a distinction between a financial planner and an investment advisor. Some planners do both, but you don’t have to find one that does. It’s entirely reasonable to hire a planner to prepare a plan, and an investment advisor, who is not a planner, to manage your assets. Some people feel this provides more flexibility and completely eliminates conflicts of interest.

The following is again from CFP, Bruce Miller:
There are two screening factors to consider in looking for an advisor. This won't necessarily guarantee you'll get more in investment return than what you spent, but will certainly increase the odds in your favor:

1. Credentials. If investment advice is what you seek (presumably to provide a sustainable retirement-life income to supplement Pension + Social Security), then the CFA, CFP and/or CPA credential will help to insure that formal training has been achieved.

2. Method of compensation. Fee-Only will minimize the potential conflict of interest. Fee-Based may reduce the conflict, but compensation by commission ensures it. Whether you rule out the later is up to you, but if you elect to speak with those paid exclusively on commission, make sure you know of what you speak.

Sometimes the best you can do is to find a planner who doesn't have a compensation plan that would seem to be at odds with your best interests. And if you have a planner who has decided that 'his/her own best interests are served by consistently providing a quality plan to his/her clients', that is probably as good as it gets.

Once you find several credentialed advisors in your area, call and ask them what they specialize in. Tell them what your approximate goals are and if they think they'd be able to assist you. I recommend you then set up personal interviews with at least 2.... 3 is better.

When you do meet, like a visit to your doctor, they should ask questions, listen and take occasional notes. You should do most of the talking. At the end of 30 minutes, they should be able to clearly summarize your position and recommend a general course of action. They should have no hesitation in encouraging you to think over their general recommended approach and their estimated cost range. Any talk of financial products or recommended specific solutions, or even the slightest pressure to sign an agreement at the end of this first meeting is a bad sign and suggests you should go elsewhere.”

Two links for finding an advisor:

Note: do not assume that just because an advisor is listed that he/she will meet all your requirements. Always ask the right questions. Some CFPs have been known to use the designation but not the intent.

One other option is the large mutual fund companies themselves. The fees seem to be competitive, and if you are opening a large account, the fees may be reduced or waived. T. Rowe Price, Fidelity and Vanguard are three large, respected companies who are now offering advisor services. Recommendations will be from the company you go with of course, but these three companies offer a wide variety of funds so choices should not be a problem.

Some questions to ask potential advisors;

1. Are You a Registered Investment Advisor under the Investment Advisors Act of 1940?
What are your qualifications? Licenses, certifications, regulatory agencies. What organizations, affiliations. How much experience?

2. Do you accept fiduciary responsibility?

3. Please provide a copy of your most recent and accurate disclosure form.
ADV-II (Registered Advisor), U-4 (Broker / Dealer)

4. What services do you offer?
How many clients, what type of clients, minimum asset requirements?

5. Are you independent of financial-product sponsors?
Brokerage firms, insurance companies, banks. Do others you work with or recommend provide you with benefits for your recommendations?

6. What approach to planning and investing do you favor?
Stocks, mutual funds, what kind of funds, annuities? Note: The advisor’s approach and risk management style should be in line with yours.

7. Will you be the only person working with me?
In the office, outside professionals?

8. How much do you typically charge and how are your fees applied?
Will you provide a written statement of all fees, including direct fees and fees paid to other firms or organizations? How will I pay you for various services?

Get an agreement, including costs, in writing for services that will be provided. It may be a good idea to copy these questions and send them before you meet with potential advisors. That will save you and the advisors some time. And it will send them a message that you know what you're doing.

Be leery of any advisor who suggests annuities, with the exception of low-cost single payment immediate annuities (SPIAs) . Avoid wrap accounts, separate accounts, limited partnerships, private real estate trusts, leveraged funds, equity-indexed annuities, insurance products, or any products the advisor tells you can’t lose money. Never hire an advisor that says you don’t pay him—the fund company pays him.

If you hire an advisor, remember he or she works for you.

On to Chapter 10

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