You know that you want to grow your wealth so you turn to a financial advisor for help. But how do you know that your financial advisor is going to get you where you want to be? These 3 tips will guarantee that you are with the right person and your money is safe. Get the tips here!
In retrospect, Debbie Klug knows she shouldn’t have trusted him with her family’s nest egg. “If you’re not comfortable with somebody,” she said, “just don’t go there.” It was a lesson hard learned.
Her previous experience working with a financial advisor had been a positive one. The advisor was part of a fee-based practice and he went to great lengths to get to know his clients. Klug parted ways with that advisor for a few years, though, and when she sought him out later, he had joined a company that didn’t take clients with less than $3 million in liquid assets. He pointed her in the direction of another advisor.
The new advisor immediately made Klug uneasy. “I didn’t like the way he made predictions. I just don’t think the market is something that can be predicted and he was predicting things 10 or 15 years down the road.” Trusting her original advisor’s recommendation though, she handed over the keys to her accounts.
She ended up doing the only thing that made sense: She dropped that advisor like a bad habit and moved her money back to Vanguard.
There is a right way to do this
Talking to customers like Klug, it doesn’t take long to come to the conclusion that for many clients, the financial advice industry just isn’t working. For some, it’s spending money on a service that doesn’t seem to add much value. For others, it’s an outright disaster aspoor communication, misaligned incentives, and high fees cripple financial standing and dash hopes of retirement.
But is it as easy to pick out advisory relationships that are healthy and successful? To find out, we talked to a wide range of industry experts from Josh Brown and David Lo to University of California professor Terrance Odean, as well as Carl Richards, author of The Behavior Gap, among others. In our conversations, three elements of a successful, valuable advisory relationship came up over and over again:
- Creating a financial plan.
- Combating behavioral biases.
- Employing clear and illuminating communication.
These aren’t the only elements of a really great advisory relationship, but if you can identify these three key components in an advisor, then there’s a good chance that you’re getting real value from the relationship.
Creating a financial plan
As the director of the Financial Services practice at quality-ratings giant JD Power, David Lo knows a thing or two about measuring the value of a financial advisor.
Regarding client satisfaction, Lo told us that “what we see is that satisfaction is correlated highly with best practices.” Which begs the question, “What are best practices?” At the top of the list, Lo puts “[having] a written financial plan.”
An investor doesn’t need a financial advisor to build and follow a plan. But will they do it on their own? Edward Jones managing partner Jim Weddle quipped, “I make a New Year’s resolution every year to lose weight, but I never do. Why not? Because I never pay for a trainer or coach.” A good advisor takes exactly that role, or, as Weddle put it, “We bring discipline to our clients’ savings and investments.”
Judging an advisor on this component is much more than checking a box though (“Yup! He gave me a printout that says ‘financial plan.’”). Today, cheap software can spit out a sharp-looking yet generic “financial plan” in no time at all, which allows some brokers and advisors to fake their way through this crucial step. By contrast, a worthwhile financial plan grows out of probing questions, a sharing of in-depth financial information, and a relationship with the advisor.
Combating behavioral meltdowns
The facts are plain: We’re not wired well to make consistently good, sober financial decisions. That’s why it can be a big help to have a third party keep our undesirable emotional impulses in check.
Richards, who wrote The Behavior Gap: Simple Ways to Stop Doing Dumb Things with Money, put it to us this way: “Unless we see Warren Buffett in the mirror, we need somebody to help us avoid making those genetic behavioral mistakes. … An investment advisor is a behavior modifier … that helps us follow some of the best advice that Buffett’s ever given: Help us be fearful when everyone else is greedy.”
Few know more about the subject of behavior-induced investing mishaps than Professor Terrance Odean. He’s a leading voice in the growing field of behavioral finance whose work has covered topics such as overconfidence, excessive trading, regret, and investors’ tendency to hold losing investments and sell wining ones — also known as “the disposition effect.”
When asked about the value of financial advisors, Odean replied, “Good financial advisors basically encourage investors to follow good investment practices. Left to their own devices, investors don’t do that.” He added that sometimes a good advisor is someone who simply “[injects] common sense where it’s needed.”
There are two ways for customers to increase the chances that their advisor does steer them away from biases. First, certain fee structures in the industry actively incentivize brokers and advisors to encourage behavioral biases like overtrading. The NBER team notes that their results are “in line with an interpretation where the advisor’s goal is to maximize fees by placing more weight on actively managed funds that create more income for the advisor.” And further, “evidence suggests that most of the interaction is driven by the need to generate fees rather than to respond to the clients rebalancing needs.”
For customers looking to avoid this outcome, fee-only financial advisors have a compensation structure that is much more aligned with clients’ interests.
In addition, customers should look for advisors that are willing to tell it how it is from day one. Unfortunately, the NBER paper notes evidence that many advisors pussyfoot around delivering the hard, but necessary, truth to clients because they’re too concerned with winning or keeping their business. When it comes to battling behavioral biases, an advisor like that is useless.
Clear and illuminating communication
David Lo at JD Power has seen the huge difference that communication makes in terms of customer satisfaction. “A huge part is the relationship with the advisor,” he said. That means not only “courtesy, friendliness, and responsiveness,” but, maybe more importantly, “did your investment advisor talk about investment performance, etc.” According to Lo, a “yes” answer to the latter “significantly raises” satisfaction scores.
David Shucavage of Carolina Estate Planners suggests that clients ask themselves: “Does this person really listen to you and ask questions of real depth? Do they understand what it will take for the money to bring you peace of mind?”
Putting the pieces together
These qualitative aspects of a good advisory relationship help set the stage for achieving the client’s financial goals. But they’re no guarantee of success. As Neal McNeil of Ibis Capital told us, “If the client needs a certain rate of return and [the advisor isn't] accomplishing that for them, then the plan doesn’t work.”
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