by WWM | Jan 27, 2017 | Financial Advisors
In “Commission Based Advisors, Part 1”, we looked at the advantages of working with a commission based financial advisor. Today we will review some of the possible disadvantages or things to watch.
As I mentioned in Part 1, I run a fee only advisory service. I try to be objective in my analysis, but there may be some bias slipping through.
Disadvantages of Commission Based Advisors
The Free Lunch
There is no such thing as a free lunch, or so the story goes.
You usually get what you pay for.
If you intend on obtaining varied or comprehensive financial planning or wealth management advise, not just purchasing a specific investment product, make sure that the advisor is competent in your areas of need. I am not saying that commission based advisors are incompetent. But if their prime function is that of product salesman, financial expertise may be second, third, or further down their list of strengths.
Match your financial objectives and needs to the advisor skill set and experience. Do not accept lower quality advice simply because that advice is free. If you get weak advice and end up in an inefficient portfolio, there is a cost associated with that.
The Lunch May Be Free, But Watch the Charges for Plates, Cutlery, and Napkins
The advice may be free, but someone is paying the advisor.
Directly, it is the company behind the products being sold. Or the advisor’s employer.
Indirectly, it is always you. Whether you pay a sales charge for the product or are assessed higher annual operating expenses, you are paying the advisor’s wages.
Small investors may pay less than large investors. But everyone pays to some extent.
Length of time holding an investment can also impact how much one pays. With load products, the shorter the holding period, the higher the relative cost. With no-load products, the longer the holding period, the greater the cost paid back to the advisor.
For example, you invest $100,000 in a large cap, domestic equity fund charging a 2.1% annual fee. An actual average annual fee for large cap, Canadian equity funds, by the way! That equates to an annual expense deducted from your investment in the amount of $2100 per annum. Over 10 years, that is a lot of lost capital. Capital that is not being reinvested and growing on your behalf.
Note the 2.1% annual expense ratio includes expenses other than simply the “free” advice component. The linked Morningstar article indicates that the average difference between the identical investment fund is 1.0%. You pay a 2.1% annual expense for a fund purchased through a commission based advisor. Whereas you only average 1.1% in annual expense ratio for the same fund purchased via a fee only advisor.
In this case, the amount paid for “free” advice on the $100,000 investment is $1000 per annum.
Through the 10 years, that annual expense will increase. Say your fund returns 7.2% net of expenses (ignoring taxes), annually over the 10 years. Even with no additional investment, your fund will be worth $200,000. That means you pay more in annual fees each year. In fact, by year 10 your costs have risen to $4200 annually.
And for that initial advice that cost you nothing? You end up paying an additional $14,952 in fees versus buying the same fund through a few only advisor. That may be substantially more than you would have paid a fee only advisor up front. Even factoring in the discounted time value of money.
As an aside, I do not agree with Morningstar’s comparison of 2.1% versus 1.1% expense ratios. Morningstar is comparing mutual funds only. This makes sense as they want an apples to apples comparison between funds that commission based advisors sell and the exact same funds sold through fee only advisors.
However, in the real world, many fee based advisors will recommend exchange traded funds (ETFs) rather than mutual funds. There are many reasons why and I will discuss them in future posts. A key factor is that ETFs often have lower annual expense ratios than comparative mutual funds. That means the 1.1% ratio cited for funds sold through fee only advisors is higher than one would expect in purchasing an ETF.
For example, Vanguard offers two Canadian equity ETFs with annual expense ratios of 0.06%. iShares TSX Capped Composite ETF runs 0.06% per annum. BMO TSX Capped Composite ETF is 0.06%. These ETFs all target Canadian equities with emphasis on large cap. All will save you 1.04% annually versus similar mutual funds sold via a fee only advisor.
And do not get me started on the cost variance between a 2.1% commission based fund’s annual fees and an ETF at 0.06%.
Is it in Your Best Interest?
When I sit down with a professional – doctor, lawyer, accountant, etc. – I expect that they are acting in my best interests. I pay a fee and get their unbiased expertise in return.
With commission based advisors, I am always extremely leery as to whether they are looking out for me or for their own family. In my mind, I can hear them say:
“If he invests in this 5% front-load, 2.5% annual operating fee mutual fund, my son can get those braces. Don’t mention the excellent ETF that tracks the same market for a fraction of that fee.”
Maybe I just have a suspicious nature. But I am more comfortable dealing with someone I know will give me unbiased advice as to what is best for me. And not someone I hope will do so.
That said, there are commissioned salesmen that act in the clients’ interests. There are also fee only advisors that act unethically. But, on average, I have more confidence with a fee only advisor than with someone whose own income is linked to what he sells to me.
One question I would ask any potential advisor, commission or fee based, is whether they act as a fiduciary or not. That will assist in determining whose interests the advisor is acting for.
As I said, there are pros and cons to all manners of advisors. I am undoubtably less thrilled with commission based, but there are some very good ones out there. And, if you are starting out with very limited capital, deferring the advisor fee may be better than coming up with a cheque today.
Next we will review the pros and cons of working with a fee only financial advisor.
by WWM | Jan 24, 2017 | Financial Advisors
In Finding a Financial Advisor, a key consideration is understanding how the advisor is compensated. As investment fees and expenses significantly impact portfolio returns, this is an area to monitor closely.
In general, there are three forms of advisor compensation: commission based; fee only; combination of commissions and hourly or flat rate fees.
Note that “commission based” is not the same thing as the “sales commission” you may pay when buying or selling an investment. Similar terms, just slightly different context. We will cover sales commissions later.
Commission Based Financial Advisors
Commission based financial advisors do not directly charge clients for their services. These advisors usually earn their income through salaries, commissions, or retrocessions paid by their employer and/or third parties. There may be some cost recovery or non-advisory fees charged to the client, but the actual advice and product placement tends to be free to the client.
Commission based advisors should disclose their compensation arrangements to potential clients prior to providing any services. In many jurisdictions, this is legally required.
Before beginning our look, a quick disclosure. I run my practice on a fee only basis, so there may be some unintentional bias in my analysis. I try to be fair, as there are undoubtably excellent commission only advisors, but please keep this in mind as you read the post. We will look at fee only advisors separately.
Advantages of Commission Based Advisors
Nothing Out of Pocket
When getting investment or financial planning advice, the investor is not charged directly for the service. Rather, advisors are compensated by the companies issuing the financial products bought by their clients.
Perhaps you have $5000 to invest. It may take a commission based advisor 1 hour to determine an investment strategy to pursue. Or it may take 5, 10, or 15 hours. Regardless, you do not directly pay a cent to the advisor.
With no money paid directly by the client to the advisor, this may seem a cost-effective solution for investors. And, in many instances, I am certain the client believes he does receive value for the service.
For small investors, this may be the key reason to choose a commission based advisor.
Possibly Useful for Small Investors
Why small investors?
The advisor’s fees are spread out over all commission products sold. Or paid by his employer. So no initial expense by the client. Small investors have limited capital. Not paying out costs up front is attractive.
For example, you and your sister invest through a commission based advisor. You will invest $5000, your sister $50,000. You meet separately with the advisor for 3 hours each and arrive at an investment strategy. The strategy involves purchasing ABC Equity mutual fund. You can purchase the fund with a 5% front-end load. Or invest in the same fund with no-load, but charging an extra 0.25% annual operating cost (reflecting retrocession payments to the salesmen by the fund).
Note that I will write down the road about various fees and costs relating to mutual funds. So if loads, total expense ratios, and management fees are unfamiliar terms, we will cover them in due course.
With the front-end load funds, you will pay $250 in a sales charge. Your sister will pay $2500. Technically, you are paying a sales commission on buying the fund. The advice you received is free. The reality is that the advisor will receive a portion of that sales commission from the fund company.
With the no-load funds, you will “pay” (through higher total expense ratios) an extra $12.50 annually on your initial capital. Your sister will end up “paying” $125 annually.
I will further note that (hopefully) the extra amount that you spend annually increases over time under the no load approach. In the example, your $5000 in invested capital generated an extra $12.50 annually in expenses (above the annual fee for the front load option). Say in 5 years, the fund grows and your invested capital is now worth $10,000. Now you are paying an extra $25.00 per annum in fees.
It may not seem like much. But if you hold the same fund for 35 years and it grows to $160,000 (assuming roughly 10% growth per annum), you are now paying an additional $400 per year. It adds up over time.
One lesson from this is that the longer you hold a fund, the more attractive a front load commission may be versus no load and higher annual fees.
A second lesson is that with commissions and operating costs, the investor with greater capital invested always pays higher fees.
Even though you and your sister required the same amount of time from the advisor and are investing in identical products, she will end up paying more.
Note that often there is room for negotiation for those bringing in substantial assets. Not everyone pays retail for investing services. Be sure to ask about any discounts. Even if you are just starting out.
Often reduced fees/commissions are available to fund investors for subsequent purchases in the same fund (or fund family). Also, many funds offer rear loads and/or declining loads which reduce the sales commission based on the number of years you own the fund. Find the option that is best for you.
Improved Service Quality in Commission Based Advisors
With so much competition in the financial planning and investment industries, it assists in product sales to have knowledgeable salesmen.
Today, many commission based advisors possess the proper technical training and experience with which to advise investors. If you can find an advisor with top credentials and not pay a full price for financial planning assistance, then you may save money in the long run.
As to whether there is a potential saving, I think this differs from investor to investor and advisor to advisor. If you find an excellent advisor (or you force the advisor to follow a low-cost strategy), the money paid by you through higher product costs may be worth the quality of service you receive. But if you end up with someone pushing high margin products, well …
Best of Breed Products
Some investment firms and commission based advisors now offer “best of breed” product sales. They do not automatically push clients towards in-house solutions. Instead, the advisors attempt to find the best product in the market for the client’s needs.
This may result in less commissions for the advisor and less revenue for the investment firm. But better results and lower costs for clients.
No, these are not Mother Teresa firms. Rather, the belief is that a satisfied customer will generate more wealth over the long-run than unhappy clients.
Studies show that satisfied clients have much longer relationships with the investment firm, which results in longer revenue streams. The firms are trading short term profits from investors who leave after experiencing high costs and/or poor performance for lower margins on clients that stay for long periods.
Secondly, satisfied clients bring additional wealth to the firm. Most investors maintain multiple investment and banking relationships. Yes, the eggs in one basket concern. But, over time, if one firm or advisor achieves a high level of customer loyalty, assets are normally shifted in from other institutions.
Assets under management is a key driver for the value of investment firms and banks. In most cases, these companies reward employees based on generating net new money to the same degree as product sales figures. You may be able to negotiate lower product costs if the advisor believes you will invest higher amounts over time.
Third, word of mouth advertising is an excellent way to generate new customers. Do you like getting a cold call at home or work from someone trying to sell you something? Probably not. But what about if you are at a party with friends and you mention that you intend to buy a house and are looking for a realtor? A friend tells you that she just bought a home and her realtor did an excellent job. You likely want to know more and may end up calling the realtor yourself. That is the principle here. While a satisfied client may produce less short term revenue, they will assist in generating new customers over time.
Key Takeaways
We will cover the disadvantages of commission based advisors in Part 2.
I think the keys to remember from this post are:
If you intend to hold a mutual fund for a long time, a front load sales commission will likely end up less expensive than the same no-load fund that charges higher annual fees.
With commissions and operating costs, the investor with greater capital invested always pays higher fees.
As in any industry, the skill and experience of financial advisors vary from individual to individual. Also, advisors may be tied to a limited product offering. If choosing a commission based advisor, look for one who is highly competent, meets your specific needs, and offers products from as wide a range as possible.
Sales commissions and fees may be negotiable. Advisors are looking for satisfied clients who maintain long term relationships and assets under management. Advisors may be able to reduce some costs in exchange for a longer (more lucrative) revenue stream. Do not be afraid to negotiate.
by WWM | Jan 21, 2017 | Financial Advisors
In Finding a Financial Advisor, I recommended assessing an advisor’s overall approach to wealth management or specific services within, the products and services offered, and type of client the advisor primarily services.
Collectively, I consider this the financial advisor service offering.
Matching your financial objectives and needs with a service offering is important. Advisors tend to have different areas of expertise, emphasis, and product offerings. You want to try and get the best fit for your needs when choosing an advisor.
Fairly obvious. But I do want to make a few observations.
Financial Advisor Overall Approach
The US CFP article we originally looked at recommends you ask potential advisors, “What is your approach to financial planning?” Or insurance, tax, investing, etc.
A good question.
The article states, “Make sure the planner’s investing philosophy isn’t too cautious or overly aggressive for your needs. Learn how he will carry out recommendations or refer tasks to others.”
Three points made, with an emphasis on whether the potential advisor may be too aggressive or cautious for your own risk appetite?
Match Your Risk Tolerance to Advisor’s Strategy
From the risk perspective, find advisors with whom you have a comfort level in their approach. If you are concerned with higher risk investments or strategies, you may not be comfortable having a portfolio of small-cap, emerging markets equities, or venture capital companies. Or, engaging in grey area tax strategies or heavy borrowing for investments may also cause high stress.
Conversely, perhaps you are somewhat aggressive in nature. If your advisor advocates a strategy of low-risk government bonds and term deposits, that may cause frustration due to low returns (and boredom – yes, many clients gravitate to exciting and cutting edge investments, just because.).
Your personal risk tolerance is based on your personality and life experiences. A good advisor should be able to assess your risk profile and come up with recommendations that strive to meet your financial objectives while operating within your risk tolerance levels.
In my opinion, a better financial advisor will work with clients to develop a more systematic approach to risk. Clients who understand the investment and financial planning processes are able to make smarter decisions. We will get into developing that understanding over time in this commentary.
The other two points cited relate to how the recommendations will be implemented and outsourcing or referring work to others. Both should be straightforward. I would focus on the fee arrangements for each.
Implementation and Outsourcing Costs
If you are being sold a product or service in-house, what are the fees to implement the planning strategies? The advice may be free, but you will pay a commission or other expense to implement.
You need to ensure that your needs are driving the implementation, not the revenues from product sales.
If your advisor is outsourcing any portion of your work, either in-house or through third parties, understand how the process works.
It can be beneficial for someone else to assist with your requirements. For example, an in-house insurance expert may help with any specialized needs. However, if you meet initially with someone who is highly skilled and they dump your file on a very junior assistant, that may not be in your best interests. Again, understand who is doing what, how the different parties are coordinated, and the supervisory process for work performed by junior staff. It is also usually a good idea to meet all in-house staff working on your file.
Outsourcing work to third parties can be good or bad. My major concern involves fee arrangements with your advisor. We will look at fees separately.
As for the outsourcing, determine how that third party was chosen? Is the third party a competent person who will perform good, reasonably priced work on your behalf? Or is just a buddy of the advisor? Or someone who may or may not be adequately skilled, but gets the business because they pay a referral fee back to the advisor?
As well, what recourse do you have against poor work by the third party? The third party? Or does your own advisor take responsibility for actions of those he outsources work to?
I have no problem with outsourcing work to third parties. Just be certain you understand who will be doing the work and any financial arrangements between your advisor and the third party.
Product and Service Offering
The types of products and services a financial planner/advisor will provide vary from organization to organization. This should be fairly straightforward at a high level.
You meet a tax lawyer or accountant. You should expect services relating to personal or corporate taxation, plus estate planning and related retirement issues. You should probably not expect the professional to sell mutual funds or develop derivative trading strategies. The broad groupings should be easy to ascertain.
But within general groupings, there is a fair bit of variation. Let’s consider financial planners.
Some planners prefer to develop detailed financial plans encompassing all of a client’s financial goals. Others choose to work in specific areas such as taxation, estate planning, insurance and investments.
If your priority is to learn how to better budget and save, look for someone who emphasizes those aspects of financial planning. More so than someone who provides pure investment advice.
You should find someone with the qualifications, experience, and service offering that best meets your primary financial objectives. Both now, as well as in the shorter to medium future.
Type of Client
Why is the type of client an advisor normally deals with important?
And by type we can consider both client “needs” and “size”.
Match Advisor to Your Needs
As stated above, obviously match your needs to an advisor on a general basis. Tax specialist for tax requirements. Insurance specialist for insurance needs.
But even within your general groupings try and find a good match to your specific needs.
Often an advisor can deal with clients having different needs and objectives. A fund salesman should be able to handle most investors’ needs. Whether they be 20 year olds beginning to invest, all the way to retirees winding down their portfolios into cash flow generators.
That tends to be true for lawyers, accountants, planners, insurers, etc. In an advisor’s particular area of expertise, they should be able to handle the requirements of most client types. The exceptions resulting from the skill and experience of the advisor versus the complexity of the client’s needs.
For example, a fund salesman may be able to handle most investors’ needs. But if you are an investor seeking advice on options trading strategies, a fund salesman might not be the advisor for you.
There may also be synergies in finding an advisor who focusses on your specific requirements.
For example, a young adult may desire a higher risk investment portfolio with a significant percentage of non-hedged international equities. Possibly some relatively less liquid and/or higher volatility assets. Actually not a bad portfolio for individuals with long time horizons. On the other hand, a retiree may seek currency hedged investments, with more emphasis on liquidity and low volatility. Again, prudent strategy.
Investment advisors or planners probably can handle both client types. But perhaps the ones that specialize in your personal situation may have a better grasp of current products, strategies, etc. for that client segment. Or maybe it brings you greater comfort knowing that your advisor works with people who have the same issues as you more regularly.
Match Advisor to Your Asset Size
This is similar to matching an advisor to your specific needs.
Perhaps your potential advisor focusses on clients with less than $250,000 in assets. Their financial needs are usually different than a client with $50,000,000 in assets.
You want to match your needs resulting from asset size with the right advisor.
Not necessarily that one advisor cannot assist, but an advisor who deals with your asset level may be more up to date in products and strategies in that market segment. Same as the client market segment above.
Optimal strategies, tactics, and investments may differ by client asset size.
If you have $100,000, it is extremely difficult to create a highly efficient and effective portfolio of individual stocks and bonds. Low cost funds are a better investment path. If you have $10,000,000, then it is possible to create a well-diversified, efficient portfolio with individual stocks and bonds. The greater the economies of scale, the better the flexibility.
Also, the larger and more complex the client, the more sophisticated (and expensive) the advice. Perhaps you have a salaried job, a few investments, some interest and dividend income, etc. H&R Block or a small tax practitioner may be able meet all your tax needs for a reasonable cost. Sure, the head tax partner at PwC could also meet your needs. But at 5 times the cost (or more).
Conversely, if you have $50,000,000 in assets you may need the higher end tax expertise that a small tax advisor cannot provide.
Look for advisor’s that work with your asset size and related requirements. Find quality advisors, but do not spend money on expertise you do not need.
Be on Same Page as Your Advisor
As a client, you need to be on the same page as your advisor. If you do not agree with the advisor’s approach, then it will be a poor match.
The key is strong communication.
A good advisor will be able to explain clearly why a recommended approach is preferable. The client, in turn, must buy in to the recommended course of action. Note that buy in is not simply acquiescence. The client must understand and accept the reasoning behind the strategy and agree.
Do not just defer to the advisor’s “expertise”. It is your money, make sure you understand and agree.
On the other hand, it is equally imperative that the client be honest, open, and explain what he or she wishes to accomplish. And the advisor needs to listen and understand.
Communication both ways is crucial. In my opinion, good financial advice is a collaborative process between advisor and client. If both advisor and client are not on the same page, results will be suboptimal. So find someone who is a good fit, then work together over time to build your wealth.
by WWM | Jan 16, 2017 | Portfolio Construction
Over time, we will look at the debate between active and passive asset management.
What each term means. In general, should you actively or passively invest? Are there exceptions to the general rule?
Today I want to briefly highlight an article I read in the Financial Times. A subscription is probably necessary to access the story, but I will cover the key points below.
Active Global Equities Outperform
The Financial Times article is entitled, “Study finds active global equity funds outperform”.
Very interesting given that it is very difficult to impossible for active managers to consistently outperform market benchmarks over extended periods. There are some exceptions, yes. But, in general, I would not expect to see actively managed global equity funds outperform their passive benchmarks.
But if the Financial Times headlines that, it must be correct. Sell all your index funds and get into actively managed. Unfortunately, if you read past the headline and opening paragraph, it is not that clear cut.
Many “Studies” Desire Pre-Ordained Results
According to the study,
actively managed global equity funds outperformed the market by between 1.2 per cent and 1.4 per cent annually on average between 2002 and 2012.
I will not impugn this study and shall accept their results.
But it is worth pointing out a problem I have found with “studies” in many instances. Something you should keep in mind any time someone claims something, especially an unconventional finding.
In this study, why choose only a sample period from 2002 through 2012? Did active fund management not exist before 2002? Yes it did, in case you were wondering. Why end in 2012 for a study that is just being published now? 4 years to assess and collate?
Watch for studies that rely on things like sample size, time period, or makeup of the participants to drive the results. In general, the larger the sample size or time period the better. Or with “makeup”, consider a poll of US voters that has a sample of 85% Democrats to 15% Republicans. You may not get a representative set of responses of the US as a whole.
The same holds true for sampling investments. You always want samples that represent the overall population as best as possible.
Again, not saying there is anything intentional here, but it raises questions. Especially given that it is very difficult to consistently beat benchmarks over longer periods.
Always view “studies” with a healthy degree of skepticism.
Investor Costs Impair Performance
I am not going to hammer the findings too much as active management can outperform in gross returns. Sadly, you – the investor – never receive gross returns. For the active managers’ services, you pay an annual management fee, plus associated costs. Your return is net of fund costs and fees.
You may have also paid a sales commission when you bought the fund. That adds to your cost structure.
This study found that active management can outperform on a GROSS basis. The study does not calculate excess returns on a NET basis. That is, the actual return that you receive. When you factor in management fees that investors pay in the real non-academic world, that 1.2% outperformance significantly shrinks.
I do not know the exact shrinkage as I do not know the specific funds assessed. But it would not surprise me if the management fees and related costs eroded the excess return to zero of worse.
The article points out that “pension funds and other big investors typically pay fees of around 0.75 per cent.” Then helpfully adds, “Retail investors often pay higher fees.”
You, gentle reader, are a retail investor.
Investopedia gives a quick breakdown of typical fund expenses that lower investor returns. Investopedia estimates that, “The average equity mutual fund charges around 1.3%-1.5%. You’ll generally pay more for specialty or international funds, which require more expertise from managers.”
If that is the average equity fund, and international funds tend to cost even more, then that 1.2% excess return in an actively managed global fund disappears quickly.
Note that active management tends to result in higher administrative and transaction costs than a passive fund. Because active funds are more “active”. Also, many international funds have higher expense ratios for a variety of reasons (regulatory, lack of transparency, inefficient markets, etc.). We will cover this in time.
Realize that your net returns (i.e., your actual performance) may be materially different than gross.
Selection Bias
Another topic to delve into at a later date. But an issue with studies of this sort, so I will briefly touch on it.
The authors looked at 143 global equity funds. Now there are more than 143 actively managed global equity funds out there, so first question is how did they choose the ones they did? Did they pick the top performers, bottom performers, etc?
If you let me look back at 10 years results, I might be able to put together a portfolio of stocks with Apple, Amazon, Under Armour, SalesForce, etc. If you ask me to put together a portfolio for success in the next 10 years, I will have less certainty.
Second, and a huge issue with mutual funds, is funds that are no longer in existence. This study chose funds that were around for all 10 years of the study. That means funds that ceased to exist during that period were not included in the results. As you can imagine, the main reason for a fund ceasing to exist is due to underperformance. Weak funds lose investors (and their capital) and usually go out of business over time. By not including low performing funds in the sample, you skew results upwards.
Think back to your school days. 30 students in class. Mid-term exam, 10 students get 80%, 10 get 50%, and 10 get 20%. Overall class average is 50%. But the lower tier students all decide to cancel the class. Same class, but instead of a 50% average, now you only have 20 students who average 65%. Simply by weaker students dropping out, the overall average rises.
Same thing with funds. Never forget that when reviewing longer term performance data.
All the Media Clickbaits
The Financial Times is not TMZ or a dodgy website that lures viewers through very enticing headlines. Yet today, everyone uses headlines to attract readers.
Even staid financial newspapers or magazines are in the business of bringing people to their sites. That leads to headlines and short blurbs that may not be 100% accurate. Do not automatically assume that what you see in the first paragraph totally agrees with the actually contents. Make sure you read things in total.
These things tend to annoy me a great deal (hence the blog post). One, they tend to be incorrect or misleading. That confuses non-professional investors and leads them to make poor choices. Two, it takes me (and other financial advisors) time to correct this misleading information with clients.
Over time, and in some sort of proper order, we will get into the themes raised in this post. The active versus passive debate being the big one. But we will also take a look at fund fees and expenses and problems with reported performance data.
by WWM | Jan 12, 2017 | Financial Advisors
In Finding a Financial Advisor, the first thing to review is your potential advisor’s professional qualifications. The second question to ask is, “What experience do you have?”
Relevant and in-depth experience is obviously an important factor. Here are some things to consider.
Experience to Match Your Needs
Stating the obvious, you want a financial advisor whose skills and experience meet your requirements. Obvious, yes. But not always an easy thing to assess when interviewing potential advisors.
Within any professional qualification there may be a wide range of technical areas of proficiency. For example, Chartered Financial Analysts (CFA) are found in a wide variety of professions.
Perhaps you are seeking a CFA with 10 years experience to run your mutual fund. You want someone with 10 years experience in fund management. Likely not a Chief Financial Officer, Risk Manager, or Financial Advisor. But all may be CFAs with 10 years experience.
Or if you need a Chartered Professional Accountant (CPA) to handle complex tax issues, you want one with significant experience in taxation. Your local audit manager, insolvency partner, or managerial accountant may not be a good fit. As with CFAs, CPAs come in a variety of skill sets and experience.
Do not blindly assume that all members with a particular professional designation have the same skills and experience. You need to discuss their specific areas of expertise and ensure they match your requirements.
Amount of Experience
The amount of experience you seek is based on your needs.
If you have a relatively straightforward tax return, a professional with only a few years experience may be fine. But if you need to perform a complex estate freeze, you may want someone with more experience.
In the perfect world, you would always choose advisors with the most experience and best reputation. But the greater the expertise, usually the greater the cost. Find advisors that meet your needs, but do not go overboard. Put as much of your money as possible to grow on your behalf. Not in the bank account of your lawyer, accountant, and financial planner.
While you may not require Warren Buffett to give you investment advice, you do want to pay for competent advice.
I know more than a few people who have used professionals (lawyers, tax accountants, etc.) on the cheap. They paid a huge price in the long run. If you need a car, I am not telling you to go out and buy a used Yugo. All I am saying is that you probably do not require a brand new Porsche.
But Get Someone You Can Grow With
When assessing experience, always consider your (realistic) future needs.
Today you are in your 20s, with no family, and are just starting to invest. Maybe all you need is someone who can help you buy mutual funds.
But perhaps you plan to buy and home and start a family in the next 5 to 10 years. Is the mutual fund salesman the right person to help you in the medium term? Perhaps, it depends on the advisor.
You should assess your realistic future needs (realistic means what will likely happen, not what will happen if you win the lottery, invent the next iPod, etc.). Then determine if your potential advisor and his team can assist you with your future requirements.
If not, it might be more efficient and cost effective to start with an advisor who can help you as your needs evolve. Otherwise, you may need to change advisors mid-stream and that may cause problems.
We will look at this issue more in our next post on the subject, Financial Advisor Service Offering.