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Choosing a Financial Adviser: The Wall Street Journal Way

by Tony Novak, CPA, MBA, MT
, revised 11/17/11

The trouble with a great newspaper article is that it does not stick around long enough to make much of a difference. This was the case with the article published in The Wall Street Journal on May 31, 2006 by well-known personal finance columnist Jonathan Clements. The extensive quoting and paraphrasing are simply an attempt to get more mileage from an exceptionally good piece of advice. Clements breaks the topic down into five simple concepts.

The influence of commissions

Realize that the majority of financial advisers earn their living from commissions of fees built into the financial products you buy from them. The more they sell, the more they earn. There is no connection whatsoever between an adviser' s compensation and the quality of the advice given to the client. Of course, that certainly does not mean that the advice is bad, but rather it means that the adviser is motivated by something other than providing you the best information available. For example, you will rarely if ever hear a financial adviser mention that a competing firm' s services are less expensive. If you want to avoid this conflict of interest, then "your best bet", according to Clements, is to "use fee-only advisers who charge an hourly fee, a percentage of your portfolio' s value or a fixed annual retainer".

Competency

Make sure that the adviser is knowledgeable. Clements notes that "Most advisers have little formal financial education". He suggests looking for the CFP designation or the CPA
-CFS duel credential. But when making in this important decision, perhaps the sites should be set a bit higher. How about finding an adviser who is recognized as a leader or an expert within the financial industry? How about an adviser with a long list of endorsers? How about someone who is well-connected in the business community and financial industry (other than to the firm' s sales manager). How about someone who has made a mark as a well known teacher, writer or lecturer in the financial planning topic? In other words, why not look for an adviser who makes an impression that knocks your socks off? I suggest that if a client chooses an "average" adviser, then the results should be expected to be "average. A client looking for exceptional results should spend the effort seeking out an exceptional adviser.

Fiduciary duty

Understand that most advisers are not required to act in your best interest. This may come as a surprise. The Securities Exchange Commission has undertaken a publicity campaign to inform the public on an issue known as "the Merrill Lynch rule" of the difference between a "fiduciary" (a person who is held legally accountable to act in your best interest) and a "registered representative" (whose primary legal responsibility is to the employer) who is only required to avoid "unsuitable" recommendations. Clements puts it simply: "avoid advisers who won' t commit to acting as a fiduciary". This is the standard required for an independent Registered Investment Adviser.

Range of expertise

Consider that "there is much more to managing finances than picking stocks and mutual funds. You might also want help with your mortgage, college cost, insurance, taxes and estate planning". If so, before you sign on with an adviser, make sure the adviser is committed to assisting you with those other areas. In fact, portfolio economists would argue that the task of picking investments play an insignificant role in your overall financial success. Also, consider this issue in relation to #1 and #2 above. Most advisers do not have a broad-based knowledge of the important topics outside of investing and an adviser who is primarily paid to sell or manage investments has no incentive to help you with taxes, loans, college tuition bills or other concerns that are important to you.  

Know the total cost

Keep a lid on total costs. This means the total of all adviser' s fees plus all commissions, built-in charges and hidden expenses. If this amount grows much past 1% of your invested assets, the rate of growth becomes impaired. It is also important to evaluate non-investment-related adviser costs. An adviser who is committed to (and experienced with) helping to reduce overall expenses can be as valuable as an adviser who helps boost your investment returns. Considering all the additional costs, Clements asks "Is your adviser truly helping your finances?" Perhaps the best approach to evaluating an adviser' s contribution is to use a simple "return on investment" analysis. The investment, in this case, is the adviser' s total cost. A client should expect to see a direct tangible net result from the adviser' s efforts and should evaluate the adviser' s return on investment in the same way as any other investment . For example, an adviser who charges a $2,000 fee but saves you $3,000 in taxes and $2,000 in other expenses has clearly proven to be a good return on investment; far more so than an adviser who is able to boost investment results on a client' s typical-sized portfolio from, say, 7% to 9%.

These selection criteria, while valuable may not be enough to differentiate between the many financial advisory firms offering retail services. Some additional criteria are proposed in a separate article.

See the related article "Choosing a Financial Adviser" - the author' s way.

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