How to choose a financial adviser

This blog post is revised from an article that I originally published in 2006 and is reproduced at At that time I operated as an independent Registered Investment Adviser. Since then, I’ve simplified and automated investment client advisory functions to the point where I presume that separate RIA registration is not required. Now, as then, differences of opinion continue on specific approaches to investment management.

Jonathan Clements, the former personal finance writer for the Wall Street Journal, published a memorable line in an article on May 31, 2006.  While I enjoyed all of his columns, I feel that few financial advice articles – by him or anyone else – have enough sharp edge to trigger the type of emotional response that could actually influence personal behavior.  This article was clearly different.  He hit a nerve with both advisers and their investor clients with this fabulous line:

“The problem with our business is that 98% of investment advisers give the rest of us a bad name.”

Funny, but so true.  The sad thing is that 98% may actually be generous to the advisers.  I recently returned from a gathering in Florida of more than 1,000 fee-only independent investment advisers to learn that I was the only member of the group who was 100% hourly with no asset charges.  That meant that 99.9% were primarily charging asset-based fees1 for managing clients’ money!

“Fee only” advisers are supposed to be the cream of the crop (or at least we act like this is true).  Most are experienced, successful and are somewhat immune from the production and sales pressure of an account representative at a bank or a broker at investment wire house.  All of these are commendable.  But virtually all of these advisers charge well more than they could possibly add to a client’s net worth so, in that sense, they are hurting their clients.  Fees have such am impact that Clements makes a good case that the average client of a financial planner could achieve better results investing in Treasury bonds2.

Clements concedes that most people are not fit to manage their own money and that most financial planners are not ill-intended crooks.  There is overwhelming data to support both of these starting points.  But that still leaves a lot of middle ground open for grabs in the financial planning industry.  When choosing a financial adviser, I suspect that most people are likely to be more impressed by a firm’s marketing brochure or office space than in the actual details of the service being offered.

Clements advocates that clients should heed these five principles when choosing a financial adviser (these are his criteria, not mine):

1) Use only hourly fee advisers.  Since the original publication of the column and this article, hourly advisers have become fewer but flat fee advisers have become more common. This article revision lumps hourly fees together with flat fees. Avoid advisers who charge commissions or asset-based fees. This seems like an obvious advantage to investor clients, yet few investors actually take advantage of this approach. Is it because the commission based people are more numerous or because they are better marketers? One thing that is clear: the large majority of advisers charge commissions and asset-based fees. It is easy to calculate that these fees are larger than hourly fees or flat fees.  This explains why less than 1 in 1,000 advisers charges only hourly fees.  Hourly based financial planning is not the road to wealth for the adviser, but it certainly represents the best model for the industry and at least a fair level of compensation for advisers.

2) Use an adviser with adequate formal education.   The most common designations in the industry are CFP and CPA-CFS.  I am not personally thrilled with the recent practices of the sponsoring organizations of either of these designations but this is not any reflection on the on the quality of the professional mark itself. I’d prefer to see more advisers with an advanced academic degree. I see far too many advisers who can pass online tests but not be able to develop “real world” solutions.  I would suggest that clients should look for an adviser with impressive credentials from an impressive educational institution.  IMO, an adviser with a B.S. degree from Wharton (University of Pennsylvania’s business school), for example, combined with adequate work experience, is better prepared to provide diverse advice to clients than a typical CFP earned through self-study and online testing.

3) Use advisers who act in a fiduciary capacity.  This means that the adviser acts in your best interest. Obvious, right?  Not so. Under the recently passed SEC rule known as the  “Merrill Lynch rule”, financial firm representatives are now required to disclose that they are not required to act in their clients’ best interest but rather that their primary role is to sell investments and that any advice they provide is only incidental and in support of to their main role of selling investments. The only legal requirement for financial planners regarding advice given is that they not recommend unsuitable investments. This comes as a shock to clients who actually take the time to understand this distinction but few actually do. Besides, the technicalities of this rule make it hard to grasp the issue; I am not sure that Jon Clements even understands that an adviser does not “choose” to be a  fiduciary but rather this is designated by the factual and legal climate in which the adviser operates. An Registered Investment Adviser who operates as an hourly fee is automatically required to act in a fiduciary capacity.

4) Use an adviser who is well-versed in areas other than investments. A good adviser can add value by saving money on mortgages, taxes, college costs and estate planning. In fact, over the long-term, the value of service provided in these other areas will clearly outweigh the value added in providing investment advice.

5) Keep total cost under control.  Whether you are paying a mutual fund fee, a tax preparer’s fee, a commission or a financial planner’s charge, all of these add up to reduce your net results and hinder the long-term growth of you net worth. Set a goal of keeping all of your professional charges – both the exposed and the hidden charges – to less than 1% of your total net worth. This might be too difficult a goal for some at the beginning the financial accumulation stage of life, but it is a worthy long-term goal for every investor.



1 Asset-based fees are recurring charges that come out of an investment account, usually ranging from one to two percent of the account value each year.  They may be referred to as “built-in” or “hidden” but financial firms imply that these fees are more desirable than commissions.  In fact, these fees are considerably more than ordinary investment brokerage commissions over the long-term.

2Clements uses the simple illustration that is the average balanced investment portfolio of stocks and bonds returns an average gross rate of 7% per year (in accordance with historical data) and adviser firms charge 2% (whether these are built-in fees or the adviser’s direct charges), then the net return of 5% is lower than an investor could have achieved by buying Treasury bonds without any professional help.

Editorial note added 3/9/2010: In his final column published before retiring from his position at the Wall Street Journal, Jon Clements stated that the only people likely to remember him ten years after his death are his two children. I think he underestimated the influence that he had on some of his readers. I will very likely remember Jon and appreciate the lessons learned from his column for the rest of my life.

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