If you are ever tempted to make a financial decision based on the recommendation of a friend, take a moment to consider that the largest Ponzi scheme in recent history relied on word of mouth. Bernie Madoff delivered high returns to select investors, then sought their endorsements to cultivate and dupe an ever-expanding circle of targets.
If investors had closely examined the opportunity he peddled (or sought vetting help from proven, credentialed professionals), they would have realized the purported returns were too good to be true. It was mathematically impossible to generate the returns he boasted, month in and month out, with no volatility. Word of mouth is a risky route for selecting an investment professional. Instead, consider whether a firm is the right match for your needs and where their incentives lie, as explained in my earlier blog post. Then dig deeper, using these additional questions.
Do They Adhere to a Fiduciary Standard of Care?
Most people assume that “financial planner,” “investment advisor,” and “money manager” are interchangeable and equivalent terms, but they are not. The fundamental difference among these labels is the standard of care to which the practitioners are bound.
Ideally, you want to work with a financial professional who keeps your interests in the fore. Only a select group—those who meet the fiduciary standard of care—are legally bound to work in your best interest. As a fiduciary, they must scrutinize all available information when making decisions and place your interests above their own, otherwise, they can be held legally liable.
Plenty of people working in brokerage firms conduct their business as a fiduciary, however, they are not legally bound to do so. While a broker-dealer may charge fees for investment advice, they may also charge commissions in other ways: transaction fees, capturing spreads from money market funds with higher fees, and by marking up the interest rate on margin loans. They can put you into more expensive mutual fund share classes or structured notes that have far higher fees than if the individual components were purchased separately.
When choosing a financial services provider, take time to tease out hidden financial incentives and the true meaning of job titles. For example, a savvy consumer knows that a stock broker and an investment sales representative are compensated for selling financial instruments—follow the money!
What’s their investment process?
To anticipate how a wealth manager will handle your money, consider how they make investment decisions, both for themselves and for their clients.
What’s their attitude toward risk management?
As Warren Buffett’s mentor, Benjamin Graham, aptly counseled, the essence of investment management is more about the management of risk rather than the management of return. When you’re evaluating a potential financial advisor, try to discern whether they favor volatile investments that could yield a windfall (or a significant loss). Or do they prefer conservative choices with minimal risk? Do they understand the importance of avoiding downside risk? Do they explain thoroughly how long your investments are locked up and how that is balanced against your cash needs and flexibility? Will they be realistic and responsible stewards of your assets?
Consider whether your comfort level is compatible with their strategy. Sad endings don't always involve somebody who steals from you. A wealth manager could operate in good faith, but make poor decisions and take too many risks trying to beat the market rather than investing in a measured way to achieve your goal. Real risk is the permanent impairment of capital. You want to avoid the wealth destruction that occurs when an investment is unnecessarily sold at a time when its price is artificially depressed relative to what its fundamentals support.
How much of their own cooking do they eat?
If a wealth manager does not have enough conviction in their skills to invest their own money in the strategies they have designed for you, why should you have confidence in their process? Always ask how much of their own net worth is invested alongside you and on what terms. This is the purest test of whether they sit on the same side of the table as you. For more insight on this revealing measure, read the Financial Times' article, “Portfolio managers shun investing in own funds.”
Does emotion or process rule their choices and recommendations?
We live in an information society, and the financial industry suffers from information overload. From the elevator to the gym, news shows broadcast the latest market shifts. Information swirls around the world 24 hours a day, seven days a week. But information is not knowledge and knowledge is not wisdom.
Some firms employ a tremendous number of analysts to research opportunities and gather enormous troves of information. But what gets done with all that information? Can they make rational sense of it and determine whether a specific investment will be a reasoned addition to your portfolio? Can they effectively parse out information from the noise?
Have a conversation with your potential wealth manager about how they approach investing during a turbulent stock market or difficult economic climate. Do they operate on emotional knee-jerk reactions, hunches, or gut feelings? Or do they follow a repeatable, quantitative process? At Balentine, we’ve developed models over the years that take the emotion out of the equation and provide transparency as to how we make investment decisions and for what reasons. We focus our efforts on identifying investment themes and reflecting an asset allocation that will best achieve a risk-reward balance based on each client’s goals and objectives. Periodically, we rebalance proactively to capture mispricings among different asset classes using low-cost index funds.
How solid is their investment team?
You want an investment team that has worked together for many years over different market cycles and can be counted on for years to come. As such, take a close look at:
Credentials and industry titles of significance. In addition to desirable academic credentials like MBAs and PhDs, seek out investment professionals who hold the Chartered Financial Analyst (CFA) designation, which is awarded by the CFA Institute after completion of rigorous exams. Look for financial planning specialists who hold the Certified Financial Planner (CFP) designation.
Past client experience. Beyond asking for references from current clients, also ask for the firm’s retention rate. While one personal recommendation indicates that a single customer was satisfied, a solid client retention rate over a long period of time signals that many people have had a good experience with the advisor. That’s a larger sign of confidence.
Succession plan. Firms or individuals who are at the pinnacle of their profession are often senior people with a depth of experience. They themselves could have retirement on the horizon; or as partners leave, they may have to sell the business to satisfy a need for liquidity. Just like your own business needs a clear-cut succession plan, consider whether your wealth manager also has a long-term multi-generational approach to their own business to ensure clients are not disrupted along the way.
What are their investment results?
Take time to delve into a firm’s track record and ask questions that can help you discern whether their results are repeatable.
When someone brags, “We're the top-performing small cap manager from Halloween 2013 through Thanksgiving 2015,” be skeptical. Numbers that suggest someone is in the top decile of results for a quarter or two may not necessarily be repeatable or even especially significant. Worse, they may have taken an extraordinarily high level of risk to get there and may not be so lucky next time. Anyone can cherry pick a beginning and ending date to make themselves look good.
A best-in-class wealth manager can show an independently audited, verifiable proof statement of past investment results. Ideally, the wealth manager claims compliance with GIPS, the CFA Institute’s Global Investment Performance Standards, after a rigorous, independent third-party audit which groups similarly managed portfolios into composites and allows for an “apples to apples” comparison of results.
What does the public record say?
When you’re screening a financial professional, remember to look at their public record from multiple angles:
Confirm their status. Visit the Investment Adviser Public Disclosure (IAPD) website to confirm that the investment professional is indeed registered and check if they’ve ever run afoul of securities regulators.
Search for any SEC disciplinary action. Take advantage of the SEC’s tools, including a searchable investor portal and a lookup of individuals who have been the subject of SEC action.
Scan the horizon. A directory provided by the Financial Industry Regulatory Authority (FINRA) contains the disciplinary and regulatory history of broker-dealers. Consult it to see what, if anything, they've ever been charged with, or if they are on the list of barred brokers. You’ll also want to check for any state-level regulatory action by visiting the website of the North American Securities Administrators Association (NASAA).
Review their Form ADV. Registered investment advisers who manage a significant level of assets are required by the SEC to release an annual disclosure document that spells out, in plain English, their number of clients, assets under management (AUM), how they are paid, types of clients, biography of the principles, states in which they're registered, and more.
How will you work together?
Wealth managers vary in their approach to working with new clients. The onboarding process can help you decipher how thoughtful and strategic a firm is and whether they have the expertise to advise you. Do they follow an approach that is streamlined, efficient, well thought out, and practiced?
Safekeeping and information flow. Will Rogers once said that we should be more concerned with the return of our money than on our money. Understand how your assets will be held in safekeeping, who will serve as custodian, what level of protection is provided, and how data privacy is ensured.
Frequency of interactions. Consider how the firm will service your account and how they communicate. Is there comfortable, common ground between their offerings and your expectations? For example, how accessible are they? What’s their communication style? Can they explain things clearly so that you understand? After all, it’s your money!
It’s common for firms serving high-net-worth individuals to meet with clients at set intervals. Would you prefer meeting with your advisor once a year or meeting with your advisor quarterly? Ask about the format and frequency of those meetings, and what they entail. Do they align with your preferences? And, in-between meetings, how easy is it to get what you need when you need it?
Trust and difficult conversations. Perhaps the most important factor in your choice of wealth advisors is the personal trust developed over time. Valued relationships are only forged in spending time with your wealth advisor, because trust is a multifaceted concept. It is personal style reinforced by actions. Trust develops when expectations are met consistently. Trust grows when an advisor listens attentively and understands your family’s unique needs and dynamics.
It’s also in your best interest to work with somebody who is willing to have uncomfortable conversations and tell you what you don't want to hear—whether it’s advising you to buy stocks when they're down 25%, to divest when stocks are at record highs, or to set up a trust that will ease family squabbles. A good wealth manager can help guide you over occasionally fraught terrain and keep you focused on long-term success.
Hiring a wealth manager is among the most important decisions you’ll ever make. By following a careful process of evaluation, you’ll set yourself up for enduring success. As you check off the list of core competencies, credentials, track record, and style, you’ll gain a clearer picture of the individual or firm to whom you are entrusting your financial future.