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Choosing a Financial Advisor


Many investors feel uncomfortable working with investment professionals. This isn't surprising, given the cloudy haze surrounding much of the financial services industry. For instance, many investment professionals receive commissions from companies for selling those firms' products -- creating an inducement for some financial salespeople to sell products that puts money in their pocket, but may or may not be the best choice for you.

But for many investors -- particularly those who don't have the time or incentive to manage their own financial situations by themselves -- a well-chosen advisor can be an important ally in creating and carrying out a long-term financial plan.

Where to Find a Financial Advisor

Most people find their financial advisors through referrals from friends, coworkers, accountants, or attorneys. Although this is a comfortable method for most people, it has two major pitfalls. First, in today's litigious society, professionals and laymen alike are less willing to refer you to others due to the implied endorsement. This is especially true for accountants and attorneys. They simply don't want to take the risk that you will have a bad experience and hold them at fault. Second, people often make a referral because they like an advisor personally -- not because they are qualified to judge an advisor's skill and knowledge about investing.

Evaluating a Financial Advisor

Referrals are a good place to start, but you've got to do your homework. Ask any potential advisor plenty of questions. Your advisor should be prepared to meet you in an initial interview and explain his or her approach to investing and planning. In particular, make sure of the following points:

  • The advisor should be compensated on a fee-only basis rather than by brokerage commissions. Advisors who work on commissions are more likely to recommend frequent transactions in your portfolio. A fee-only advisor has fewer conflicts of interest and is more likely to have your best interests in mind.
  • The advisor should focus on risk in selecting your portfolio. Reviewing historical portfolio performance in bad markets is the best way to get a feel for the potential volatility of a particular asset mix. Paying attention to risk will give you the best chance of staying invested throughout your time horizon since your portfolio will be consistent with your risk tolerance.
  • The advisor should work with you to set target rates of return -- the returns you will need to achieve your objectives. A fee-only advisor can show you different models and mixes of investments that have the highest probability of achieving your goals.
  • The advisor should write an investment policy statement for you. This statement should provide specific instructions covering the following objectives and constraints: target return, risk tolerance, time horizon, anticipated withdrawals or contributions, tax constraints, and regulatory issues, if any.
  • The advisor should rebalance your portfolio periodically. If an asset differs significantly from its original target allocation, the advisor should either buy or sell some of the assets until its target percentage is restored.
  • Your advisor should provide you with a quarterly assessment of the portfolio?s performance and market values. He or she should determine whether the market value of your portfolio is growing fast enough to achieve your objectives and whether any adjustments need to be made.

Some investors and inexperienced advisors believe that once they build a portfolio, particularly an asset class portfolio, they won?t need to make any changes. If we look back just five years, we see that asset class investing has improved dramatically. Researchers have identified new asset classes leading to the development of many new asset class funds. Value and emerging market funds are two recent introductions, for example.

Over the next five years, it is likely that we will see even greater changes. It would be foolish for any investor not to take advantage of new knowledge and products. Finding an advisor to help you keep informed of new developments will add tremendous value to your portfolio.