11 Principles for Selecting an Advisor

By Larry Swedroe | Jun 10, 2009

I saw the video by our MoneyWatch editorial director Eric Schurenberg on “How to Find an Advisor,” and I quickly thought about the principles I recommend you follow when trying to find an advisor you can trust. I thought it might be helpful to share this list with you. The following are 11 principles your advisor should live by.

Please note that I touched on a few of these in my post “How to Choose a Financial Advisor,” but I thought the full list would be beneficial as well.

Act in the best interests of clients
This should go without saying, and thus should be your advisor’s guiding principle.

Follow a fiduciary standard of care
This goes along with my first point. Many advisors (including broker-dealers) only have to follow a suitability standard, meaning the investments they recommend only have to be suitable for you and not necessarily in your best interest. There’s no reason why you should accept a suitability standard. If an advisor will not provide a fiduciary standard in writing, run.

Deliver attentive service
You want to work with an advisor who will develop a strong personal relationship with you and your family. This becomes especially important during times of stress. I know that there will be times when the conversation won’t be pleasant (like many I’ve had during the market decline), but that’s when it’s most important to be discussing the issues. Thus, you want to make sure you are working with someone who will be communicating even more during such periods.

Build customized investment plans
All investors have unique abilities, willingnesses and needs to take risk. Your investment plan should reflect those unique characteristics.

Give advice that is goal-oriented, not returns oriented
Your investment plan runs into danger when you focus on the short term instead of the long term (and your goals). That’s why advice should be focused on your goals and not on the noise of the market or the product du jour.

Seek out experts when needed
When I think of your investing needs, I think of the App Store for Apple’s iPhone: “There’s an expert for that.” Those experts should be leveraged to make sure you’re getting the best advice possible. No one can be an expert on everything. There should be a team or the advisor should be able to leverage strategic relationships to provide you that expertise.

Focus on advice, not products
It’s more important to figure out your needs, and then find the most appropriate investment vehicles to meet those needs.

Make sure fee structure is in your best interests
You want to minimize the potential conflicts of interest between yourself and your advisor. A fee-only structure is the best way to do that.

Practice full disclosure
For those conflicts that still exist, make sure they are fully disclosed and explained.

Take advantage of academic research
Make sure that the advice given is based on the latest scientific research, not on opinions.

Practice what I preach
Why would you work with an advisor who doesn’t invest in the same vehicles he or she recommends?

Should Average Investors Do It Themselves?

By Larry Swedroe | Aug 14, 2009

My friend Bill Bernstein is one of the best personal finance writers around. If he has written it, it’s a must read, and his latest book The Investor’s Manifesto is no exception. There are very few times over the years that I’ve disagreed with Bill (which is good, since he’s rarely wrong). Thus, I was pleased to see that he no longer believes average investors can do it themselves.

Bill used to think most people could handle their investments with little or no assistance, since ”After all, the flesh was willing, the vehicles were available, and the math wasn’t that hard.” But there’s simply more to investing than that. I agreed with his post on his Web site Efficient Frontier that there are four requirements to be a successful investor:

• “An interest in investing. It’s no different from cooking, gardening, or parenting. If you don’t enjoy it, you’ll do a lousy job. Most people enjoy finance about as much as Carmela Soprano enjoys her husband’s concept of marital fidelity.”
• “The horsepower to do the math … The Discounted Dividend Model, or at least the Gordon Equation? Geometric versus arithmetic return? Standard deviation? Correlation,for God’s sake? Fuggedaboudit!”
• “The knowledge base — Fama, French, Malkiel, Thaler, Bogle, Shiller — seven decades of evidence-based finance back to Cowles. Plus, the ‘database’ itself — a working knowledge of financial history, from the South Sea Bubble to Yahoo!.”
• “The emotional discipline to execute faithfully, come hell, high water, or Bob Prechter. Mr. Bogle makes it sound almost easy: ‘Stay the course.’ Alas, it is not.”

Bill noted: “Even if you optimistically believe that there is a 30 percent success rate on each count, if each is independent only 1 percent of the population can make all four. However, that may be too pessimistic since these four abilities are not entirely independent — if you’re smart enough, it’s more likely you’ll be interested in finance and be driven to delve into the appropriate finance literature. But even if true, more than a little luck is involved. Head down to the personal-finance section of your local Barnes and Noble, and you’re more likely to run into Suze Orman than Jack Bogle. You’ll need a telescope to find the really important stuff.” Bill concluded the article: “I wish I had a nickel for every smart, savvy and motivated financial type I’ve met who simply could not execute.”

While there are individuals who can do it themselves, they’re few and far between. Unfortunately, as the academic research demonstrates, far too many are overconfident of their abilities. A good financial advisor adds value by:

• Developing an investment plan that provides the greatest chance of achieving your financial goals without exceeding your ability, willingness or need to take risk.
• Integrating your investment plan into an overall estate, tax and risk management plan.
• Helping you act like a postage stamp — sticking to your plan until you reach your financial goal.

Is the Market Rational?

Weston J. Wellington, Vice President, Dimensional Fund Advisors

Over six years ago, Fortune writer Justin Fox wrote an article titled, “Is the Market Rational?” Much of the article focused on the intellectual rivalry between two Chicago professors—Eugene Fama and Richard Thaler—and Fox made no secret which of the two he found more persuasive. The next generation of finance professors, he said, were “ripping Fama’s teachings to shreds,” and market efficiency as an organizing principle was being shouldered aside by something called “behavioral finance.” In this view, irrational investors make systematic judgment errors that produce predictable patterns in stock prices. Fox noted approvingly that the Nobel Prize in economics had been awarded the previous month to a Princeton psychology professor in recognition of his work on behavioral biases and suggested it was possible for investors with sufficient “contrarian gumption” to outperform the market by exploiting such biases. But he doubted most of his readers would be successful in this effort, due to their own propensity to make mistakes. His conclusion for investors? “That’s easy,” he wrote. “Buy and hold. Diversify. Put your money in index funds. Pay attention to the one thing you can control—costs—and keep them as low as possible.”

Fox has been hard at work since that time; the article has mushroomed into a 328-page book and the title is no longer a question but an assertion: The Myth of the Rational Market. The book has much to recommend it—a wide-ranging survey of the battle of ideas among financial economists over the last century, with an enormous cast of characters. Readers of Peter Bernstein’s Capital Ideas will find themselves covering familiar ground, but there is enough new material to make it worthwhile. Fox’s breezy style is effective in distilling complicated ideas into digestible portions, and his colorful sketches help maintain our interest in a dry, statistics-laden topic. Social critic Thorstein Veblen, for example, is a “crotchety philanderer.” Yale economist Irving Fisher is a prohibitionist and health-food advocate. Milton Friedman finds the early research on efficient portfolio design similar to his work during World War II on the statistical properties of artillery shell fragmentation.

There is so much ground to cover that some intriguing questions are left barely explored. After pointing out the flaws of the efficient market hypothesis using the CAPM model of expected returns, Fox quickly dismisses the alternative Fama/French multifactor approach as “clunky” and moves on. The value premium, in his view, is attributable primarily to investor irrationality. This is certainly one interpretation, but a more nuanced view deserves attention as well. Chicago Ph.D. and hedge fund manager Cliff Asness has pointed out that despite the extensive literature on the issue, an explanation for the value premium remains a “gigantic, subtle, and still unsettled academic debate.”

For those hoping to find some concrete suggestions for improving the investment results, the book is apt to be disappointing. Fox finds little evidence of success among professional money managers in exploiting the inefficiencies he believes are so clearly evident. He has some kind words for academics who have set up money management firms to apply research on behavioral biases to generate superior returns, but he cites no evidence of their success, perhaps because their results are generally well explained by the standard asset pricing models he is so quick to condemn.

Fox appears frustrated that the evidence of market irrationality appears so clear but the evidence of investor success in exploiting these mistakes is so thin. His brief message to investors toward the end of the book carries an air of resignation—all the effort devoted to identifying flaws in the rational market model doesn’t appear to offer hope of a superior approach. Almost as an afterthought, his practical advice to investors includes the following suggestions:

• “If you have money to invest, the only sensible place to start is with the assumption that the market is smarter than you are. You don’t have to stop there. But if you do come up with an idea for beating the market, you need a model that explains why everybody else isn’t already doing the same thing you are.”
• “If you’re picking somebody else to manage your money, the chances of finding a market-beating path are even harder.”

Bottom line: Ideal way to bone up on financial economics if you want to sound like a know-it-all. But it’s unlikely to change anyone’s mind with regard to the optimal investment strategy.

Asness, Clifford. “The Value of Fundamental Indexing.” Institutional Investor, October 19, 2006.
Bernstein, Peter. Capital Ideas: The Improbable Origins of Modern Wall Street. Hoboken, NJ: Wiley, 2005.
Fox, Justin. “Is the Market Rational?” Fortune, December 3, 2002.
Fox, Justin. The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street. New York: HarperBusiness, 2009.

Retirement, Risk, and Return

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Can you trust your financial advisor?

Can you trust your financial advisor?

Jonathan Chevreau,  Financial Post

Today’s subject title comes from a recent show on CBC News Sunday Evening. It aired on April 12th but a related segment on pensions and retirement ran Sunday evening, May 10th. The latter segment used several familiar sources from the consumer advocate community — like Robert Kyle, Stan Buell, Dianne Urquhart and others — to make the case that when it comes to financial services, it’s a buyer beware world out there. The “black hat” seen in the illustration is the industry’s slang for financial advisors who are not acting in the best interests of clients. As we argue below, they’re few and far between.

The CBC also used pension consultant Keith Ambachtsheer to make their point that because investment costs are lower in traditional pension plans, retail mutual fund investors will do far worse saving for their own retirement than letting a low-cost pension fund do it on their behalf.

Well, yeah, most of us that knew that already. The problem is many employers are dumping their Defined Benefit pension plans if they can and many of us can’t get access to such low-cost employer pension plans even if we wanted to. We can’t all join the civil service, run for office or become teachers. We’re forced to in effect run our own pension plans, which often means tapping into mutual funds or exchange-traded funds. There are so many of both that it’s just as hard picking funds or ETFs as it is picking individual stocks. One of the things a good financial advisor does is to help in that decision-making, preferably after bigger-picture stuff like risk tolerance, time horizon and investment objectives are determined.

Heinzl, Reynolds and other authors exposed industry’s warts long ago

I saw little new in the way of revelation on Sunday’s show. John Lawrence Reynolds covered all these points in The Naked Investor back in 2004 and more recently in a revised edition (illustrated below.).

More than a decade ago, Mark Heinzl made the point that high-fee mutual funds seldom beat the indexes in his Stop Buying Mutual Funds. I made a similar point in 1998 with my own co-authored book, The Wealthy Boomer: Life After Mutual Funds, which — via a long circuitous route — led to the blog you are now reading.

It’s good to see the tax-funded Corp. has finally discovered that mutual funds charge high fees and that some financial advisors — by no means all — are as motivated to build up their own retirement accounts as their clients.  But the piece could have benefited from a little more balance.

“Over the top” with a horror-movie soundtrack

You can view the CBC clip on advisors by clicking here: it’s a coin flip if your computer system will be configured properly to run it. If it can’t it may take weeks and some money to order tapes or transcripts.

Judging by the 86 comments underneath the clip, many Canadians don’t trust their financial advisors and more than a few have been burned by them. With an estimated 100,000 of them in Canada alone (counting insurance agents, stock brokers, financial planners and mutual fund salespeople), I’ve no doubt there are a few bad apples out there.

Even so, my personal experience of interviewing hundreds of advisors over the four years I wrote the Post’s Advisor Post column was that 95% of them are highly educated, competent professionals who are paid fairly to do a tough job. You can view many of them in my Wealthy Boomer video clips by clicking here. Some recent examples are Jeff Wareham and Robert Cable, both of ScotiaMcLeod; Preet Banerjee, formerly of the same firm; David Chalmers of The Rogers Group; John De Goey of Burgeonvest,  Marty Kosterman at Fiscal Agents, and the list goes on.

I can tell you this much — if you DON’T trust your advisor you should probably find a new one. The relationship between a client and a financial advisor is similar to a marriage — if there’s no trust, you’re just not going to go the distance and you may as well pull the plug now.

“Television doesn’t lend itself to nuance.”

Curious about how the financial services industry viewed these latest media attacks on their industry, I chatted with a few sources. Dan Richards, president of Strategic Imperatives, didn’t see it but “heard about it” from a few industry contacts. “They weren’t worked up about it. The industry has been so beaten up” already in the bear market. “Part of the problem is television doesn’t lend itself to nuance.”

Mutual fund analyst Dan Hallett — whose Windsor-based firm helps financial advisors choose the mutual funds they sell to clients — felt that while the underlying message may have been valid, “it was over the top in my opinion … Like all such exposes, the title was sensational.” Even the segment’s background music seemed to come out of a horror movie, he quipped.

Hallett [pictured, left] suggests a more useful title might have been something like “how to know if your advisor is dishonest or incompetent.” As it stands, the title the CBC chose implied that most advisors can be described by either of those negative attributes, which is “silly,” Hallett says. “It’s good to open investors’ eyes to the realities but what’s more helpful and meaningful:  scaring people into stuffing bills in their mattresses or arming them with information to help ferret out the black hats? I choose the  latter.”

But consumers do need to ask tough questions, says RayJay rep

I also asked Raymond James’ Mike Bayer [photo, below right] to comment on the show. Here’s his take, via email:

“I did not think the story was entirely balanced. There is no question that the lack of transparency has led to spectacular examples of fraud and abuse. As you have already pointed out, some of the losses are a result of greed and excessive risk taking on the part of investors.  We should also separate the clear fraud from the more subtle fleecing. Most people spend more time deciding where to go on vacation or what type of car to buy then they do on selecting the advisor who will be investing their life savings. 

“If you want to find a good advisor you need to ask the right questions. One of the most important things you need to know is how your advisor is getting compensated. Is your advisor a commissioned salesperson or a professional fee based advisor? Find out how much you are actually paying in fees and expenses. If you don’t understand what you are investing in find an advisor who will take the time to explain in plain language what they are doing. Does your advisor have a clearly defined investment process that avoids stock picking and market timing? Has your advisor clearly explained how much risk you are exposed to? What professional qualifications do they have? Are they a Certified Financial Planner? Look for an independent advisor who is free to select the very best investment tools including broadly diversified, low cost exchange traded funds and enhanced index funds? Don’t be afraid to ask tough questions, after all we are talking about your family’s life savings.”