Investment advisers are everywhere. There are thousands of them. Finding one that’s right for you is a challenge. How do you find an adviser that fits your needs? I’ve read articles that provide 20 questions, 10 questions, etc. Here are my “3 Big Questions” to narrow the adviser universe down to a manageable list of potential candidates.
1. What it your investment philosophy?
How an investment adviser views the process of investing is the most important factor in determining if that adviser will fit your needs. This assumes that you have beliefs in how investments should be managed beforehand. If you don’t, then I suggest doing some soul searching before looking for an adviser that you’ll be happy with over the long-term.
There are four investment philosophies to choose from. These four investment philosophies are based on two strategies for picking individual investments and two strategies for allocating investments in a portfolio.
The two strategies for selecting individual investments are passive and active. Passive-oriented advisers select low-cost index funds and index tracking exchange-traded funds (ETFs) that capture the returns of markets or segments of the market. Advisers who believe in active management attempt to find actively managed mutual funds or other investments that will outperform the markets and you’ll pay a higher price for those products whether they outperform or not.
The two strategies for asset allocation are strategic and tactical. Strategic asset allocation means creating a fixed allocation to stocks and bonds based on your needs and maintaining this allocation over the long-term by rebalancing back to your target occasionally. Tactical asset allocation is an active strategy that shifts the weighing of asset classes based on the adviser’s belief about the future.
These two investment dimensions form the four investment philosophies:
Passive selection & strategic asset allocation
Passive selection & tactical asset allocation
Active selection & strategic asset allocation
Active selection & tactical asset allocation
If you know where you fit into this list, then it makes your search for an investment adviser more manageable and less time consuming.
2. What services do you provide?
The range of services offered by investment advisers varies widely. For simplicity, I’ve separated these into two services and four basic plans. The two services are investment advice and money management. You can choose an adviser who does one, the other, or both.
Investment advice runs in a range from simple online help to full-fledged wealth management services. Several web-based resources exist today that offer investment assistance through questionnaires and do not require speaking with anyone. The other extreme is a concierge service where you meet regularly with an adviser who mentors you through every facet your personal financial life.
Managing your investments is a separate service from investment advice. On one end of the spectrum is self-management where you invest your own portfolio and on the other end is full discretionary portfolio management where an adviser manages and monitors your money.
Together, the two dimensions of investment advice and portfolio management make up the four broad service models that advisers provide:
Simple advice & self-management
Simple advice & adviser management
Concierge service & self-management
Concierge service & adviser management
If you know the services you’re looking for in an adviser, you’ll be able to narrow the search down using the above service criteria.
3. How much do you charge?
Costs matter. Advisers need to be paid for their services, but they should not be overpaid. Consider what services you’re seeking and how much you should pay for each service and overall.
Self-managed investors who seek as-needed investment advice may consider purchasing this advice by utilizing an hourly fee financial planner or hourly fee investment adviser. This adviser doesn’t need to be local. An hourly fee adviser who works out of New York and one who works out of Texas have access to the same markets and the same products.
An adviser who manages money on an ongoing basis should be paid according to the amount of money they manage. An asset management fee (AUM) is fair because the adviser is looking after the portfolio daily and they have overhead costs based on the amount under management.
Often an adviser will charge an AUM fee for both investment advice and portfolio management. While this is fair if the overall fee matches the amount of overall service provided, I believe all-in-one AUM fees is where mispricing occurs most often. If you’re seeking simple advice as needed as well as a managed portfolio, don’t pay for concierge services.
What about performance?
Past investment performance may or may not be a relevant question to ask. It depends on the adviser’s investment philosophy. A passive adviser who recommends a fixed asset allocation to low-cost index funds based on your long-term needs does not control what happens in the markets. So, a discussion of past performance is rather useless. In contrast, past performance may be a question to ask an adviser who tries to beat the market using security selection or tactical asset allocation.
Philosophy, services and cost are the three big questions I would start with when hiring an investment adviser. Chances are you’ll find someone you’ll be able to work with over the long-term when you’re satisfied with the answers to these three questions.
This blog, which first appeared on Rick Ferri’s blog, is part of a regular series of articles on ETF.com featuring some of the most influential voices in the world of index and passive investment. Ferri is the founder of Portfolio Solutions, a Michigan-based registered investment advisor with about $1.2 billion in assets under management.
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