A while ago, I penned a post to encourage my readers to take charge of their finances and to manage their own investments. One of the main reasons for writing that post was to encourage my readers to be financially literate. The second reason was to arm them with financial knowledge to help them avoid committing money mistakes. Most importantly, I wanted to help my readers hire the right financial advisor or avoid unethical financial advisors – licensed or unlicensed.
Now, I am in no way implying that the whole financial industry is unethical nor am I saying that you shouldn’t hire a financial advisor. There certainly are great financial advisors out there that are worth every penny of the fees that you paid them. Nevertheless, what I am trying to do is to remind my readers of the importance of financial knowledge, regardless if you are interested to manage your money or not.
An Investor’s Worst Nightmare
You see, from time to time, I would come across a financial horror story here and there. With the latest story, a senior claiming her trusted financial advisor unethically churned her account to make money for himself. Over a four-year period, her advisor had conducted numerous trades in her account that amounted to over a quarter of a million dollars in commissions/fees.
We are not talking about an institutional trading account with hundreds of millions in assets here. We are talking about a personal investment account. A quarter of a million dollars in commission/fees? Really? Who on Earth is willing to pay such astronomical commission/fees to manage an account that’s probably no more than $2M to start with?
So, instead of trying to analyze the court case and be the judge, it’s much better for us to learn from this incident and protect our finances and avoid the downfall of this situation. Let’s take a look at some of the important criteria for hiring and evaluating the qualities of a financial advisor that you want to hire for.
How Does The Advisor Make Money?
To evaluate if the potential advisor’s interest is aligned with your own interest, you have to know what and how he/she is charging you for the service provided. Is the advisor being compensated based on the activities on your account or the investment being purchased? From the article, this was the case. In my opinion, I don’t think that this type of financial advisor’s interest is aligned with an investor’s interest. I would avoid hiring these financial advisors.
The other methods that financial advisors make money are the fee for service model or charging a percentage of the asset under management model. Depending on how much money you have to invest and the number of accounts, you can find a balance between these two models. Your goals are to minimize your investment fees and to compensate your advisor fairly for the service provided and to design a portfolio to maximize the return based on your risk tolerance.
To find the balance, let’s take a look at two investors with identical situations except for the amount of money to invest. One investor has $200,000 to invest while the other has $800,000. If a financial advisor charges $100 per hour (or 1% of asset under management) and it takes about 25 hours (three days) of work to construct a personal portfolio, which payment method is best for each investor?
For the fixed fee service, the cost is $2,500 (=25*$100) for both investors. For the 1% asset under management fee, it cost $2,000 (=1%*$200,000) and $8,000 (=1%*$800,000) for the investors. Based on these numbers, it’s better for the $800,000 investor to choose the fee base option as that investor can save $5,500 in fees. For the $200,000 investors, I would still go with the fee base model even if it meant an extra $500 for the initial setup. Going forward, it shouldn’t cost that much to meet with the financial advisor once or twice a year to review your portfolio’s performance. The investor will save more money in the long run.
How’s Your Money Managed?
When you read stories of investment fraud victims, you usually would encounter a couple of reoccurring themes. The first is the financial advisor and the custodian of investor’s asset being the same entity. This allows the financial advisor to have full control of the investor’s investment asset and abuse their authority. This is a situation that investors need to avoid.
The second thing that you often hear about is the financial advisors having full control to conduct investment activities in a client’s account without having to consult with the client. I understand that one of the reasons that investors want to hire an advisor is to delegate the investment task to the financial advisor. But just remember one thing, “no one should care more about your money than you do.” The less attention that you pay to your investment, the more you are putting your money at risk.
How Do You Evaluate Performance?
Your main goals for hiring a financial advisor are to help manage your money and to earn a reasonable return on your investment based on your risk tolerance and asset allocation. So what’s a reasonable return? This will be a great question for your financial advisor to answer based on the portfolio that’s designed for your situation. By answering this question, you’ll also indirectly answer another question, “am I taking too much or too little risk with this portfolio?” Adjust your portfolio asset allocation to a level that’s suitable for your risk tolerance if needed. The question to ask yourself is, “if the worst case scenario happened, can I sleep at night?”
Once your model investment portfolio had been created for your personal situation, it’s prudent to ask for a benchmark or a weighted average of a few benchmarks to measure your investment performance against. If you are going to pay for a service, you may as well hold your financial advisor accountable for the service provided. I would recommend my readers to do a performance review at least once a year for both your investment and the financial advisor.
Monitoring Your Investment
Many investors made the mistake of entrusting their money to their trusted financial advisor and rarely review their investment performance or statements. Once you’ve got a portfolio designed for you and set it on autopilot, it doesn’t mean that you should forget about it. This mistake can be fatal and you may lose all your hard earned money if you trusted the wrong financial advisor.
To avoid this potential downfall, ask your potential financial advisor to provide a sample investment statement and review the statement with him/her thoroughly. If you can’t understand the investment statement, then you should either ask if there is a simpler investment statement or find another financial advisor that can provide you with a statement that you can understand easily.
My Two Cents
A financial advisor should only be an advisor, an investment mentor or an expert that you can rely on to assist you with your investment decisions. No more, no less. What you are paying for should be their advice, coaching or expertise. After all, it’s your money, your livelihood, and your success. You should be the one making the decisions, accountable for growing your savings, and the beneficiary of this wealth at some point in your life. You get what you put into it.
So readers, do you have a financial advisor to assist you with your investments? If you do, what’s your experience like when working with a financial advisor? Would you recommend your current financial advisor? If you are investing for yourself, how do you measure your performance?
About Leo
Good topic Leo.
Two of the reasons I love Personal Capital are related to your post: How are my investments doing and How much am I paying in fees. PC will very easily provide answers to both of these questions. I used it, and shared screenshots, in my personal Q3 financial update I recently wrote about.
@Brad, I have heard of Personal Capital and quite a few PF bloggers recommend it for individual in the U.S. So far, I haven’t seen anything like that in Canada yet. For now, I am just using my excel spreadsheet and it’s good enough for me.
Good read and insights…
@Smayer97, I am glad that you enjoyed it 🙂
Good school of thoughts about paying for financial advisor. If you have a significant amount of money, then it will be better to find a good financial advisor.
@Pellrider, you are definitely right. For example, if you have an account worth $1M, a 1% return means $10K. So if you can improve your return by 1% to 2%, and paying less than a couple of thousands of dollars, you still come out on top after paying for an advisor.
Great post, Leo. My view and approach, before I teamed up with my financial advisor, was like an other investment. I researched, asked a ton of questions and then made an informed decision.
Investing isn’t one of my strengths, so for a reasonable fee I let the professionals handle. Plus, there is a lot of value in the holistic approach they take to connect various aspects of your life
Well done.
@Church, asking the right question and ensuring that you find a knowledgeable and trustworthy individual/organization is very important when looking for an advisor. As with any kind of service, I definitely recommend that my readers meet with at least three potential advisors.
Hey Leo! This was a good read.
The article you linked is a good reminder that we should be cautious and aware of financial advisors out there. $250k is definitely a $hitload when the initial investment was only over a million dollars. 😱
On top of that, I read the part about trading penny stocks. I wouldn’t consider penny stocks as a “low to medium” risk. Definitely failed to follow the client’s investing mandate.
I personally don’t trust anyone with my money, so it never crossed my mind to hire anyone. Like what the article mentioned:
“People have an incentive to behave in a very self-interested way,” says Cumming. “That’s how the world works.”
Though I’m not saying everyoneeee is like that, and I understand that people are busy so they delegate, but I just don’t think that there’s anyone who cares over 100% about your money than yourself.
For now, I’ll continue to invest in the boring passive low-fee ETFs regardless whether markets are up or down. I’ll just keep buying and buying (not going to time markets either). IMO the best “set it and forget it” method. I know it’s recommended to rebalance your portfolio once a year, but at least there’s no need to worry about what an advisor would do with your money throughout the course.
Thanks for this post, Leo! I hope your readers learn something from it! 😊
@Fin$avvy Panda, truthfully, I think that it’s too risky not managing your own money. I understand that not everyone is good with money and investment. However, no one is born with knowledge. It has to be acquired over time. For me, I am more afraid of being a financial fraud victim than a failed investor. Regardless of how much money I can potentially lose, the lesson learned from being a failed investor is much more valuable. When you are a fraud victim, I don’t think that any lesson is valuable coming from this front.
Oh it is so important to find a good financial advisor. There is so much misinformation out there and getting the right info means everything these days.
@Robin, your comment proves a great point. Regardless if you like to manage your money or not, it’ still important to have the knowledge to differential the difference between facts and opinion.
Yes i have a financial advisor which I signed a few investment plans with. I agree that we should monitor the progress of our own investments and not entirely leave it on autopilot!
@Milton, you’re right. Life is changing all the time and you definitely need to review your personal situation with your financial advisor to ensure that your financial goals change along with our life events.
These are some really good tips, it can make all the difference having someone who knows what they are doing help you out with money.
@Sarah, if you find a great financial advisor, they can greatly improve your finance. The key is knowing how to find the right financial advisor to work for you. Ask as many question as it takes.
I think we’ll need one of these people in a few years. We just want to be careful with our money, especially when my husband retires.
@Amber, Don’t wait till your husband’s retirement to start looking for a financial advisor. Start doing your homework now. The good thing is that you can get a feel of the type of financial advisors that are out there without having to make a commitment.
I’m not in a position to invest yet. When the time is right we will research before we invest.
@Rose, the right time to start your research is today :).
Great read. My husband and I might have to think about a financial advisor in the next few years since he’s thinking about retiring early.
@Susie, I am happy to hear that early retirement is achievable. What does he want to do when he retires early? I am always interested to know and looking for ideas. I am also an early retiree wannabe.
This is all really great information. Especially for someone who has no idea where to start when looking into hiring a financial advisor.
@Joanna, I am glad that his post is helpful to you. Hopefully, you can spend more time to do the research and to find the right financial advisor that can help you achieve your person financial goals.
I have never had invested money anywhere yet, though when i get in a position too i may plan to have an advice. These are nice tips to keep in mind for the future.
@Rahul, the earlier you start investing, the more time your money has to grow. I would encourage you to start investing as early as possible.
It’s a nightmare for me to owe money and thankfully I never have. I know many people here that could benefit from a financial advisor though. Overspending and not caring has brought disasters!
@Akamatra, it’s always prudent to look for help if finance is not your greatest strength. Ask lots of questions to ensure that you are able to assess if the financial advisor’s interest is aligned with yours.
Noone likes my money like i do. No financial advisor to me at the moment. If my finances got really complicated i might hire one for advice but currently they are pretty simple. Good post
Cheers!
@PassiveCanadianIncome, Yep. Our finance is our responsibility and we should definitely take charge of it.
I start reading about investing, and my brain just starts to swim. It’s all so scary for me. I’d love for my money to start working for me, but it seems so risky!
@Heidi, a great financial advisor will be able to explain things to you in simple terms that you will be able to understand without a great deal of financial knowledge.
I am very lucky to have two financial savvy people in my family. It can be scary investing your money. This is a great post.
I’m currently not in the market for a financial planner, but these are great tips! Maybe if I win the lottery I’ll be finding one ASAP! Ha!
Using a money manager can be a great help when figuring out your finances. However, we must each educate ourselves so we are not relying on someone else to protect our investments. A good friend of ours lost his fortune by depending on a financial advisor. It was a very sad situation.
This is great information that everyone should read. It does not matter what your financial status is a financial advisior can help you make the proper decisions when It comes to money issues.
This is going to help a ton of people. I really need to look into this.
A financial advisor is so helpful for anyone wanting to get the most out of their earnings. Investing can be quite tricky if you are not familiar with how it works. I would definitely need to seek out help when it comes to investments.
I’ll totally admit that I am financially illiterate. I don’t know the first thing when it comes to investments or any sort of savings! This piece was perfect for me!
I think I should hire one soon. Thanks for the great tips as usual!
I have never considered hiring a financial advisor but it totally makes sense. I know my mom has one and he handles all of her investments which makes things so much easier on her.
I personally do not have a financial advisor that I utilize. I have friends that are that I bounce things off of but for the most part my portfolio is on autopilot with my passive index fund investments. It’s pretty boring at this point but then again it took a long time to get where I was. If I had a financial advisor early on I probably could have reached FIRE earlier but you live and learn 🙂
I’ve been managing my portfolio myself so far by acquiring information available through online courses and free advisors provided through the employer. I try to make sure the asset allocation is appropriately aligned with the risk. The challenge I face is not having enough time to monitor the portfolio closely on a regular basis. My question will be how would you figure out if hiring an advisor will make a difference on the returns or not?