For the second time in its history, D Magazine offers two “best of” categories for financial advisers: financial planners and wealth managers. And for the second time, there will be individuals and firms on both lists, which raises a question. What’s the difference between a financial planner and a wealth manager? In some cases the answer is “Not much,” and in others it’s “A great deal.”

The bigger question is this: what do you want in an investment professional? Someone who can earn a greater return on your portfolio than you can? Someone who will create a financial plan or assist with income and estate tax planning? All of the above are worthy criteria. But as consumers, we do not always ask the right questions or have a clear list of qualifications for investment professionals.

The average investor, when asked how he chose his financial adviser, will say that he asked a friend or colleague for a reference. In other instances, the investor knew the adviser from the neighborhood, country club, or church. When asked why he chose the adviser, the investor often says he made the decision because he trusted the referral source or liked the adviser. Less frequently could the investor list specific reasons for the hire. Let’s remedy that. Following are some specific criteria that you can use to choose an adviser.

Credentials. Today you will find an alphabet soup of credentials in the financial arena. For financial planning professionals, the most prevalent designation is the Certified Financial Planner, or CFP (full disclosure: I am a past president of the national organization’s local chapter). Holders of this designation have an undergraduate degree, and at least three years of experience and have passed a 10-hour exam. Thirty hours of continuing education are required every two years, as well as a background check and adherence to a code of ethics, professional responsibility, and financial planning standards. The Chartered Financial Analyst designation, or CFA, is held primarily by those in the field of money management. Candidates take three challenging exams over a three-year period, have four years’ work experience, and adhere to a code of ethics and standards of professional conduct. Other designations include Certified Investment Management Analyst (CIMA), Chartered Financial Consultant (ChFC), Certified Public Accountant (CPA), and attorney (JD).
Designations imply a level of intelligence, competence, motivation, and exposure to ethical standards.

Custody. Here is one of the more important questions to ask: where will my money be held? The answer should be a well-known third-party custodian such as Charles Schwab, Fidelity, or Merrill Lynch. Investors who have invested with less reputable custodians have faced dire consequences. Bernie Madoff is the obvious example. Madoff held custody of his clients’ money and produced his own statements. Make sure your statements come directly from a third party. Securities held, ticker symbols, and account values should be clearly detailed.

Experience. How long has the adviser practiced and just what were his daily duties? Someone can tell you he has been in the financial services industry for 20 years, but if he sold insurance during this entire time, how will this help him determine the best investments for your portfolio? A secular bull or bear stock or bond market cycle can last 10 years or more. Longer tenure in the profession is a definite advantage.

Business Continuity. Business continuation is a big issue, given that advisers are in an aging profession. How long will your adviser practice? If you are 50 and your adviser is 60, make sure you understand his succession plan. Who will serve you when you retire, the inexperienced new guy? Is there a succession process in place that will ensure ongoing competent counsel?

Fiduciary. A great deal of drama exists around professional standards. There are two standards: a fiduciary standard and a suitability standard. A fiduciary must hold his client’s interests above his own and disclose any conflicts of interest. The other standard is called a suitability standard and has been viewed as less stringent than a fiduciary standard. An investment professional under a suitability standard must have a reasonable basis to believe that an investment or investment strategy is “suitable” based on the investor’s investment profile. The limited space here prevents an in-depth discussion of this issue, but know that many professionals believe a fiduciary standard offers the consumer the highest standard available. At present, Congress is debating a possible universal standard for investment professionals. Until this is accomplished, you should ask your investment professional if he is acting as a fiduciary.

Compensation. Compensation is a very confusing part of the adviser evaluation process and yet vitally important for you to understand. Conflicts of interest may exist that hurt your performance. Ask the adviser or broker how he is paid. Does he get a commission if you invest in a product, or does he charge a fee? If your adviser acts to broker an investment between you and a seller, then a commission may be an acceptable approach. In a broker situation, you should deploy natural skepticism, just as you would in any type of transaction.

When an adviser is compensated by fee, the lines can become blurry. You need to understand when an adviser is motivated to serve you or himself. One example would be a scenario in which you invest in a wrap account (an account where portfolio managers buy and sell stocks and or bonds on your behalf). You then pay an advisory firm a fee. From this fee, your adviser’s firm compensates the wrap account manager directly. Here is where the conflict exists: let’s assume your adviser has two wrap account options. Wrap account No. 1 charges the adviser’s firm the largest fee but has the best long-term performance record. Wrap account No. 2 costs the advisory firm half as much yet has a poorer investment record. In this case, the adviser is motivated to put you in the lower-cost wrap account because this investment will double the adviser’s compensation. The problem for you is that the most lucrative wrap account for your adviser is the poorest investment option. A more transparent arrangement would be to pay a stated fee directly from your account to the advisory firm. A direct compensation approach would alleviate this conflict of interest.

Fees. As mentioned above in the compensation discussion, fees are a very important component of performance and a hot topic during the current range-bound stock market. Throughout the huge bull stock market of the ’80s and ’90s, fees were of less concern because the stock market’s performance could easily cover up these costs. Today, with modest stock returns, journalists and investors are paying more attention to the expense arena. Know that total expenses in the 2 percent or higher range could prove a big barrier to overall performance. Conversely, some individuals concentrate so much on fees that they lose sight of net performance after fees. In numerous instances, above-average fees can be offset by excellent manager performance. Carefully conduct your due diligence in this area and make sure you understand all the fees the adviser charges, as well as the underlying investment costs of a mutual fund, wrap account, exchange traded fund (ETF), or other investment.

References. One of the better strategies for finding an investment firm is to ask other professionals for an introduction. Your CPA, estate planning attorney, or corporate lawyer can be your best source. In many instances, an accountant or attorney will work with investment professionals on mutual clients. These allied professionals have a good venue to watch the adviser work and observe his competency and dedication to his clientele.

Background Check. The U.S. Securities and Exchange Commission provides a helpful resource at SEC.gov to review registered investment advisers. By scrutinizing a firm’s form ADV, you will see how long it has been in business, assets under management, the type of services it offers, clientele it serves, and any disciplinary actions against the firm. If the professional works for a stock brokerage firm, the above information can be found at FINRA.org under “Broker Check.” If the adviser is a CFP, check the Certified Financial Planner Board of Standards website at CFP.net for any disciplinary history.

Written Contract. Make sure the adviser’s entire offering is well-documented in a written contract. If the engagement is for investments only, then what type of securities will be purchased? How much risk is involved? Have your needs for income and liquidity been taken into consideration? When considering financial planning services, what type of planning will you receive in the areas of tax, estate, and insurance and at what frequency? Finally, is your adviser’s compensation clearly outlined? Can you describe the fees or commissions you are paying? If not, you should dig deeper or exit quickly.

Finding the right adviser need not be a daunting task. Decide what you want in an investment professional, organize your questions from the list provided here, and be thorough in your interview process. The end result should be well worth the effort.

 
Mark McClanahan is an adviser with the wealth management firm of Robertson, Griege & Thoele. Write to [email protected].