How to compare financial advisors and their services
A financial adviser is a person who provides financial advice, including asset allocation and investments.
In the United States, a Registered Investment Adviser (RIA) must register with the U.S. Securities and Exchange Commission or with a state's securities agency. Investment advisers are held to a "fiduciary standard" which means that they must hold the client's interest above their own.
Pros of using a Financial Advisor:
- a Financial Advisor can provide an asset allocation that is tailored to your risk appetite and specify the funds to buy
- a Financial Advisor can automatically rebalance your portfolio, buying and selling funds as needed to maintain your target asset allocation. Some will even optimize your portfolio for tax considerations.
- a Financial Advisor can customize your investment plan to match your particular savings or spending needs.
- a Financial Advisor may be experienced with investment products and asset classes that you are not familiar with.
- Financial Advisors may have access to money managers and mutual funds that are sold directly to individual investors. For example, the Dimensional Fund Advisors (DFA) family of funds is sold only through Financial Advisors that have a relationship with DFA.
- You have complete visibility into the investment that the advisor is making on your behalf. An advisor will typically setup a "separately managed account" for you that is in your name, but allows him/her to make trades.
Cons of using a Financial Advisor:
- Financial Advisors are expensive compared to using a model portfolio for asset allocation. For example: a publisher of a portfolio recipe (i.e., a model portfolio) might charge a fixed fee of $249 per year. A typical Financial Advisor charges an annual fee of 1.0% of your total assets under management. If you have $500,000 invested, the Financial Advisor fee is $5,000, which is 20 times more expensive than using a pubished portfolio recipe.
- Financial Advisors with a local office and support staff are more expensive than Financial Advisor who operates purely online. For example, Wealthfront is an online financial advisor that charges 0.25% of assets. The Wealthfront fee would be $1,250 if you have $500,000 invested, and a typical local financial advisor with a 1% fee would cost $5,000 per year. So in this case the local financial advisor is four times as expensive as Wealthfront.
- Financial Advisors are often reluctant or unable to share historical performance data for their asset allocation portfolios. Because each client's needs are different, each client may have a slightly different portfolio so it's difficult to compare. See "Questions to Ask" below for ways you can investigate an advisor's performance.
- If the Financial Advisor uses a strategic (i.e., fixed or static) asset allocation, you could replicate that portfolio on your own at a discount broker for much lower cost.
Questions to ask a Financial Advisor:
- Are you a Registered Investment Advisor (RIA)? What other designations do you hold?
- What is the 7-year (or longer) performance history for each of your asset allocation portfolios?
- What data source do you use for the performance data?
- Is this performance history based on back-tested (theoretical) data or actual trades that you have made?
- May I see a risk vs. return graph for all your portfolios compared to the market, including the 2008 downturn?
- For each product that you recommend, how much (in dollars and percent) do you receive from the provider of that product?
- Is this paid as a commission, bonus, or other compensation?
- What firm or brokerage will have custody of my assets?
- What are your assets under management?
- Do you recommend mutual funds to your clients that have a front-end or back-end load (i.e., sales charge or redemption fee)?
- What is the maximum drawdown (largest percentage loss) for each of your asset allocation portfolios over the past 7 years?
- How have your asset allocation portfolios performed compared to the leading all-in-one allocation funds, such as Vanguard Wellington (VWELX), Vanguard Wellesley (VWINX), or Janus Balanced (JANBX)?
How to find a financial advisor
Investment Advisor Search (www.investmentadvisorsearch.com) lists RIAs by state and by name. Using this site you can view the "Form ADV" for an advisor, which contains important disclosures.
Charles Schwab has prepared a list of its affiliated advisors at www.riastandsforyou.com/FindAdvisor.