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Professional Financial Advice

These notes were started sometime after 2001 as part of a Financial Planning Special Interest Group (SIG) project. They were last revised on June 2, 2011. The original project participants were reasonably knowledgeable investors who volunteered to interview financial advisors. Here's what we learned.

Fee-Based vs. Fee-Only vs. Commission Based Financial Advisor

A Fee-Based Financial Advisor can receive fees paid by you, and commissions paid to them by a brokerage firm, mutual fund company, insurance company, or investment partnership.

A Fee-Only Financial Advisor receives fees paid directly by their clients. These fees can be fixed dollar amounts OR they can be a percentage of the portfolio. Fee-Only Financial Advisors have a fiduciary responsibility to choose investments that are in your best interest. They typically use investments that have low internal expenses such as no load mutual funds and investments that have no 12B-1 fees.

A Commission-Based Financial Advisor receives a commission paid to them by a brokerage firm, mutual fund company, insurance company, or investment partnership for products they sell to customers.

Before you interview an advisor, determine EXACTLY what you want the advisor to accomplish. Do NOT sign a contract unless the objective is included in the contract. Remuneration should be dependent on satisfying the measurable objective.

A Fee-Only Financial Advisor is probably the best choice. Furthermore, the fee should be a fixed dollar amount rather than a percentage of the portfolio so you know exactly what you're paying.

What will a professional financial manager do for you?

1.    You are the boss. If you know what you want and if you're not a complete idiot, then almost anyone will do anything you want. Let's face it: If they didn't do what you wanted them to do, you'd fire them. But be prepared to pay more if you have special needs and a moderate portfolio. If you don't know what you want and if you don’t have special needs, then almost every investment advisor in the world is going to say their investing style is whatever worked well in the last ten or so years. But what are they really gonna do?

A. They will try to determine your risk tolerance i.e., they will try to determine how much of a loss you can tolerate before you panic and fire them.

B. They will try to determine how much income you need.

C. Based on your answers to questions A and B they're going to determine a stock/bond allocation for you. The stock allocation will probably be 85% US large cap stocks or mutual funds designed to mimic the S&P 500 as closely as possible and a combination of US small and mid cap stocks or stock funds and international stocks or stock funds designed to mimic appropriate indexes. Note that a combination of 15% US extended market and foreign stocks isn't going to help or hurt your portfolio regardless of how well or poorly these asset classes perform. The advisor/manager is doing this simply to say, "I was there" if they out-perform and, "I avoided over-exposure" if they under-perform. The bond portfolio will consist primarily of laddered intermediate term US bonds with some short and long term bonds and cash thrown in for the same reason.

The paragraphs above were written shortly after 2001. The portfolio that was described in "C" above worked reasonably well during the ten-years thru 2000, but it did NOT work as well during the ten-years thru 2010. As a consequence, most advisors are now recommending more small and mid cap exposure, more international exposure, and perhaps some emerging market, commodity, real estate investment trusts (REITs) and international bond exposure for more daring investors.

Hindsight is wonderful.

Can you do all this yourself? In theory you can do anything yourself IF you understand why the stock/bond allocation that was originally determined should be maintained OR changed, AND IF you have the intestinal fortitude to do it. Two BIG IFs. If you can say yes unconditionally to both IFs then you can be your own manager; if NOT, then you need a manager.

2.    Relatively few investment advisors in this world will have exceeded the risk adjusted return of an appropriate index and, if they did, you won’t know if they were smart or if they were lucky; nor will you know if their luck or brains are going to prevail once they start managing your portfolio. If you're searching for a guru or a savior then read what happened when the AAII Rochester, NY Mutual Fund Special Interest Group tried to identify out performing mutual funds before the fact. For more go to Mutual Funds. If you settle for the returns of an index then you’ll get whatever the index yields minus some modest transaction costs. If you chase performance then you may out perform, but the chances are far greater that you’ll under perform by 4% or more per year.

3.    Management fees are generally 1% of your entire portfolio, but this is a competitive business so it is fairly easy to negotiate lower fees or, better yet, fixed fees, especially if you have a portfolio greater than $500K. If your advisor is trailing an appropriate index by 1% (and most of them will trail for a variety of reasons) then factor that into the total cost. Consulting fees and co-fiduciary fees can easily add 1% or more. All things considered, professional management will probably cost about $20,000 PER YEAR if you have a $1 million portfolio and if you don't have any special needs; $30,000 if you're a PITA (Pain in the Ass). Is professional management worth the price? Only you can decide if the management or companionship you're buying is worth the money you're paying, but recognize that if you lack discipline and intestinal fortitude then you could benefit from professional management.  

4.    I have not commented on our impressions of any of the advisors whom the project volunteers interviewed because it’s subjective and irrelevant i.e., the advisors have been trained to make a good impression. However, in my opinion, an overwhelming percentage of advisors are simply salesmen who want to sell a financial product that has been manufactured by their organization. Most of the products they're selling have high fees and/or expenses that usually subtract value from an appropriate index.  

5.    The best advisor you're likely to meet is the person who stares at you when you look into a mirror IF you're willing and able to educate yourself. If you're not willing and able to educate yourself, then you're a fool, and the advisor you choose is likely to be a charlatan. A fool and his money are soon parted.

A special report on the rich
Show them the money
The rich have become disillusioned with the people who look after their fortunes
Apr 2nd 2009 | from the print edition of The Economist

ONE of the problems with being rich is that you cannot just leave your money to sit there: you have to do something with it. Few people feel confident enough to throw themselves into the hurly-burly of financial markets on their own. The wealth-management industry exists to take that problem off their hands, for a pretty hefty fee.

Unfortunately for all concerned, the industry tends to promise more than it can deliver. Last year was disastrous for financial markets, with the MSCI World index of equities falling 42%. Moreover, many clients, having been persuaded of the benefits of diversification in recent years, had bought alternative assets, such as hedge funds and private equity, which supposedly offered absolute (positive) returns uncorrelated with the stock market. But when the crisis came, those assets turned out to be highly correlated to the mainstream and lost value as well.

The final straw came at the end of last year when the extent of the Madoff scandal was revealed. Bernard Madoff pleaded guilty to running a Ponzi scheme in which he was paying early investors consistent returns by taking the money from later ones, with potential losses in the tens of billions of dollars. Just what were wealth managers doing to earn their fees if they could not spot the scam?

So there is now fairly widespread dissatisfaction with the industry. “The old wealth-management universe is not just broken, it’s been broken and tossed away,” says Russ Prince of Prince & Associates, a market-research firm. “Nobody believes anything anybody is saying any more.” A survey by his company showed that 15% of the wealthy had left their main adviser last year and a further 70% had pulled some of their money away.

A survey of rich Americans by Harrison Group found that 63% had lost faith in financial institutions. And Caroline Garnham of Lawrence Graham, a London law firm, says that half of her clients do not use private wealth management at all, and half of the remainder are dissatisfied with the advice they received.

The private wealth-management business has always been rather murky. Ask for performance figures, and the best you will get is the record of some model portfolio; clients are all different, managers say, and have different attitudes to risk. Besides, they argue, looking after a client is not just about performance, it is also about tax management, family structures and all manner of other things. Some clients have strong opinions and will want a say in how the portfolio is run; others will have long-standing positions in particular businesses or properties that they may be unwilling or unable to sell. So a private-client portfolio will normally look quite different from a pension-fund version with its careful mix of equities, bonds and property.

These constraints are real enough, but they make it very hard to measure the “success” of a private-client manager. A lot may depend on the trust between the individual client and the relationship manager at the bank; if the bond is strong, then a bad year such as 2008 can be explained away. This can be an advantage to private banks once clients are on the books; inertia may keep them there, if only because clients can rarely be sure that they would be better off elsewhere.  

Who rates as rich?

How much money do you need to count as wealthy in the first place? For a wealth manager, it depends on how big a portfolio you can give him to manage. For example, Merrill Lynch’s wealth-management report starts counting at $1m in “investible assets”. That excludes people’s main homes, which may seem reasonable. But it means that a Londoner who sells his home and decides to rent can suddenly find himself “rich”.  

In fact, a lot of wealth managers will not bother with anyone who has less than about $10m in assets. After all, a portfolio of $1m these days would generate an income of only $30,000 if invested in Treasury bonds, which does not leave much scope for the playboy lifestyle.  

Putting performance to one side, another big issue for the industry is the quality of advice on offer, and whether it is sufficiently impartial. In many cases private banks may be part of larger groups that see an advantage in having a captive client base for their other activities.

This link is made explicit in a recent report on the wealth-management industry by Boston Consulting Group (BCG). “Some players position their private banks within their corporate or investment banks,” the report says. “This approach aims to keep the client’s wealth in a single institution and tap product-development synergies.”

These synergies often turn out to benefit the banks a lot more than the clients. As Stefan Jaecklin of Oliver Wyman puts it, “in the integrated banking model there are limited benefits for the private bank from having an investment bank attached; the benefits mainly flow the other way round. A lot of private banking has not been about advice but about pushing products. Often bankers will be rewarded not just on the basis of assets under management but on product sales.”

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