Cutting Through the Bear and Bull: Selecting a Financial Advisor

The August 29th edition of

included a twenty-four page special report, titled

. For someone seeking a financial advisor in their area this type of report would seemingly help narrow the list down considerably. Additionally, with the report being from a trusted name like

one would expect that there was significant in-depth research done to select the best-of-the-best financial services professionals. A quick scan of the fine print preceding the top 100 list yielded the following disclosure regarding the methodology: “Here are America's top independent financial advisors, as identified by

. The ranking reflects the volume of assets overseen by the advisors and of their teams, revenues generated for their firms and the quality of the advisors' practices.” In other words, according to

, the three main criteria one must consider when selecting an advisor are 1) assets under management (AUM), 2) revenue that they generate and 3) quality of the services offered. I propose that this methodology is fundamentally flawed both because it is incomplete and in the cases of the first two criteria almost completely useless to the client.

How much an advisor manages says little to nothing about the advisor other than the obvious. The list presupposes that an advisor who manages $2B is necessarily better than one who manages $1B. This is ludicrous because it fails to consider that greater assets often mean more clients and consequently less time available to spend per client. Furthermore, larger assets could suggest one adviser is merely better at selling than his colleagues are. Would you want an advisor who is more interested in bringing on new clients than in managing your portfolio? Using asset size as one search criteria, among many others, is valid if you intend to eliminate very small firms that may be overwhelmed by a new, large account. But using it as a means to select the ‘best' advisor is akin to picking a wedding photographer based on their height – it simply does not make logical sense.

No one seeks to hire an advisor who does not make money for himself. First, if an advisor cannot earn a living, how likely is he or she to be able to give good advice to you? Second, an advisor who generates sufficient revenue is more likely to remain in business than one whose practice cannot support him. In this respect revenue is important. Where we differ, however, is in

assertion that an advisor is somehow better by generating more revenue for himself and his firm. I would strongly argue the opposite. An advisor who generates substantial revenue for his firm may be doing so by managing a large book of business at a reasonable cost or by selling high cost/high margin products and services. If it is the latter than they are not a ‘good' advisor as far as the client is concerned, they are merely good at padding their own wallets.

I have no argument with the last criteria used to determine the top 100 list other than it would have been useful to understand what constitutes quality, how the advisors were evaluated and what weighting quality had relative to revenue generated and AUM. Ideally, this last point would contribute the greatest weighting in determining which advisors truly are a cut above the rest.

Given that generic rankings, such as these, often lack a cohesive rationale and even so would not be customized to the individual investor, we've compiled a list of questions to ask a prospective advisor to help you determine whether they are a good fit for your needs.

Not all advisors offer the same services. Some manage investments only, while others focus on insurance or financial planning. Understand what you need and whether these are services that the advisor offers.

Understand how much your advisor is paid and whether he/she gets any additional compensation from mutual fund companies in the form of 12b1 fees. If trading costs apply you'll want to know how they are calculated and how often your advisor trades. Understand all costs involved, not just those paid to your advisor. This would include expenses on funds or fees paid to third parties.

Learning your advisor's background can help you understand whether they are knowledgeable and gauge their level of experience. Ask about their education, where they went to school, or whether they have any post-graduate degrees or professional designations. Also inquire about their past experience at other firms, specifically what they did prior to advising on client assets.

If you're hiring an advisor specifically to manage your investments and are less focused on financial planning, take the time to inquire about their philosophy on managing client assets. For example, you'll likely be more comfortable with an advisor who takes a cautious approach if you are a conservative investor. An advisor who has a poorly defined philosophy on investing is more likely to panic in volatile markets and make poor choices. As part of their philosophy make sure to inquire as to their sell discipline for securities not just their buy discipline. As usual, one must be careful not to accept the printed word as gospel, even from industry ‘experts'. Making important financial decisions without understanding all the implications can be hazardous to your portfolio's performance. The complete list of top advisors according to

is available online by clicking

. Michael T. Prus

-September 9, 2011