Looking for Mutual Fund Advice? Ignore "Top Advisor" Lists
Like I'm sure many of the readers of Allan Roth's recent piece on Ric Edelman, I checked out Edelman's site, where I learned that he was ranked as the nation's #1 independent financial advisor by Barron's. That tidbit got me thinking about investment advice, and the rankings of advisors.
With the advent of 401(k)s and millions of baby boomers in or nearing retirement, investment advice has become one of the most contested fields in the financial services industry. Everyone from independent advisors such as Edelman, to stock brokers, to many of the nation's largest mutual fund managers are battling to garner their share of the estimated $11 trillion in assets that are in the market for investment advice.
There's little doubt that many -- if not most -- mutual fund investors would benefit from sound, conflict-free advice provided for a reasonable fee. The problem is that those three qualifiers -- sound, conflict-free, and reasonable -- eliminate a broad swath of would-be advisors, whose services can actually end up doing more harm than good.
So how does an investor navigate this landscape and find an advisor who's worthy of their trust? It's not easy, but here's one thing to keep in mind that will serve you well in your search: Ignore the "best of" lists which rank investment advisors.
Why? First of all, as Allan showed in an article last year in which his dog was named one of America's top financial planners, many of these lists indicate nothing more than the fact that the advisor ponied up a fee for the "honor" of being included. So no matter how magnanimous the name of the organization that bestowed the honor sounds, a few minutes of Googling will often reveal that there's far less there than meets the eye.
Many other lists -- such as those published by Forbes.com and Registered Rep magazine -- are nothing more than rankings of advisors by the amount of assets they oversee. And while a reader might be impressed by, as Registered Rep puts it, the leaders' "crowning achievements," choosing an advisor based on the amount of money they oversee makes about as much sense as selecting a mutual fund on the basis of its size. While such a strategy might lead to success, it's hardly recommended as the best way to pursue it.
Finally, there's Barron's annual rankings of the Top 100 Independent Financial Advisors, the Top 100 Women Financial Advisors, the Top 100 Financial Advisors (i.e. not independent), and the Top 1000 Advisors. Obviously, the Barron's name lends these rankings a good deal of credibility and prestige. But while their methodology is more rigorous than those described above, you might be surprised at how they quantify the nation's "best" advisors.
According to Winner's Circle -- the firm that developed the methodology before being acquired by Barron's in 2008 -- the independent financial advisor rankings are based on qualitative criteria (at least seven years of experience, an "acceptable" compliance record, client retention and satisfaction) and quantitative criteria, which includes the amount of assets the firm oversees and the firm's profitability.
The qualitative criteria are fine, as far as they go, ensuring a certain level of experience and making sure that the advisor has kept his regulatory nose clean. But what's interesting is the quantitative criteria. While the firm's assets and profitability are important considerations for the advisor, I'm not sure how they can help a potential client find an advisor who will serve them best, which presumably is the point of the list.
All else equal, it would appear than an advisor who charged his clients 2 percent annually for his services would rank higher on the Barron's list than one who charged 0.5 percent. While the former is surely more profitable, clients of the latter will earn higher net returns. For that reason, an advisor's profits are a near contrary indicator from a client's perspective, for those profits come directly out of the pockets of his or her clients.
Need proof? Consider that an Edelman client with a $1 million portfolio will pay Edelman $14,000 a year for his services, or 1.4 percent. That same client would pay a firm like Portfolio Solutions $2,500, or 0.25 percent. While fees at the first level might produce enough profits to garner a top ranking from Barron's, the latter fee schedule is surely a better deal from the client's perspective, who will earn 1.15 percent more per year given equivalent portfolios.
So if you can't rely on lists purporting to identify the top advisors, where should you turn? The first thing to do is to limit your search to fee-only planners who are paid only by you, and don't receive commissions on the basis of their recommendations. The National Association of Personal Financial Advisors' website will help you in your search. Second, consider using an advisor who carries a CFP or CFA credential, both of which require compliance with a rather strict set of ethical standards. Third, closely examine their fee schedule, making sure you translate seemingly small percentage points into actual dollars. If the price they purport to charge seems too high for their services, keep shopping. Finally, press them on just how they'll add value. If they claim that their wisdom will allow you to outperform the broad market, keep shopping. An advisor who's setting realistic expectations will promise nothing more than helping you maximize your share of the markets' returns, adding value by keeping you from making big mistakes when the markets turn choppy.
Of course, not all advisors who pass through such a screen will ultimately prove trustworthy -- the world is an imperfect place. But the steps above will get you far closer to your goal than blind reliance on any list of the top advisors ever will.
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