Quest for Alpha: How to Get the Right Help with Your Portfolio

Last Updated Feb 4, 2011 5:10 PM EST

(The following comes from the appendix Doing It Yourself in Larry's most recent book, The Quest for Alpha, which presents compelling evidence on the failure of individual investors, mutual funds, pension plans, venture capital and hedge funds in their efforts to outperform the market. To see what you need to consider when handling investment on your own, see Thursday's post What You Need to Consider When Handling Your Own Investing.)
Some individuals recognize that they do not have the knowledge, the interest, or the discipline required to do it on their own. They also recognize that a good �nancial adviser can add value in many ways. There are also individuals who would rather have someone else focus on �nancial matters so they can focus their attention on the more important things in their lives. They know that even if they have the skills to do it themselves, the time spent on �nancial matters is time not spent with family and friends, doing community service, and so on. And they place a greater value on that time than on the cost of an adviser. They might also hire an adviser because doing so would allow them to spend more time doing more of the work at which they are experts (such as being a doctor or lawyer), and for which they get paid more than they pay in advisory fees.

A good �nancial adviser can add value in many ways. For example:

  • Developing an investment plan that provides the greatest chance of achieving your ï¬?nancial goals without exceeding your ability, willingness, or need to take risk.
  • Integrating your investment plan into an overall estate, tax, and risk management plan.
  • Helping you act like a postage stamp-sticking to your plan until you reach your ï¬?nancial goal.
Unfortunately, it is far too easy for someone to become a �nancial or investment adviser. The requirements are few and the tests far too easy. In the case of most Wall Street �rms, training is mostly sales and compliance oriented with little emphasis on investment knowledge. If it weren't so dangerous, it would be humorous that advertisements for brokers typically include the phrase "no experience necessary."

So how do you �nd a competent adviser whom you can trust to act in your best interests? When interviewing a poten­tial �nancial adviser, you should require them to make the fol­lowing 11 commitments to you. Doing so will give you the greatest chance of avoiding conflicts of interest and the greatest chance of achieving your �nancial goals.

  • The ï¬?rm should be able to demonstrate that its guiding principle is to provide investment adviser services that are in the client's best interests.
  • The ï¬?rm follows a ï¬?duciary standard of care. A ï¬?duciary standard is often considered the highest legal duty that one party can have to another. This differs from the suitability standard present in many brokerage ï¬?rms. That standard requires only that a product or service be suitable; it does not have to be in the investor's best interest.
  • The ï¬?rm serves as a fee-only adviser -- avoiding the con­flicts that commission-based compensation can create. With commission-based compensation, it can be difï¬?cult to know if the investment or product recommended by the adviser is the one that is best for you or the one that gener­ates greater compensation for the adviser.
  • All potential conflicts are fully disclosed.
  • Advice is based on the latest academic research, not on opinions.
  • The ï¬?rm is client-centric -- advisers focus on delivering sound advice and targeted solutions. The only requirement they have in offering particular solutions is whether the client's best interests will be served. The ï¬?rm is focused on providing advice, not products.
  • Advisers deliver a high level of personal attention and develop strong personal relationships, and because no one can be an expert on all subjects, clients beneï¬?t from a team of professionals to help them make sound ï¬?nancial decisions.
  • Advisers invest their personal assets (including the ï¬?rm's proï¬?t-sharing/retirement plan) based on the same set of investment principles and in the same or comparable secu­rities they recommend to their clients.
  • They develop investment plans that are integrated with estate, tax, and risk management (insurance) plans. The overall plans are tailored to each client's unique personal situation.
  • Their advice is goal oriented -- evaluating each decision not in isolation but in terms of its impact on the likelihood of success of the overall plan.
  • Comprehensive wealth management services are provided by individuals with Certiï¬?ed Financial Planner (CFP), Personal Financial Specialist (PFS), or other comparable designations.
Because the cost of bad advice can be so high, you should also perform a thorough due diligence on the �rm. That due diligence should not only include requiring the adviser to make the aforementioned 11 commitments to you, but it should also include a careful review of form ADV -- a disclosure document setting forth information about the adviser, including the invest­ment strategy, fee schedules, conflicts of interest, regulatory incidents, and so on. And, �nally, you should consult other pro­fessionals (CPAs, attorneys) in the area, as well as current clients, to get independent references on the �rm. Careful due diligence will minimize the risk of having to make expensive repairs.

Excerpted with permission of the publisher John Wiley & Sons, Inc. from The Quest for Alpha: The Holy Grail of Investing. Copyright 2011 by Larry Swedroe. This book and e-book is available at bookstores, through Amazon and Barnes & Noble and from the Wiley Web site.
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    Larry Swedroe is director of research for The BAM Alliance. He has authored or co-authored 13 books, including his most recent, Think, Act, and Invest Like Warren Buffett. His opinions and comments expressed on this site are his own and may not accurately reflect those of the firm.