A reader wants to know how to find an investment adviser who can be trusted. It should be easy, but unfortunately it's anything but.
Before beginning my career in personal finance news, back in 1991, I worked for about 10 years as a stockbroker, also known as a “financial adviser.” So this week’s question is right up my alley. Here it is:
How do you choose a good, reliable stockbroker? — Anonymous
Here’s your answer, Anonymous:
How to pick a stockbroker? Carefully
Stockbrokers serve two functions. Technically a stockbroker acts as a registered agent to buy or sell securities on behalf of a client. (Hence the term “broker.”)
But the type of stockbroker Anonymous is asking about is probably the one offering a second service: investment advice. And the question is a good one, because the quality of advice you receive can mean the difference between creating a fortune and destroying one.
What’s in a name?
While I called myself a stockbroker back in my day, those in the advice business these days rarely do. Instead, they use titles they presumably hope will convey trust, like financial analyst, financial adviser, financial consultant, financial planner, investment consultant and wealth manager, among others.
When it comes to quality advice, these are all interchangeable labels. None requires any specific education, skill or certification. In fact, your barber probably has more strict licensure requirements than is required to call yourself almost any kind of financial adviser or consultant.
More important than titles? Compensation
While I left the financial advisory business decades ago, the problem for consumers today is the same as it was then. Namely, most advisers make money from commissions. And anyone who does that can never be completely trusted.
Overly harsh? Maybe. There are undoubtedly many commission-based advisers who are both sharp as a tack and honest as the day is long. But they’re working within a rotten system — one that requires them to move your money around to get paid, when often that’s not in your best interests.
Furthermore, the typical stockbroker isn’t required to act as a fiduciary, which would require that they place your financial interests ahead of their own. Instead, they adhere to a lesser standard of conduct, known as suitability. Suitability requires only that they suggest investments that are suitable for an investor with your goals, risk tolerance and financial means.
An example to illustrate the distinction: Suppose your goals and risk tolerance suggest that a stock mutual fund is right for you. There are two similar funds available. One charges a 5 percent commission and the other 2 percent. A fiduciary would be honor-bound to suggest the fund with the lower cost, because that’s obviously in your best interests. The suitability standard, on the other hand, allows the adviser to suggest the fund that pays them the higher commission, because either fund is suitable.
The bottom line is this: A system built on commissions and without fiduciary standards invites abuse. That was true when I started as a stockbroker 35 years ago, and it’s true today.
Who can you trust?
To receive objective advice, you’ve got to take commissions out of the equation. There are two ways to do this. The first is to replace commissions with a simple, annual fee based on the amount being managed. I explained the pluses and minuses of that setup in the post, “Ask Stacy: Why Is My Investment Adviser Charging a Fee on Idle Cash?”
The other way to take commissions off the table — and the better option, in my opinion — is to pay for your financial advice by the hour, the same way you do with an accountant or lawyer. The problem with this approach: Depending on whom you pick, the fees could be high. The adviser I was talking to in the video above, for example, has a minimum fee of $1,500. There are cheaper alternatives, however.
A third option, of course, is to learn the ropes yourself, then make your own decisions. Unlike taxes or law, investing doesn’t require massive training or an advanced degree. Check out “Ask Stacy: How Do I Invest in the Stock Market?”
How to pick an adviser
Here’s how to go about picking the right adviser, however they get paid. These rules also apply to picking an accountant, lawyer, doctor or plumber.
- Ask your friends or co-workers for referrals. The most useful will be from people who are in situations somewhat similar to yours.
- Check out credentials. You don’t have to be a genius to pass the exams required to obtain securities licenses. Look beyond that and check out educational background and other professional credentials. The Certified Financial Planner (CFP) designation is a good one.
- Ask about experience. Credentials and education are nice, but as with most things in life, experience is often the best teacher. If two professionals charge the same price, you’d certainly rather have one with 20 years of experience versus 20 months.
- Ask them for references. Any professional in any field should be happy to provide them. Of course, only an idiot would provide the name of someone who would bad-mouth them, so don’t put too much weight on this one.
- Talk to several before you decide. This is easily the single most important thing before hiring any service professional. Only after you talk with several possible candidates for the position will the positive attributes you’re seeking surface in one of them.
- Ask how they get paid. If you read what I wrote above, this one should be obvious.
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I founded Money Talks News in 1991. I’ve earned a CPA (currently inactive), and have also earned licenses in stocks, commodities, options principal, mutual funds, life insurance, securities supervisor and real estate. Got some time to kill? You can learn more about me here.