I wanted to share a document that an attorney we know uses (full disclosure, we have managed his family’s portfolio and assisted with their financial planning since we got aquainted about a dozen years ago). Robert Port is one of the smartest people I know and he specializes in securities and fiduciary litigation (i.e. helping clients whose financial advisors and other fiduciaries haven’t acted appropriately). To ensure he knows the field well, he has taken all of the Certified Financial Planner classes also (but since he never sat for the comprehensive exam, he is not a CFP).

Due to this academic knowledge and practical expertise, he gets a lot of questions from folks understandably anxious to know how to select a good financial advisor. Here is his standard e-mail response (which we had no part in writing):

A more detailed discussion of my views on choosing an advisor is below, but my summary of the “bullet” points to consider would be these:

  • Avoid anyone who is compensated based on commissions, sales contests, a percentage of the investment sold, or any other sales incentives.
  • Use only “fee only” investment advisors who have a fiduciary duty to you.  Not stockbrokers.  Not insurance agents.
  • Avoid anyone (and any firm) that claims to be able to “time” the market, to know exactly the right time to buy or sell, does any active trading, sells “products,” or promotes hedge funds, “non-traditional” investments, or illiquid investments.
  • Use investment advisors who take the time and effort to determine your individual investment needs and risk tolerance. 
  • Avoid anyone who has the same investing solution for everyone.
  • Use an investment advisor who will broadly diversify and allocate your assets over many investment categories (US and international stocks and bonds, large cap and small cap, emerging markets, etc.) and will stay with the plan long term, even during market ups and downs.
  • Use an advisor who is aggressive about saving you fees and costs – my preference is for an advisor who primarily uses low cost index-funds.

My [this is still Robert] more detailed comments:

For investment management and financial advice, I generally avoid traditional stockbrokers and brokerage firms.  Instead, I strongly prefer “investment advisors” who are "fee only" and who are members of NAPFA, the National Association of Personal Financial Advisors. Fee-only investment advisors do not work for a commission, but are paid based on assets under management; charge an hourly fee; or charge a flat fee.  The ones I respect generally charge no more than 1% annually of assets under management.  These advisors are to be distinguished from "fee-based" advisors or stockbrokers, who also earn commissions.  I have a strong aversion to any investment advisor whose business model is based, in whole or in part, on earning commissions. 

A true “investment advisor” is registered with the SEC and/or state regulators under the federal Investment Advisors Act of 1940.  They have a statutory duty to act as fiduciaries toward their clients, something that is not required in most relationships investors have with stockbrokers at traditional brokerage firms.  The technical designation for the individual is Investment Advisor Representative (IAR), and the firm they work for is a Registered Investment Advisor (RIA).  I also prefer someone who is either both a CFP (Certified Financial Planner) and a CFA (Chartered Financial Analyst), or has people with those designations primarily in charge of the investment process.   The CFA is a difficult to obtain certification for finance and investment professionals, particularly in the fields of portfolio management and financial analysis.

I also prefer investment advisors who follow a “passive” investing strategy, based primarily on investing in stock and bond indexes for the long term.  This is to be contrasted with “active” managers, who claim they can “beat” the market by identifying which stocks, bonds, or mutual funds are about to go up or go down, and buy or sell in the hope of “timing the market.”  All of the academic evidence indicates that active managers rarely beat the market averages in the long term, and indeed, because of the costs and taxes incurred in actively buying and selling, they have a greater chance of underperforming the market in the long run.

I would never, ever, use a traditional “Wall Street” brokerage firm or any of their stockbrokers to manage my money.  I am not suggesting they are crooked; I have many friends who work for such firms.  But the problem is that most traditional brokerage firms generally operate on an "active” management basis, and are commission driven, or if they charge on a fee, charge very high fees. (Note that in an attempt to imitate the “investment advisor” model, many brokerage firms now offer a “managed” or “wrap” or similar type of account, under which they manage assets for a fee.) 

Bottom line, my experience with Wall Street firms is that they provide poor investment management coupled with very high fees, which can greatly reduce an investor's net worth over a lifetime.

I also have a strong preference for investment advisors approved to offer index funds from Dimensional Fund Advisors (“DFA”).  DFA creates index funds based on Nobel Prize winning models of how portfolios should be constructed so that a portfolio's probable return matches a client's risk profile.  DFA does not permit just anyone to offer their funds, and from my understanding, requires that advisors who offer their funds undergo a rigorous approval process.  As far as I am aware, no traditional brokerage firms offer DFA Funds.

I also would never, ever have an insurance agent, or any advisor who works for an insurance company, or anyone who primarily offers insurance products, or anyone who earns commissions from selling investment products, manage my investments or provide investment advice.  As a legal matter, many insurance agents do not have the licenses necessary to properly offer investment advice.  While insurance is a very important part of financial planning, too often an insurance agent or an advisor with an insurance license sees insurance as the cure for every ill.  That is because many insurance “products” pay high commissions to the agent/broker, so naturally, many will steer a client to insurance that will cause them to earn the higher commissions, rather than a low cost non-insurance alternative.  Often, insurance (such as whole life insurance, variable annuities, and equity indexed annuities) is a very expensive solution to a problem that can be addressed using a different, and less expensive, investment strategy.

Please note that the traditional investment advisor model provides that the advisor is given full discretion, in an agreement signed by the client, to manage the account, and can purchase and sell securities without obtaining the client's prior approval each time a transaction is made.  What a competent advisor will do, however, is thoroughly review and investigate a client’s circumstances and develop an appropriate risk profile, so that the investments can be managed to try and achieve results consistent with the client’s needs, risk tolerance, and time horizon.

[This is David now.] He also has a wonderful talk he gives, Everything I know about investing I learned in court.

Since we fit all his criteria, we loved his analysis and sincerely hope his way of thinking spreads.

While Financial Foundations is intended primarily for our clients, we are happy to expand our readership so feel free to pass this along.

We have clients nationwide; if you know someone we may be able to help with their financial planning and wealth management, we would be happy to have a conversation. Please feel free to pass along our contact information.



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