None of the following should be construed as investment advice or as a recommendation to buy or sell a specific security. Consult a financial professional prior to making investment decisions.
When a person agrees to hire a financial advisor, typically they believe they're hiring an investment expert who knows the ins-and-outs of financial markets. Unfortunately, that's not always the case. Some advisors are primarily insurance salesmen, and they spend relatively little time thinking about investments in general. Others are financial middlemen who connect their clients to investment professionals instead of doing the work themselves. Still more are mainly salesmen and relationship managers who spend the vast majority of their time out looking for clients, not analyzing investments. The bottom line: Your fee might not be paying for the investment expertise you expected.
Think this is outlandish? A study from a respected industry publication found that the typical advisor spends only 5.5 hours per week working on investment-related tasks, while 23.1 hours each week went to finding new clients or meeting with current ones. That means the average financial advisor spends more than four times the amount of time trying to get or keep clients as they do working on investment management!
So how do you know if your financial advisor is actually an investment expert or just trying to look the part? Here are 7 signs that you might not be working with an investment expert.
#1: Your Advisor Outsources Your Investments
Some advisors either don't want to work with investments or believe they won't succeed at it, so they don't even try. Instead, when you hire them to oversee your accounts, they turn around and outsource the investing to an outside firm. Often that means using what's known as a TAMP, which stands for Turnkey Asset Management Platform. TAMP's are investment firms that primarily provide outsourced investing for financial advisors, so that the actual investment decisions are not being made by the advisor, but by the TAMP's staff members. Often, when you initially sign up with an advisor who uses a TAMP, you'll sign paperwork for both the advisor's firm and the TAMP, giving both companies access to your accounts.
Not only do some investors find it unsettling that their advisor isn't actually managing their accounts, but some take issue with the fee arrangement in this scenario. Since the advisor isn't performing the investment management, they're charging a fee to play the role of a financial intermediary, connecting you to someone who actually has the expertise you're looking for. That raises the question of whether the advisor's share of the fee is justified or you'd be better off working directly with an investment management firm without that advisor involved.
#2 Your Advisor Uses Annuities or Life Insurance as a Bond Alternative
Don't get us wrong: there's nothing wrong with life insurance or an annuity in the right context. But fundamentally, these are insurance products, not investments. At their core, they're meant to protect you against a risk, not function as growth vehicles. Some insurance agents or fee-based advisors (which are VERY different from Fee-Only advisors) fall in love with the commissions these products tend to give them, so they look for opportunities to sell them to their clients. Often that means telling their clients that the portion of their account that would normally go to fixed-income (or bond) investments would be better put to use in an annuity or life insurance contract.
Unfortunately, this can be a sign that the advisor doesn't understand risk management in an investment portfolio. Rather than doing the hard work of finding ways to limit the downside of a bear market, these advisors are letting an insurance company do their risk management for them, often at the cost of high expenses and mediocre growth for their clients.
#3 Your Advisor Has Irrelevant Certifications (Or None At All)
Advisors love designations, not only for the information learned, but also because it signals to clients that they're an "expert" at something. But not all designations are created equal, and some signal that you're working with someone who doesn't specialize in investments. For example, the CLU designation primarily pertains to selling life insurance, so working with someone with the CLU designation likely means listening to someone pitch you a life insurance policy.
Additionally, some designations have lower requirements and are easier to get, and financial advisors know this. A quick and easy certification process means getting letters after your name faster, and some advisors count on their clients not knowing the difference. In fact, one common advisor certification doesn't even require a college degree. Many investors would be shocked to know that their advisors' certifications don't actually pertain to the need they originally sought help for.
The gold standard for financial planning is the Certified Financial Planner®, or CFP, designation, and for investing, it's the Chartered Financial Analyst designation. Someone with one of these designations has displayed mastery of important investing principles in order to get their certification.
#4 Your Advisor Invests Based on His Gut or Feelings
Early in my career as an advisor, I remember hearing an older advisor say something like, "I like to include investments in [a particular industry] because I feel like it's going to keep expanding." No analysis. No data. Just a feeling that it would grow. I would argue that this probably isn't the kind of investing his clients were hoping for.
Investing without a process isn't investing. It's gambling. Your advisor should have defined frameworks for when and why they choose both to enter and exit a particular investment. If they don't, they're left riding the waves of emotion, which can have disastrous consequences. In up markets, they can slowly become more aggressive, and if the tide ever turns, you can be left with outsized losses. And in a down market, they can become overly cautious out of fear, which means you might miss out on the rebound.
#5 Your Advisor's Clients Are All Invested Differently, Even If Their Situations Are Similar
Investors with different life circumstances and different risk tolerances shouldn't be invested the same. That should be pretty clear to the average investor. But if the same advisor is working with similar families in similar situations, but their investments are very different, it could be a sign of one of two problems.
The first problem is that the advisor may not have a defined framework for choosing investments. Every time they select an investment portfolio for a client, they are starting over on how they think about investments. One day, higher returns might rule their thinking. Another day, less risk might be the priority. Yet another day, management style might be the most important factor. As an investor in this situation, your portfolio is being heavily influenced by the whims of your advisor on the particular day they looked at your accounts. Which obviously isn't good. You want an advisor who's thought through the most important facets of portfolio construction before they started reviewing your portfolio, and who uses the the same process each time they make investment decisions.
The second problem is that the advisor may not have a plan for reviewing accounts. When you hire an advisor, you're paying them to oversee your accounts so you can be free to focus elsewhere. But sometimes advisors get busy (particularly if they're mainly spending their time looking for more clients) and don't have time to review your portfolio on the consistent basis you'd like. Or if they are reviewing your accounts, they may not have a process set up for when to pivot from an older investment. As in investor, you could be left with the same investment lineup even if your advisor is no longer recommending those investments to the new clients whose portfolios are more at the center of his or her attention.
#6 Your Advisor Can't Explain His Investing Philosophy
And no, statements like "Stocks are more aggressive; bonds are more conservative," don't count. Those are investing basics that should be understood by even novices, and aren't a sign that your advisor knows what he or she is doing with your accounts. Your advisor should be able to explain the view they take of the investing universe, and there are several. At a very basic level, there are two schools of thought. A "Fundamental" investor concerns themselves with discerning the intrinsic value of a given investment. If the price is lower than the intrinsic value, they purchase. If the price is higher, they sell. A "Technical" or "Quantitative" investor, in contrast, tracks what investments are rising or falling and attempts to profit from whatever price movements are already happening. They don't attempt to explain why those movements are happening or whether the investments are at an appropriate price, only that they are rising or falling. Both Fundamental and Technical approaches are valid, and experienced advisors should know how to execute their philosophy well. Your advisor should know and be able to explain exactly what approach they're taking with the money you're trusting to them.
Similarly, your advisor should be able to put into words the detailed process they use to decide exactly what investments will be in your portfolio. Too many advisors haven't systematized their investing approach, so there is no consistency behind what investments they choose for their clients. When advisors don't have a disciplined investing process, they're left investing their clients' money based on whatever inclination has their attention on a given day. That can mean shifting back and forth from overly aggressive to conservative and back again, or "changing their minds" on various strategies from day to day. Even at its best, lacking a system for portfolio management means having difficulty analyzing and learning from prior management decisions, meaning they'll have a tough time perfecting their approach.
#7 Your Advisor Invests In Whatever Had the Highest Return, Without Regard for Risk
One of the most fundamental flaws in investing is called "recency bias." It means that people are susceptible to believing that whatever has happened most recently is likely to continue happening in the future.
Particularly in rising markets, advisors can be guilty of slowly edging their clients' portfolios more aggressive. If it has been a while since the last downturn (or if the advisor is somewhat inexperienced), the focus can slowly shift away from risk management and more toward what generates the most return. But the most crucial time to have an experienced investment manager is when things are going badly. It's easy to generate returns when the whole market is up. It's more difficult to stave off losses when the market turns south.
If your advisor is only considering those investments that have the highest return in the last period, he or she is ignoring the built-in risks in the portfolio they're recommending. Believe me, I've seen portfolios that were poorly constructed because the advisors behind them failed at doing their due diligence. A good investment manager should be looking at returns, yes, but also at fund holdings, strategy, geography, risk metrics, investment style, and a host of other factors that can reveal potential drawbacks to an investment option.
If you're considering hiring a financial advisor, know the signs that he or she knows what they're doing with your investments. Many financial advisors know how to look the part and meet clients, but fail at the most fundamental part of the job: managing your money. Make sure to do your homework and locate an advisor who understands investment management.
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