Vance Barse AIF®, Wealth Strategist

Think of all the wisdom you’ve gleaned in your career from years of hard work, sacrifice, and dedication.  Now consider what you’ve learned about your profession simply by being in it.  You know, the good, the bad, the ugly.

For nearly a decade, I served as an investment consultant to leading financial advisors around the country.  During that time, I learned a lot about financial advisors, the banking system, and the financial services industry.  I’m here to provide insight that I believe will help you decide what kind of advisor you should work with.

Advisors are not all the same: who you have serving you can make a big difference in achieving your goals.  The relationship you have with your advisor should be about more than “just” trust or the name on the door.  I offer some guidance that can go a long way in helping you avoid some of the common planning gaps left behind by many advisors.

I’ll cover:

● Do you know the standard to which your advisor is being held?

 ● Do you know how much your advisor is really charging you?

 ● Is your advisor bridging the gap between the tax and investment worlds?

 ● Comprehensive planning – what it means and why it’s important to you

 ● How to choose the advisor that’s right for you

In the transition from consulting advisors to becoming a wealth strategist directly serving individuals and families, I’ve observed five common financial planning myths.  Choosing the right advisor is a big decision, as I’m sure you know.  You owe it to yourself to make an informed decision.

“Life is what happens while you are busy making other plans” – Allen Saunders.  Learn about why I transitioned from consulting advisors to becoming one:

Myth #5: I pay no fees at firms like Fidelity, Vanguard, or Schwab.  Reality: probably not.

We’ve all seen the commercials: free trades = good, fees = bad.

It’s not so simple and may not always be true. There are actually three levels of costs in the advisory and investment business:  1) investment cost 2) administrative cost 3) advisory cost.

1.      Investment Cost

This what you pay for the actual investments themselves, such as a mutual fund, exchange-traded fund (“ETF”), or stock.  It’s important that we take a moment to note the difference between active management and passive management.

In active management, you pay a portfolio manager to select the underlying holdings, stocks or bonds, in the portfolio they are managing.  Mutual fund managers are often “restricted” to a certain style box, such as large-cap growth or mid-cap value, and cannot deviate from their investment mandate.

In passive management, you buy the actual index, such as the S&P500, via an ETF, often at a much lower cost than what active managers charge.  In addition to their low cost, the intrigue behind ETF investing is that, over longer periods of time such as a decade or more, index ETFs have often historically outperformed active managers.

Investment cost can vary and will be understandably higher in special situations.  Consider emerging and frontier markets.  It may be worth paying the additional cost for an active manager who is familiar with the geopolitical environment, local currencies, industrial landscape, etc.

Investors should also be aware of the terms “beta” and “alpha.” Beta is the return of a market index, such as the S&P500.  Alpha is simply the additional return that an active manager seeks to provide over the index.  If an actively managed mutual fund that costs more than an ETF is outperforming the index, this manager is said to have provided alpha, and this may be worth the additional cost.

Active managers also provide value in strategies that seek to anticipate market downturns, thereby minimizing extreme volatility in a portfolio.  You’ll notice that in bull markets, such as the one we’ve been in for the past 10 or so years, investors tend to rush into passive index funds because of low cost and performance.  When markets turn down, historically investors seek active managers who can customize portfolios and strategies that may perform better than index funds.

Some investors appreciate active portfolio management in all market cycles, other investors prefer passive portfolio management, and some investors find value in blending the two. What we’ve seen, time and again, is that there’s no predicting the markets.

2.      Administrative Cost

There are various administrative fees, such as annual custodial fees and trading costs, that can diminish portfolio returns.  I get a kick out of the free trade enticement of the self-directed account commercials.  They imply that everyone who can open an account is qualified to do their own trading.  Nearly everyone can, but whether everyone should is open to debate.

Administrative costs in a self-directed account: if you’re a do-it-yourselfer, you’re probably using a platform that has competitive trading fees.  If you have significant assets with an institution, you may be able to get the trading fees waved or get a certain number of free trades per year.  For most of us, though, there’s a cost per trade.

Administrative costs in an advisory account: in this type of account, you’ve hired someone to manage your portfolio (be sure to read Myth #3, below, on the 3 common types of advisory accounts).  It may be a person, such as an advisor, or it may be an institution, such as Fidelity, Vanguard, or Schwab that allocates your portfolio to their model. Sometimes you can speak to an employee regarding your account.

Some institutions advertise portfolio management for a lower cost than hiring an advisor.  Be careful.  You may not get the additional services and strategies that can benefit you.  Consider hiring a qualified advisor, if only to review your profile.

3.      Advisory Cost

This is the compensation you pay an advisor or firm to advise on products and services, which may include investment management, financial planning, estate planning, and risk management, such as long-term care, disability, life insurance, etc…

There are four cost models for financial advisors: a) commission, b) percentage of assets under management (“AUM”), c) flat fee per year or project, and d) by the hour.  The model you choose should depend on your planning needs and investment objectives, and ultimately be in your best interest.

A) Commission basis – e.g., A-share mutual funds, where the advisor earns an up-front commission, often starting at 5.75%, and a trail commission of 0.25% that starts in year two.  This is common for so-called brokers.

Pro: if you have a long-term investment horizon, a decade or more, and don’t need much planning, hiring an advisor on a commission basis may cost you less over the long run.

Con: advisors who charge commissions may be incentivized to “make the sale,” but may not provide the additional advice and planning strategies you need.  Commission-based advisors are compensated with a lower “trail commission” that may not be enough of a financial incentive to tweak your portfolio as economic conditions and your investment objectives change.  Another consideration: if a mutual fund you own underperforms and the advisor wants to invest in a mutual fund offered by a different fund family, you’ll have to pay another upfront commission.

B) Percentage of your assets under management (“AUM”) – e.g., 1% of your account balance over the year, billed at 0.25% per quarter.  This cost usually drops on a graded scale the higher your investable assets are: for example, someone with $1,000,000 may pay 1% for fully comprehensive financial planning services while someone with $20,000,000 may pay 0.50%, or one-half of one percent.

Pro: this model removes the potential conflicts of interest when commissions are involved.  Additionally, the advisor’s compensation is tied to your account value; so, in theory, the advisor is motivated to provide you with sound portfolio management and the planning strategies that are unique to your profile.

Con: advisors who charge a percentage of your assets under management may arguably be charging you too much if what they are ultimately providing you is portfolio management and not implementing the planning strategies for which you are eligible. See the section: Comprehensive planning – what it means and why it’s important to you.

C) Flat fee – e.g., like an attorney’s retainer, which is common for fee-only financial planners and/or advisors who offer project work like estate planning, tax planning, and advanced strategies for business owners, such as cash balance plans.

Pro: assuming the advisor is providing you with the full range of financial planning services, you remove the potential to pay more to the advisor as your account value grows over time.  For some, there is also the preference to compensate an advisor on an annual or per project basis independently of the size of their investable assets.

Con: advisors who are compensated by a flat fee may not be incentivized to work for as many hours as they usually would because they have already been paid.  Also, if your account value goes down during a recession, from withdrawals, or both, the advisor is technically being compensated at a higher rate because the planning cost remained the same as your account went down in value.

D) By the hour – could be $75 to $250 per hour depending on the advisor’s expertise and the complexity of your needs.

Pro: if you’re a do-it-yourself investor who has the time and aptitude to manage your portfolio effectively, perhaps you want to spend some time with a qualified advisor to have a second look and evaluate if there are planning strategies that you may not be aware of.  The peace of mind may be worth the cost.

Con: advisors who charge by the hour may be incentivized to have more billable hours (as with #3 above, my counter to this is simply: pick an honest, transparent fiduciary, and ask that they document their time).

Now that we’ve reviewed the compensation models, what’s an investor to do? 

Robo advisors: So-called “robo advisors” are computer-based platforms that provide automated, algorithmic investing and financial planning services.  The intrigue of robo advisors is their low cost – because, after all, free trades = good and fees = bad, right?

I remember when robo advisors came out just a few years ago.  Many believed that financial advisors would die on the vine (this may still be the case, but it’s because of their age), actively managed mutual funds were a thing of the past, and ETFs were the future of investing.

Financial advisors who charge 1% and only provide portfolio management (or worse, outsource the portfolio management at an additional cost), I hope you’re paying attention: robos are your biggest threat.  The one thing that robos don’t provide well is that one thing that, despite the “social” media world in which we live, we humans still long for, and that’s the human connection.  Is a computer program or robo advisor employee whom you’ve never met in person going to understand the intricacies of your family, your core values, your desire to circumvent heirs fighting over your assets, and your tax returns; give you a hug at the end of your planning meetings; and, work alongside your CPA and estate planning attorney?

My personal opinion: the true cost of not hiring a qualified advisor could potentially be more expensive than hiring one.  Your financial picture is more than just investments.  The question to ask is not “What are your fees?” – this is like walking into the grocery store and asking the same question of the store manager.  The questions to ask are, “Based on your review of my full picture, what are my true planning needs, how can you add value, and what will it cost?”

Remember to ask the advisor to delineate fees in writing and, if you’ve narrowed it down to two or three advisors who are charging the same, consider hiring the one that offers the most strategies with the goal of bringing the greatest value.  If one advisor charges a bit more but is the most qualified from a strategy standpoint (not just age or credentials, see Myth #4, below), it may very well be worth the additional cost.

Recent market volatility got you down?  Learn about three strategies I’m using to navigate volatility by reading this Think Advisor article.

Myth #4: Financial advisors are all the same.  Reality: experience and expertise can make a big difference.

There’s a big difference between experience and expertise.  Many of my former financial advisor clients had decades of experience doing the same things, but don’t necessarily have a broad range of expertise.  Conversely, I consulted financial advisors who had the expertise by way of credentials but didn’t have much experience in practice.  Knowing the difference is part art and part science. My thoughts:

Let’s begin with advisor accountability.  Remember, this is your money and your financial future. While financial advisors are in the business of being personal, the relationship you have with your advisor is founded on business.  It’s OK to hold your advisor to a high standard – or, find a new advisor who can serve you better.  If your advisor hasn’t implemented the services and strategies that a more qualified advisor can, what else isn’t your advisor doing?

Have you ever seen the Certified Financial Planner commercial in which the clean-cut guy who gets positive feedback from potential clients then reveals at the end of the commercial that he is actually a disc jockey with dreadlocks and has no financial experience whatsoever?  You can find it by searching “CFP DJ commercial” on YouTube.  I had many CFP advisors as clients in my former career and can tell you that they don’t always implement the full range of financial planning strategies and services for which their clients are eligible.

People may rave that their advisor is the largest producer at a well-known firm, manages a ton of money, and has lots of awards in their office.  It’s impressive.  Having consulted many advisors who manage large amounts of money, I can share that managing more doesn’t necessarily mean being more qualified. It simply means they manage a lot of money.  Some of those awards are production level awards given by product sponsors.  Other awards are provided by their firm for reaching certain asset management levels.  In other words, these awards are recognition for sales, not necessarily for bringing value to their clients.

My personal opinion: if your advisor doesn’t use your tax returns as the basis for your planning, it may be time to find a more qualified advisor.  Credentials can help, but they don’t mean the advisor is going to offer you more services and strategies than someone with both experience and expertise.  Either way, consider hiring a true fiduciary.

Myth #3: My advisor personally selects all my investments.  Really?

If you’ve had a financial advisor for several years, you’re likely happy with your portfolio performance.  After all, what’s not to like about the stock and bond markets since the Great Recession of 2008?

Let’s dig a little deeper into how your advisor may be selecting your investments, which generally depends on his or her compensation model (see Advisory Cost in Myth #5 above).

Before we jump in, here are a few thoughts to consider about the management of your portfolio:

● Some advisors outsource portfolio management to a third party, which may be at an additional cost to you.

● Some advisors use model portfolios provided by their home office, which may be at an additional cost to you.

● It’s extremely rare for an advisor to consistently outperform “the market” over long periods of time.

4 types of portfolio management

Your advisor likely manages your investments in one of four ways.

1) The brokerage model wherein your advisor gets paid a commission.  This is the “classic” (some would say: “old school”) brokerage model where a broker sells you a commission-based mutual fund, stock, or bond.  Under this model, your advisor is generally selecting the individual investments in your portfolio.

2) The advisor-managed account in which your advisor manages your portfolio using portfolio models that the advisor creates using their own research and/or research provided by an independent third party or their home office.  Some advisors will offer to pay your trading costs depending on their service model and the amount of money you have with the advisor.

3) The “home office” model may go under different names because various firms have different names for them.  In this type of account, your advisor places your money into a portfolio managed by the research team in their home office, usually at an additional cost.  Some firms, for example, may charge 0.25% for this in addition to what your advisor is charging for his or her advisory services.

4) A separately managed account or “SMA”.  In an SMA, your advisor outsources the management of your portfolio to a third party.  This often comes at an additional cost (sometimes as much as 1%, I might add), but your trading fees are typically covered by the SMA manager.  If your advisor suggests an SMA for your non-qualified dollars (that is, with after tax money that you decide to invest), be sure to understand the tax implications of this type of account.  Remember, there are tax implications when you buy and sell in a non-qualified account, so you’ll likely want an SMA that does some level of tax loss harvesting.

My personal opinion: ask your financial advisor to confirm in writing how your investments are selected and the tax efficiency of your non-retirement (after tax) portfolio, if you have one.  You may want to have your CPA review the tax efficiency of your non-retirement holdings. 

Do you donate cash to charity or have a frustrating tax bill every year due to capital gains?  Learn tax reduction tips and tricks in “Closing the Gap Between Investments and Taxes”.

Myth #2: My advisor claims to be a fiduciary and therefore is acting in my best interest.

It’s official: the Department of Labor’s proposed Fiduciary Rule is dead.  The proposed rule would have required financial advisors to serve as fiduciaries for retirement assets, such as 401(k)s and IRAs, but did not apply to non-retirement assets, which are investments made with after-tax money.  While many advisors in the community are disappointed that this rule did not go into effect (and others are jumping with joy), the highly publicized rule heightened investor awareness of what it means to be a fiduciary.

So, how do you know your advisor is only doing what is in your best interest?  I encourage you to start by looking for potential conflicts of interest that your advisor may have. Some things to look for:

Ask your financial advisor about relationships with product sponsors, also known as “wholesalers”.  Wholesalers are hired by an asset management firm to get financial advisors in their territory to use their company’s products for their clients.  Wholesalers are the investment industry’s equivalent of pharmaceutical sales reps.

An acquaintance who I’ll call Teddy was recently raving about a wonderful presentation and free steak dinner he enjoyed at Ruth’s Criss after receiving an invitation in the mail from a local financial advisor.  I asked if he knew who paid for the dinner and whether the speaker was a wholesaler for the firm whose product (in this case, an annuity) the advisor was suggesting dinner attendees purchase.  He called the advisor, asked a few due diligence questions, and learned that the wholesaler paid for the entire dinner on behalf of the advisor who was recommending the annuities provided by the company for which the wholesaler works.

This situation isn’t necessarily bad—if the annuity is in the best interest of Teddy, then that’s a suitable recommendation—but the fact that it wasn’t disclosed that the dinner was being paid for by the company whose product the advisor was recommending was frustrating in hindsight for Teddy.  Furthermore, he wished he had known about the different kinds of annuities that are out there.  Some wholesalers can add tremendous value for advisors by way of education on products and economic and market insight.

My personal opinion: Google “FINRA broker check” to research your current or prospective advisor and request that the advisor confirm in writing what potential conflicts of interest may exist.

Myth #1: My advisor does comprehensive planning.

This is undoubtedly the number one misconception I encounter. When I transitioned from my role of consulting financial advisors to becoming an advisor, I was truly surprised to see how the general public views financial advisors as all the same.

Some financial advisors may only offer insurance or investment products, not necessarily both, and some that offer both may not offer estate planning, tax alleviation, and other strategies.  Understanding your true financial planning needs can help you select the right advisor for your particular situation.

If I only had a nickel for every time I’ve heard, “Oh, you’re a financial advisor – yeah, I have someone for that. He does it all!”  With a few casual questions, though, I can get a pretty good sense of whether their advisor is, in fact, doing a great job given their situation.

Here are some typical questions I’ll ask:

*Does your advisor work with your estate planning attorney to develop your overall planning strategy and help minimize the potential for your heirs to fight over your estate?

*Does your advisor ask for your tax returns and demonstrate how they drive the development of your overall financial plan?

*Does your financial advisor work with your CPA to implement possible tax alleviation strategies that could reduce your tax burden?

*Are you one of the “lucky” business owners whose net worth is tied up in your business and real estate and you’re not sure how a financial advisor can add value because you don’t have liquid investments?

*Given current valuations of stocks, real estate, and yes—even bonds—has your financial advisor spoken with you about investment strategies that have historically helped reduce downside risk in periods like the Credit Crisis of ‘08 or the Tech Wreck of ‘00 – ‘02 (assuming capital preservation is part of your objective)?

*During your annual review, does your financial advisor have you complete an investment questionnaire to evaluate the extent to which your risk tolerance and investment objectives may have changed?

*How do you compensate your advisor for the products and services you’re getting?

 My personal opinion: financial advisors often use the phrase “comprehensive financial planning” and don’t really provide the full range of services that can benefit you most.

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 D. Vance Barse AIF® (CA Insurance #0L70885) is a registered representative and investment adviser representative with and offers securities and advisory services through Commonwealth Financial Network®, A Registered Investment Adviser, member FINRA/SIPC.  Advisory services offered by Manning Wealth Management are separate and unrelated to Commonwealth.