Earning your trust is big business. This has become even more poignant with the maturation of the Internet. Now, more than ever, you as a consumer have gained incredible power over businesses simply by being able to access large amounts of information about them. Consumers have become more skeptical over decades of being bombarded by advertising and lured by empty promises. One of the worst offenders is the financial industry, which excels at making investments looks attractive, only to disappoint after you sink your money into them. With all this “noise”, how do you find a financial advisor you can trust?
Below are four criteria that can help you to determine how trustworthy a financial advisor may be.
1. He/she commits to putting your interests before his/her own
There are various standards against which you can measure an advisor’s ethical position; one of which is how stringently they are committed to acting in your best interests. In fact, most Canadian financial advisors are not legally bound to any obligations stronger than satisfying their “suitability obligations.” This is a fancy way of saying that they should take reasonable steps to ensure that the investments they recommend are a good fit for your needs. Where the slope gets slippery is when two investments might be entirely suitable for you, but one of them might be more expensive and more lucrative to your advisor. Under this standard of care, you advisor is free to present only the option that suits him or her best.
Portfolio managers are a group of financial advisors that are accountable to you on a higher level. These folks are investment advisors who are legally required to act in your best interest (much like a lawyer or an accountant). The phrase that describes this level of responsibility is known as “acting as a fiduciary.” The downside about having a portfolio manager is that they generally require a minimum investment of $500,000. If hiring a portfolio manager isn’t in the cards for you, you’ll have to pay close attention to how your advisor is compensated.
2. He/she tells you exactly how much you are paying for his/her services
It isn’t always easy to know how much money your investment advisor makes from the services provided to you. This is because the fees can be hidden right inside the investments recommended to you. The biggest culprits are mutual funds. Mutual fund fees, known as MERs, are a bundle of fees that often include your advisor’s compensation. The problem is that you have no way of separating those fees into their components because that information isn’t made available to the general public.
To make matters worse, you may also encounter the dreaded Deferred Sales Charge (DSC). Here’s how a DSC works: After selling you a mutual fund, your advisor can take an advance on his/her compensation from the mutual fund company who owns the fund. For example, he/she can receive five years’ worth of service fees in an upfront lump sum. The catch is that by doing this, your advisor has committed you to a five-year contract with the mutual fund company. This contract stipulates that if you want to sell that investment before the advisor’s advance has been paid off, you will be responsible for compensating the mutual fund company for the money your advisor received from them. The dubiousness of this type of contract is perhaps why DSCs have been banned in the UK and Australia, and why regulators in Canada are fighting the investment industry for greater transparency and disclosure to clients about the real costs of investing.
While it remains to be seen if regulators will succeed in banning DSCs in Canada, there are still other advisor compensation structures that are more transparent. Some advisors charge annual fees based on a percentage of your assets. With this method, your overall costs tend to be lower and they are clearly reported to you. More importantly, this compensation structure better aligns your advisor’s interests with your own. This is because their incentive is to earn a high return on your portfolio so that they themselves can earn more money. Because there is no hidden reason to sell you mutual fund “X” versus mutual fund “Y”, you end up with only the investments your advisor genuinely feels will work best for you.
3. He/she’s got solid credentials
There are over one hundred thousand people in Canada who describe themselves as financial advisors. In reality, their education, qualifications, and experience vary widely. The majority of advisers act more like salespeople for investment products. While some financial advisor courses can be as brief as a single weekend, there are some certifications that can take several years to complete and involve a more rigorous curriculum.
There are several highly credible Canadian certifications that you should check your advisor’s resume for. The most rigorous and respected of all investment management credentials is the Charted Financial Analyst (CFA) designation. There is also the Chartered Investment Manager (CIM) program, which is less intensive than the CFA curriculum, but places an emphasis on portfolio management.
In a slightly different category is the realm of financial planning. Financial planning differs from investment management in that it extends beyond investments to help you with tax planning, debt management, and retirement planning. The heavyweight designation to look for amongst financial planners is the Certified Financial Planner (CFP) designation. The “lighter” version of the CFP is the Personal Financial Planner (PFP). All of the aforementioned certifications and designations are given out by governing bodies that require that members adhere to a code of ethics.
4. He/she worries as much about risk as about performance
Some financial advisors may promise to earn you great returns on your investments. They may go on to show you samples of products and portfolios they can buy for you that have impressive performance records. However, what is often left unmentioned is the amount of risk that was taken to achieve those returns. A general rule of investing is that higher returns often come from taking more risks. So while it’s nice to see a series of large returns in a performance chart, you need to ask about the potential downside of those investments. If there’s a chance you could lose 30% of your portfolio’s value in one year, is that a risk you’re willing to take on a portfolio that averages a 10% return?
While good advisors try to manage your investments according to your need for returns, great advisors understand what’s realistic given your life circumstances, and openly discuss with you the risks associated with choosing a particular investment before taking any action.
A relationship based on trust
Be not afraid: there are many thoughtful, hardworking, and ethical financial advisors out there. They take their time to get to know you, and they build a portfolio according to your needs of comfort and security. While the market may be emotionless and amoral, it is the trusting relationship that you build with your advisor that brings life to an otherwise dull process.