Comparison Shopping for an Investment Advisor

by Rick Kahler

Most of us comparison shop before any major purchase and most small purchases. Choosing the wrong investment advisor can cost you a lot more than overspending on the wrong car. Use these guidelines to compare investment advisors.

You can spot comparison shoppers a few aisles away at any retail store. They are the ones carrying articles from Consumer Reports, badgering the salesperson with a million and one questions. People who manage money well are usually big fans of comparison shopping.

If comparison shopping is important before choosing a new refrigerator or lawn mower, it’s even more essential before choosing an investment advisor. Unfortunately, there is no easily available consumer’s report on advisors. Even more frustrating, those selling financial products often have incentives not to be forthcoming with the information that is crucial for comparing advisors.

One aspect of shopping for an investment advisor is knowing what questions to ask. One common mistake is to focus on investment returns. Shoppers may ask for the average recent returns of the advisor’s portfolios or may want to know whether the advisor’s returns beat the market averages.

There are several problems with focusing on returns. First, the numbers mean nothing without also knowing how much risk the advisor took to produce the return. It’s like someone on a diet focusing only on fat grams without regard to total calories. Consuming ten soft drinks in a day may give you zero fat grams, but you could easily exceed your daily calorie limit before eating one bit of food.

Second, any unscrupulous advisor can put together a portfolio consisting of the hottest investment classes over the past 10 years and show you how fantastically they did.

Third, whether an advisor beats the market is overrated. Why? A whopping 97 percent of all mutual fund managers don’t generate an “average return” over 20 years. Just finding an advisor who has done so means you found someone in the top three percent.

Fourth, some financial advisors may show you a phenomenal track record for the short term (under 10 years). Since wise investing focuses on the long term, beating the averages over a short term isn’t necessarily significant.

If so many games can be played around returns, what questions should a savvy comparison shopper ask? Focus on one word: transparency. You want to find out if the returns, costs, and risk (standard deviation) of your portfolio will be clearly displayed and contrasted against appropriate benchmarks.

Here is how to accomplish that goal. Most advisors have model portfolios. Ask them to show you the standard deviation and the expense ratio of their model over five and ten years. Ask them to contrast the return of the portfolio against a similar benchmark. For example, if the portfolio has US stocks, US bonds, and foreign stocks, have them compare it to a benchmark of indexes proportionate to those asset classes.

Next, either ask the advisor to run a similar analysis on your existing portfolio or have one done independently. You may even have done better than the advisor’s model.

Ask the advisor to disclose all fees in addition to the expense ratios charged by mutual fund or sub-account managers. You need to find out how the advisor is paid and how much. Ask whether there are any wrap fees, transaction costs, administrative fees, mortality fees, redemption fees, annual 12b(1) fees, surrender charges, or up-front sales charges.

Don’t be surprised if you get a bit of resistance when you ask for all this information. Brokerage firms, life insurance companies, and many commission-based advisors don’t have much incentive to give you this data and may not even be able to.

If you don’t get clear disclosure on fees and costs, keep asking. If you persist and still don’t get understandable answers, you may need to do more comparison shopping before you choose an advisor.

• 7 Questions to Ask a Potential Financial Advisor
• Do You Need a Financial Advisor In Retirement?
• Do Investment Advisors’ Credentials Matter?

Reviewed January 2023

About the Author

Rick Kahler, MSFP, ChFC, CFP, is a fee-only financial planner and author. Find more information at KahlerFinancial.com. Contact him at Rick@KahlerFinancial.com or 343-1400, ext. 111.