Many students, residents, and physicians wonder about the process of choosing a financial adviser.  In many respects, the process is similar to choosing your physician.  There are no rigid guidelines, the personality fit can be key, expectations need to be realistic, you should avoid the bad apples, and by the time you know enough to choose properly, you may not need one at all.  These 12 guidelines should help you make your decision.

1)  Consider whether you need an adviser at all.

Many successful investors, including physician investors, draw up their own financial plans, do their own taxes, and manage their own investments.  This has several advantages.  First, you avoid paying the fees associated with paying someone else.  In investing, unlikely most of life, you get (to keep) what you don't pay for.  Second, there are fewer surprises because you are intimately involved with the process.  You're not going to “Bernie Madoff” your own account.  Lastly, since you are intimately familiar with your financial plan, taxes, and investments, you can make decisions on the fly that are most beneficial to your portfolio, rather than waiting to meet with your planner.  A successful investment plan need not be complicated, as you can see from my previous post, The Default Portfolio.

2) You need to understand how your adviser is paid.

This helps you understand his conflicts of interest.  There are basically four models:

Commissions

The first is a commission based model.  The adviser gets paid when he sells you a product.  These commissions can range from 3%-8% of the amount invested in a mutual fund (a “load”) to 50% or more of the first year of premiums for a life or disability insurance policy.  The obvious conflicts of interest are that the more you buy and sell, the more the adviser makes.  Also, it is in the adviser's best interest that you pay the highest loads possible.  An adviser (or more typically, his company) may also get “soft money” in addition to the load to offer particular mutual funds to an investor.  This, of course, all comes out of your pocket.  This type of adviser also has the incentive to sell you expensive, complicated investments, such as variable annuities, privately traded REITs or Master Limited Partnerships and cash value life insurance.

Assets Under Management Fee

The second is an assets under management (AUM) model.  The adviser gets paid 0.25%-2% of your portfolio a year.  These advisers tend not to take you on as a client until you reach a certain level of assets, usually from $100K-$1 Million.  This does you little good when you really need the advice, such as educating you in the beginning, developing a financial plan, acquiring appropriate insurance, and selecting your first few investments.  Conflicts of interest are fewer than in the commission-based model, but still present.  At least the adviser is interested in seeing your portfolio grow, because as it gets bigger so does his take.  The adviser, however, is more likely to recommend against anything that would decrease the size of the portfolio, such as appropriate levels of retirement spending or even alternative “investments” such as paying down your mortgage.  The other issue with this method of compensation is that it really doesn't take any more work to manage $1 Million than $100,000, so as your portfolio size goes up, your adviser should offer a break.  Perhaps 1% on the first $500,000, 0.5% on the next $500,000 and 0.25% after that.

Hourly Fee

The third is an hourly-based model.  The adviser is paid for his time, like an attorney.  This is a difficult business model for an adviser because of the lack of a steadily growing stream of income and because investors don't like seeing just how much advice costs (the above models are much better at hiding it from you) and so it can be difficult to find an hourly fee-only adviser.  Conflicts of interest include working slowly, withholding information so more visits are required, and making things overly complicated so they require more time.  In addition, it introduces the factor that since each time you get advice it costs you money, you are less likely to ask questions that could save you money in the long run.

Annual Retainer or Flat Fee

The fourth model is a flat-fee model.  You pay one flat fee each year for all the advice and services you need.  This is a particularly uncommon model, at least used alone without being combined with one of the other models.  The conflicts of interest include the adviser trying to avoid spending time on you and your account, since he gets paid the same no matter how much work he does for you.  This could cause him to use an overly simplistic portfolio, neglect tax-saving strategies, fail to educate you appropriately etc.

Advisers like to use the terms fee-based and fee-only to confuse the picture.  Fee-only means there are no commissions.  The advisor makes money only from you, whether you pay hourly, annually, or as a percentage of AUM.  Fee-based means that you pay a fee and then in addition, the adviser makes money off commissions too.  Just because an adviser collects a flat fee each year, doesn't mean he isn't making commissions off the recommended investments.

3) You need to understand how much the advice is really costing you. 

For instance, if your investment fees total 2% of your portfolio a year, that's the equivalent of your investments earning 2% less a year than they otherwise would.  Thanks to the miracle of compound interest, that adds up to a lot of money over your lifetime.  Consider two investors who invest $20,000 a year over a period of 30 years.  Both have investment portfolios that earn 6% after inflation a year.  One pays 2% to an adviser.  After 30 years, the first investor has $1.58 Million.  The second investor has only $1.12 Million, 29% less.  Over the years, that advice cost the second investor $460,000, or over $15,000 a year!  That's almost as much as he was investing!

financial advisor

4) You need to understand that designations can mean very little.

When it comes to credentials for a financial adviser, there are dozens and dozens of credentials, and the minimum requirements are almost nothing to get some of these letters behind your name.  Medicine can be a little confusing with designations such as MD, DO, DC, ND, PAC, RNP etc, but that is nothing compared to financial advising.  Most physicians wouldn't go searching for a doctor for their family and accept the designation of DC, but for some reason they are just fine with a financial adviser who has the designation RIA (registered investment adviser.)  Never mind that the chiropractor spent years learning his craft and the RIA may have spent less than a week.  So which of the hundreds of designations mean something?  CFP (Certified Financial Planner), CFA (Certified Financial Analyst), ChFC (Chartered Financial Consultant, an insurance designation similar to CFP) and CLU (Chartered Life Underwriter, an insurance designation). Each of these requires at least a year of coursework and many hours of examinations.  If an adviser doesn't care enough about his career to earn at least one of these designations, you need to look elsewhere.  Note that although one of these designations should be considered minimum adequate training, they are not sufficient to ensure quality advice.

5) Realize that 95% of advisers out there are not very good, and many are likely to be harmful to your financial health. 

Unlike in medicine, where a basic level of competency is generally present and most doctors are very qualified, most financial advisers are crappy.  If you haven't yet read my post on What Advisers Think About Doctors, you may find it eye-opening.  You should also realize that most advisers, even those who carry the weighty certifications discussed above, may demonstrate an appalling lack of knowledge of what actually works in investing.

6) You should know that most financial advisers cannot take care of all your financial needs. 

There are very few financial advisers who can help you with financial planning, insurance, investments, taxes, and estate planning.  Even if they do consider themselves qualified to help you in all these areas, they may be a jack-of-all-trades and a master of none.  You actually might be better off having 5 different financial advisers:

  1. An hourly fee-only adviser to help you develop an overall financial plan
  2. An insurance specialist to help you get adequate life, disability, liability, and property insurance
  3. An investment manager to manage your investments
  4. A certified public accountant to help with your taxes and
  5. An estate-planning attorney to help with wills, trust, estate plans, asset protection etc

When you realize an adviser may only be helping you with one of these needs, you'll see just how high fees can get!

7) You need to have a realistic view of what an adviser actually does. 

An adviser's role is not to help you beat the market or to predict the future.  He cannot do this anyway, although he may believe he can, and might even try to convince you he can.  (You should avoid an adviser who claims he can through security selection or market timing.)  An investment adviser's role is to help you set up an adequate investment plan, maintain the investment plan, to know when significant tweaks should be made to the plan (hint: they should be made rarely and with a great deal of thought, generally in reaction to changes in your life circumstances, not changes in financial markets), and mostly, to help you avoid shooting yourself in the foot.  Managing YOUR non-productive financial behavior is the biggest benefit of a financial adviser.  Unfortunately, those who don't believe this don't hire advisers and those who do don't need advisers.  Although 1% a year is pretty expensive for investment advice, if he can keep you from selling out at the bottom of a bear market like 2008, he'll have earned his fees.  The best planners do this not just by hand-holding during crises, but by designing an appropriate plan in the first place!

8) Your investment adviser should have access to DFA funds.

DFA funds are passively managed funds similar to index funds with a great long-term track record and a sound theoretical basis.  They are generally not available to individual investors without an adviser.  They cost a little more than typical index funds but are probably worth it.  It is not clear that they are worth the additional cost of an adviser JUST TO GET THE FUNDS but if you are hiring an adviser anyway, you might as well get “DFA Access” at the same time.  Likewise, you don't want an adviser that is wedded to a particular company.  If an adviser works for Edward Jones, guess whose investments he's going to recommend?  Anyone managing your investments should be able to invest them with any firm, not just his own.  Watch out for conflicts of interest, some advisers get paid more by their company to get you into their own funds.

9) You should interview multiple advisers, and realize this is a business relationship, not personal. 

Don't hire your father's adviser or your brother-in-law.  It'll be much harder to fire them later.  You should also check with regulatory authorities to see what kind of complaints have been filed against your adviser and his firm.  You can check this out on the FINRA site, or the SEC.  You might also check with state authorities and the Better Business Bureau.  Just think about what you would do if an adviser screwed you.  Who would you complain to?  Check with them.  Ask for references also.

10) Realize that just because you are a do-it-yourselfer, doesn't mean you need to be a rabid DIY-er. 

You can always get financial advice a la carte.  You can manage your own investments, but still pay a CFP to help you develop an overall financial plan and pay a CPA to do your taxes for you.  You can also get a second opinion about your financial plan.  You have to hire an insurance agent to buy an insurance policy, but you would be well-advised to know what you want before you walk into his office, lest you walk out with an expensive cash-value insurance/investment hybrid plan like whole life insurance.  Many mutual fund companies such as Vanguard will have a CFP do this for a low fee, or even free if you have enough assets with the company.  If you set up a simple plan, you might only need financial advice every year or two.  Paying 1% of your portfolio a year is an awful lot when you only need an hour of advice every 5 years.

11) Remember that hiring an adviser doesn't absolve you from all responsibility to know about financial subjects.

This is still your second job, whether you like it or not, even if you hire someone to help you with it.  You'll still need to read at least a handful of books on the subject and keep up with new developments over the years.  A good adviser will provide you with some education, but you still have to know how to speak their language.

12) Being a specialist in advising physicians doesn't mean much. 

Lots of advisers “specialize” in physicians because they think, like most of America, that M.D. means mucho dinero.  While there are a few unique things about the financial life of physicians (late start, lots of student loans, highly specialized, rapid increase in income upon residency completion etc), most of their financial needs are the same for them as for anyone else.

What has been the most effective way you've acquired financial advice? Comment below!