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Choosing a Financial Advisor: Six Red Flags

Choosing a financial advisor – like choosing a doctor, dentist or other professional – is an important decision. Asking the right questions beforehand will help you find the right advisor. Click through for some of the red flags that you should watch for along the way.

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Choosing a Financial Advisor: Six Red Flags

Avoid red flags when choosing a financial advisor by doing your homework.

Marc Ryan publishes the web site, a source of free, independent investment information for Canadians.


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Six Red Flags When Choosing a Financial Advisor: Where Do I Begin?

When choosing a financial advisor, think about your needs and expectations, and visualize how your ideal financial advisor would meet them. Then start looking for candidates, interviewing at least two people.

Keep in mind that the term “advisor” has no precise legal meaning. Depending on the context, it might include a bank branch employee or an advisor with a full service broker; or, for larger accounts, an advisor with the private banking arm of a chartered bank, or with an independent investment counseling firm.

Red Flag #1: Before retaining an advisor, check the range of products he or she is qualified to sell. Investors may expect their advisor to consider the full range of investments. However, if you are using an advisor who can only legally sell one type of product (such as mutual funds), or who only sells products promoted by his employer, conflicts may arise.

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Selecting the Right Money Manager and Avoiding Mistakes

Discount brokers, whether independent or owned by big banks, offer execution services on a cost-effective basis. If you know which investments you wish to make, a discount broker may be right for you. But if you need personalized advice, this is not the place for you.

Other investors feel comfortable managing their investments alone, but want access to strategic financial planning advice from time to time. The most common example is determining what percentage of your investments should be shares or bonds.

Red Flag #2: Many financial planners propose waiving any upfront fees, provided they subsequently manage your portfolio. It may be cheaper in the long run to pay your planner up front (this can be a lump sum, or an hourly fee), and later manage your investments yourself, using a discount broker.

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Can the Money Manager I Find “Beat the Market”?

No money manager is infallible. The investment world is generally divided into two categories: Those who invest passively and are content to earn the return of the market as a whole (often, by buying index products), and those who invest actively and aim to beat the market.

Red Flag #3: Few investors or advisors can regularly out-perform the market in the long run. If an advisor you interview claims he can pick individual stocks that will beat the market, or claims he can predict future stock market moves (sometimes called market timing), be skeptical.

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Is My Investment Advisor the Next Madoff?

Many investors have become worried by recent scandals involving investment managers like Bernard Madoff in the US, Earl Jones and Vincent Lacroix in Quebec, and, more recently, Milowe Brost in Alberta.

Features common to many of these scandals are: lack of registration with securities regulatory authorities, lax or non-existent third-party custody of client funds, and promises of suspiciously-high returns. In hindsight, these scams are clearly so-called Ponzi schemes, in which high returns can only be paid out from funds received by later investors.

Red Flag #4: A tried-and-true principle is that returns are always related to risk. If you are promised above-market investment returns, undisclosed risks may be involved. If it is too good to be true, don’t believe it. Unless you are dealing with a household name (for example, one of the major chartered banks, or their subsidiaries) do not hesitate to check if both an advisor and his employer are registered with regulatory authorities.

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What is My Asset Consultant’s History?

Following an interview, you should feel that your asset consultant is not only competent but also trustworthy. If you have doubts, don’t go any further. Trust is at the backbone of the client-advisor relationship, and is not something to take chances on.

The background of the advisor and his firm is also important. Satisfied clients are an important indicator, although recent scandals suggest this is not always sufficient.

Red Flag #5
: An advisor who has repeatedly changed firms, or who has been the subject of disciplinary proceedings, may not be a good choice. Disciplinary records can be checked with regulatory authorities.

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How Will My Money Expert be Compensated?

Compensation is one of the most common points of contention between clients and money experts. To minimize this risk, discuss money up front. How much will the advisor receive annually based upon the expected size of your account? An advisor should explain clearly how he is to be paid, including any amounts paid indirectly by third parties.

Red Flag #6
: If discussing compensation with the advisor feels like pulling teeth, a future dispute may be just over the horizon. Keep in mind that financial advice never comes for free, and that you shouldn’t pay for financial advice you don’t need. This includes mutual fund managers, who can charge up to 3% per year to manage your money.

Marc Ryan publishes the web site, a source of free, independent investment information for Canadians.