How to Select a Financial Advisor

I often meet entrepreneurs who spend decades using a disciplined, process-oriented approach to building their businesses and, as a result, accumulate great wealth. However, it’s remarkable how many of them devote more time to planning their next vacation than to choosing a wealth manager to steward the proceeds from their life’s work after a transition event.

Selecting a wealth manager is among the most critical decisions you can make, with reverberations far into your life and potentially that of the next generation. A positive outcome provides peace of mind and fulfillment; a poor outcome yields unfortunate and unforeseen circumstances. Consider the clients of Bernie Madoff, whose fraudulent activities made headlines more than a decade ago. His investors expected to be comfortably retired, but many had to return to work when their portfolios evaporated.

To grow and protect your hard-won earnings, you need a trustworthy professional who acts as your advocate at all times, and it’s vital to carefully consider your options. I suspect one reason investors take shortcuts is the flood of choices and myriad job titles, credentials, and fee structures of today’s investment professionals. Titles like financial advisor, broker, financial planner, and investment advisor can seem hard to distinguish from one another. It’s easier to ask around at the golf club and rely on the recommendation of a friend—but do so at your own peril.

A study published this year in Financial Analysts Journal illustrates the widespread confusion surrounding investment job titles and roles. Of 460 individuals surveyed, many could not accurately answer basic questions about this topic. For example, 51% incorrectly believed that a broker is legally required to behave in the customer’s best interest. Slightly more, 62%, understood that brokers are in the business of selling investments or financial products. Surprisingly, survey respondents with a college degree or higher education did no better answering questions about investment job titles and roles than did their less-educated peers.

I encourage you to take the time and effort to begin an objective, unemotional, evaluation process. If you don’t know where to begin, you might start by asking a trusted advisor, such as an attorney, for names of potential wealth management firms to interview. With your family’s enduring prosperity and legacy at stake, it is well worth it to invest time to take ownership of the process, ask probing questions, and, ultimately, find the right fit. There are several important criteria to consider. The questions below are a good starting point.

Is Their Specialty and Experience a Good Fit?

The first and most important point to consider is whether your profile and needs match the firm’s typical client. Your ideal advisor should be used to working with people like you. You don’t want to be their biggest and most complex client, nor do you want to be their smallest and simplest client. It’s best to fall somewhere in the advisor’s mid-range, the sweet spot which reflects their experience and expertise.

If you’re a corporate executive with a complex balance sheet that includes stock options, restricted stock, and deferred compensation, you’ll want someone knowledgeable in that area. If you have a sizable net worth, you’ll want an advisor attuned to estate tax issues. Currently, estates above $23 million—or $11.4MM per person—have a significant tax burden to consider. Laws, however, are expected to change. If you fall into the upper levels of wealth, you’ll want an advisor who is attuned to the latest thresholds and requirements of estate tax issues or complicated trusts. Otherwise, they may not have the experience or expertise needed to help you bring in the right specialists and reduce your tax burden.

If a firm’s typical client is worth much more than you, the advisor may say, “Yes, we're going to take care of you; all of our clients are equally important.” Then, a year later, you find yourself wondering why you rarely hear from this person.

How are They Compensated? Follow the Money!

You also need to ask, specifically, how an advisor earns their money. What’s their business model? How are their fees structured? Do they get paid only if they bring in new business or sell you a product, like a structured note? Often “business development officers” are tasked with going out and landing clients. Once they've won the business, you may not hear from this individual again.

The most common way for advisory firms to charge for their services is to base it on assets under management (AUM). But be aware this could create a conflict of interest between you and an advisor who hopes to manage the proceeds from the sale of your company, especially when the best advice might be to keep running your business and not sell it yet.

For the business owner, a fixed-fee engagement letter enables the client and his or her advisor to sit “on the same side of the table.” The advisor is agnostic as to whether you sell your business and give him more money to manage. Instead, the advisor might recommend that you take on additional debt or equity partners and use that capital to expand and grow the business. In such a structure, think about whether the terms ensure that you and your advisor “win together and lose together,” as the traditional AUM fee structure does.

In other words, work to understand the advisor’s underlying business model and sources of revenue. Do they receive commissions on products they recommend? Do they earn a spread on lending? What financial incentives are created for the wealth advisor, either explicitly or implicitly? You can find great people who look after their clients well in a variety of business models, but it's important to be aware of the potential for conflict.

Teasing out the Details

In the next part of this article (read Part 2), we’ll look at additional questions to ask before retaining a wealth manager. These questions will reveal the legal standards to which the specialist is held, credentials to consider, and how to assess their track record. We will explore the nuanced differences between a financial planner, a stockbroker, an investment advisor, and other industry titles, and how they might contribute to your family’s enduring legacy and prosperity. Continue to Part 2: A Closer Look at Financial Advisors.