How to Choose an Investment Advisor

Choosing an investment advisor is similar to choosing a doctor. You want someone you can trust. Getting a recommendation from a friend or colleague is a start, but it may not be enough. Find out if your prospective advisor holds a professional designation, such as Certified Financial Planner (CFP), Chartered Financial Consultant (ChFC), or Chartered Financial Analyst (CFA). You should also ask for references from existing clients. You can check with the SEC or state securities regulators to see if any complaints have been filed against the
advisor in the past.

When you first talk to your prospective advisor, be sure to ask how he or she is compensated. Most advisors are paid either on a commission basis or a fee basis. Commission-based advisors charge transaction fees on all stock, bond, and mutual fund trades. They also receive periodic kickbacks on their clients' mutual fund holdings via hidden charges called 12b-1 fees. "Fee-only" investment advisors, on the other hand, make no money on commissions. They are compensated by receiving a small percentage of the assets under their care. A typical arrangement would be an annual charge of 1% of funds under management.

There are two problems with commission-based advisors: 1) They are rewarded by increasing the number and frequency of trades; and 2) their compensation increases when they buy securities with high mark-ups and sales charges. In other words, a commission-based advisor has financial incentives that run contrary to your best interests.

In contrast, a fee-only advisor's financial interests are directly aligned with your own. Since the advisor's compensation is linked to the size of your account, she has every incentive for the account to grow as large as possible. She is also motivated to minimize your transaction costs, tax liabilities and anything else that might hinder the growth of your account.

Here is a quote from Jane Bryant Quinn, who writes the personal finance column for Newsweek:

"Financial Planners who take commissions have a built-in conflict of interest...even with disclosure, my choice would be a Fee-Only planner."

As usual, her advice is right on the money.

November 2002

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