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Common Mistakes that People Make While Picking a Financial Advisor

By: , dated January 25th, 2013

Hiring anybody to do anything is always tricky because you find yourself having to predict the future and how that person will perform in it. In addition, there’s always a judgment call that has to be made while evaluating the integrity and honesty of the person you hire. But selecting a financial advisor is even trickier because the stakes are much higher. For example, if you hire a plumber and he doesn’t work out, you pay him the agreed amount and move on with your life. But if you hire a financial advisor and he doesn’t work out, then not only do you have to pay the agreed fee but you also have to deal with the fact that your life savings or retirement fund may have been jeopardized. Therefore, selecting the best possible financial advisor is much more critical because you are giving that person access to your finances.

Common Mistakes

However, many people further reduce their odds of finding a competent financial advisor by not gathering enough information and by making the following common mistakes.

Cutting corners and not putting enough effort into the process

People tend to take the process too lightly. There are a number of steps in this process (e.g. identifying your needs, researching different advisors, checking references etc.) and each one of them is time consuming. But in the long run, it’s time well spent not only because finding the right person can help you achieve your goals but also because finding the wrong person can cost you a lot of money.

Relying solely on recommendations from friends and family to make a decision

Everybody’s financial situation is unique, so an advisor who worked well for somebody might not work well for you.

Not understanding what kind of advisor you are looking for

There are numerous types of financial advisors out there (e.g. brokers, fee-only planners, fee-based planners, comprehensive planners, tax advisors, estate planners etc.) and people tend to assume they are all basically the same. That is not the case. If you just want tax advice, don’t go to a broker just because he calls himself a financial advisor.

Confusing salesmen with financial advisors

Salesmen are typically individuals who work for brokerage houses. Often their primary job is to sell stock. They tend to call themselves financial advisors but they are not usually registered as investment advisors, which means they do not have a fiduciary duty (that is, a legal obligation) to do what’s absolutely best for you.

Not understanding what fee structure you will be paying

For example, paying a financial advisor a commission every time you purchase or sell a stock is not the same as paying an advisor a fee based on assets under management. In the former, the advisor makes money no matter whether your investment goes up or down but in the latter, the advisor makes a lot more money when your investment goes up. Therefore, the advisor’s interests are more aligned with yours.

Not researching an advisor’s background to check past disciplinary actions

Not spending enough time judging core competence

An advisor can charge the right fees and have the correct licenses but if he is not good at his job, there is no point in hiring him. Therefore, people should take the time to gauge whether the advisor knows what he is doing and has a sufficient level of expertise. One way of judging this is looking at the past performance of the advisor, especially in bear markets (everybody can make money in bull markets).

Not evaluating investment philosophies and risk tendencies of an advisor

People need to make sure that there is a good fit between their and the advisor’s investment style and tolerance for risk; otherwise, the relationship can turn out to be frustrating (and expensive).

Putting too much emphasis on an advisor’s personality

Don’t hire an advisor just because he is personable. Some financial advisors are especially good at coming across as friendly because that is part of the sales process, but that’s not the most important consideration.

What Can You Expect Out of Your Financial Advisor?

This often depends on the kind of financial advisor that you hire. If you are hiring a ‘niche’ financial advisor (e.g., estate planner, tax advisor, etc.), then your expectations should be more specific than if you were hiring a comprehensive financial advisor or planner. However, in both cases, you have a right to expect the advisor to do a good job.

People tend to expect too much from their financial advisors when it comes to investment performance and they tend to expect too little when it comes to other things. To expand on this a little bit, some people think of their financial advisor as a professional stock picker. They have unreasonable performance expectations and when they don’t see those results, they are disappointed. Obviously, those expectations are unrealistic and people need to keep this in mind going in.

However, there are a number of other important areas where people don’t expect enough from their advisor when they have a right to. Some of these things include not expecting a full explanation of why an individual should follow a certain recommendation (people tend to think they have to follow a financial advisor’s advice blindly), and not expecting an advisor (especially if he is comprehensive planner) to give them advice on the financial impact of major life changes (e.g., marriage, birth of a child). Individuals should consult with advisors before these events but sometimes are hesitant to do so because they think it falls outside the purview of an advisor’s responsibilities.

There are also small administrative expectations that people don’t have of financial advisors when they should, such as getting detailed quarterly reports and receiving timely updates on the performance of key investments.

Having said all this, people also need to realize they also have a responsibility to make the relationship work and they have to do certain things too (e.g., keeping the advisor informed, understanding the investments being recommended) and not let the advisor do all the work.

This article was brought to you by the InvestorGuide Staff Writers and Editors.

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