Financial Advisors Require More than a Simple Referral

The late Dr. Harry Clark Noyes, a psychologist who examined consumer behavior for his New York firm Psychological Motivations, said there are plenty of people who generate good references from customers despite mediocre results. "Some people re-sell themselves when they give a referral," Noyes said, "They list the attributes of someone to you, and they are also re-examining the decision on their own. They may want you to choose the same person because it confirms their decision and because if you choose someone else it could raise more doubt in their mind.

"It's not that everyone who makes a referral does this, but it certainly happens."

This is precisely why consumers should not take referrals at face value and why they should want to turn a "referral" -- where someone gives you a name and minimal information -- into a "reference," where you delve into the experience someone has had with an advisor.

Smart Investor Tip

Don't take referrals at face value.
Instead, try to turn a "referral" -- where someone gives you a name and minimal information -- into a "reference," where you delve into the experience someone has had with an advisor.

Getting a name from someone who answers the question "Who is your insurance agent?" is insufficient. You want to know why he recommended that agent, if his work with the agent covered the same ground you now need help with, and more.

Even when there is an obvious conflict of interest, referrals can have some value. I have bought my cars for the last 15 years from an establishment where every time you refer someone who buys a car, you get $100 off your next purchase or repair job. The incentive is there for me to make the referral, but I wouldn't do it if I expected someone to be dissatisfied with the dealer. Such disappointment could, potentially, erode a friendship.

And so while the people who first told me about stockbrokers in Allentown may have had their own biases or conflicts of interest, chances are they would have told me to avoid anyone with whom they had a bad experience.

One key factor to guard against with referrals is the "instant trust" factor, where you put so much faith in someone that you let your guard down. It is too easy to use a referral as the sole basis for hiring a financial advisor. You trust your friend, who got a big fat tax refund check, so you believe he must have a good tax preparer. Or you get a referral from your financial planner for a tax preparer. You trust the planner (or already should have dumped him), creating instant trust in the referral.

That trust may be well founded, and the referral may be perfect, but the basic rule holds true: No one gets a position on your financial team until you have checked him out and feel comfortable that he belongs.

Referrals are a great way to make a short list of candidates for any position on your team. Asking your financial planner and banker for the names of estate planning attorneys can yield you very good choices (particularly if they name the same person), and the word of a trustworthy friend should generate your confidence in an advisor. But the crucial thing is to compile a short list and not stray from the process of selecting a financial helper just because one candidate was built up by friends and colleagues as the "right" choice.

Smart Investor Tip

Don't stray from the full process of selecting a financial helper just because one candidate was built up by friends and colleagues as the "right" choice.

You may not take the same approach to financial relationships as your friends or need the same kind of assistance. Your neighbor may drive a fancy car and be a "wealthy doctor," but that may also make him self-employed and dealing with a completely different kind of retirement savings situation than you have working for a big, public company or the local school system.

Your other neighbor might be satisfied getting an update on his portfolio every six months, while you want a report every time the market burps.

What you think of the person making the referral also colors how you feel about the advisor; that's why it's important to dig deep. Like your mother's decorator, the advisor you have been referred to may be competent and skilled but not your style.

In essence, once you have the referral, you need to treat your friend like a reference -- asking all the same questions -- so that you can use that information in making your own decision.

Some Advisors Refuse to Give References

Some advisors will throw up a major roadblock in your quest to get good information; they don't give references. Oh, they will pass you to another professional they have worked with, but they'll say that giving you the name of a client is an invasion of the client's privacy. They'll cite confidentiality agreements, where they are not supposed to discuss their customers, and you're asking them to give you a name and contact details.

They may also say that references are silly, since your circumstances are your own, and since anyone they pass you to, obviously, will be on their side.

Explain the kinds of questions you will ask a reference, and tell them to take any client or two with whom they have a reason to talk today and to ask that client if he or she is willing to function as a reference. Yes, you will get someone who is on their side, but you are asking tenor-of-the-relationship questions, not "How much money did he make for you?" and the advisor cannot necessarily give you a true picture of how he interacted with a customer at all times.

If the advisor still refuses to give a reference, think long and hard about whether you want to do business with him. This refusal to do something that you consider important raises a significant question -- one you should raise with the advisor -- which is, "If you are not willing to work with me on something I consider important before you have my money, how should I expect you to treat me if I become a client and you no longer need to impress me to work with my money?"

By Chuck Jaffe
Chuck Jaffe is a senior columnist and host of two weekly podcasts at MarkWatch. He has also been a guest speaker on several television and radio shows.

Copyrighted 2020. Content published with author's permission.

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