With the U.S. stock market and other assets like crypto and real estate reaching record highs, many investors are getting nervous. What should you do now to avoid giving back your profits? And given rising inflation, how can you best safeguard your financial future?
We sat down with John Odell, CFP®, a financial advisor with over 33 years in the business, for some insights.
Q: I am interested in making the most of my resources but also avoiding mistakes. What should I do?
Most people do best with a financial advisor simply because there’s too much at stake. The wrong financial decisions could mean the difference between a great retirement and one where you’re constantly feeling financial stress.
If you don’t manage money for a living, it’s too easy to overlook something critical. So for most people, having a trusted professional help you invest and plan your financial future is vital.
But here’s the key: it needs to be the right financial advisor. Too many people simply hire the individual who manages money for their parents or friends. But not all financial advisors are created equal. Some help clients build wealth and manage risk, but unfortunately, others may be more concerned with achieving their goals than yours. Or they may have good intentions but simply not be skilled investors. Most people go by verbal sales promises, but that’s not enough when your money is on the line. That’s why you must do your research and choose wisely. Basically, you need to find out if the financial advisor is good at their job and make sure they can prove it.
Q: That makes sense. So how can we find the best advisors?
The first thing I recommend looking for is their track record. You want a firm that discloses their investment history, so you can actually see how good they are at investing client money. And not just over a year or two, be sure to look for at least ten years of history. You want someone who consistently meets or beats the indexes, plus also helps you control risk.
Most firms don’t even report their results, which leaves you without the information you need to decide. So most people end up making their choice blindly, just hoping the advisor has the skills to manage their money in good and bad markets. But hoping is not enough…you need proof.
Q: So, what exactly do we need to ask?
Ask the prospective advisor to see a copy of their verified track record. If the advisor is serious about transparency, they will adhere to industry best practices called Global Investment Performance Standards or GIPS®.
GIPS® is a worldwide gold standard for reporting investment performance. This reporting style accurately displays an advisor’s track record, after fees, against market indexes. It also measures risk and shows something called “dispersion.”
Dispersion is the range of investment returns the advisor has achieved. For example, you might talk to an advisor with an average return of 10%, but the dispersion is plus or minus 10%. So, in reality, the average account returns 10% per year, but some accounts may have a 20% or a zero return. That’s not what you want to see. Instead, look for more consistent results for all of their clients, not just some of them.
Ideally, you want to find a financial advisor with great returns and a low dispersion. While there are no guarantees, that can help you stack the odds in your favor.
Q: Why else is GIPS® beneficial to you as an investor?
With GIPS®, you know that every advisor is using the same methodology to calculate results. Then these results must be independently verified.
So you end up with reliable information so you can evaluate advisors and make the most educated selection. In other words, you can compare apples to apples.
Q: What else is important when hiring an advisor?
There’s another critical aspect you want to research: who holds your money when you work with a particular financial advisor. This firm is called the “custodian.” The custodian should never be the investment advisor or a firm they control…that’s what helped Bernie Madoff fool so many investors for so long.
So make sure the custodian is independent. Usually, it should be a household brand you’ve heard of. The important thing is that the firm should be financially strong with a clean track record. In the 2008 global financial crisis, many custodians had to be bailed out.
So be sure to pick an advisor who works with an independent, strong custodian, so you don’t have to worry about someone stealing your money or the firm failing when the market gets rough.
Q: This is really helpful since most of us have no idea to ask about this. Is there anything else we should look for?
It’s important to understand that a professional has few requirements to call themselves a “financial advisor.” But since you’re going to be investing your life savings with them, you want someone with the proper knowledge and training.
So look for advisors who have earned a specialized certification. The best ones are the CERTIFIED FINANCIAL PLANNER® (CFP®), or the CHARTERED FINANCIAL ANALYST® (CFA®). Both of these certifications take years to obtain and require the advisor to complete an extensive course of study and pass a rigorous exam. They also must keep up with continuing education, so you can be reasonably assured that their knowledge is up to date.
Q: Is there a difference between a broker and a financial advisor?
I know those terms can be confusing. Sadly, it is by design. In the past, big firms lobbied to allow their brokers to call themselves financial advisors.
In reality, there is a vast difference between the two. So, regardless of the title on their business card, you need to ask another question. Ask if the professional serves as your legal fiduciary at all times. A fiduciary is legally required to put your interests before theirs. Believe it or not, not all must act as a true advisor to you. Instead, brokers simply have to recommend something suitable to you, even if it earns them a higher commission. That just costs you more money which, over time, can seriously erode your wealth.
Plus, sometimes these commissioned brokers are so motivated to sell you things that earn them commission, they ignore basic risk management principles. There are too many news stories about unethical advisors ruining people’s financial futures, so this is an important point.
So always insist on working with a fiduciary. After you ask the question—will you act as my fiduciary at all times? — get it in writing, too.
Additionally, you can look for fee-only advisors. By removing commissions from the equation, you end up with a professional paid to give you advice. That’s what you want, so you don’t have to worry about other motives.
Q: Any last words of advice?
Yes. Ask about the financial advisor’s selling strategy. Look, we’ve been in a record-breaking bull market, so most everything has gone up. So even those without investing skills can look good. But your financial advisor earns their fee when they help you navigate volatility and bear markets.
There’s no crystal ball out there, so they need a selling strategy. That way, they have a disciplined and systematic approach to helping you minimize losses and take profits, so you can stay on track to achieving your goals.
I find few financial advisors even have a selling strategy, so those advisors are likely to disappoint their clients sooner or later. So ask how they handle it and listen carefully.
So, that’s my advice that can help you find a qualified professional. I understand it can feel awkward to ask these questions, but keep in mind that the best advisors welcome educated clients. If your questions are met with any hesitation, that may be a valuable red flag that this financial advisor is not a good fit to help you build wealth and protect your life savings.
John Odell, CFP®, is the founder of Arroyo Investment Group, a GIPS® compliant wealth management firm based in California but serving investors nationwide. John also oversees Capital Research + Consulting, a retirement plan consulting firm that advises over $5 billion in assets.