How to choose an investment advisor

How to choose an investment advisor

December 1, 2016

Choosing a financial advisor is often a daunting task.

At the Evidence-Based Investing Conference held in New York City in November, 2016, I had the opportunity to listen to one of the leaders in the investment industry, Bill McNabb, Chairman and CEO of Vanguard.

Vanguard is one of the largest investment companies in the world and manages in excess of $3 trillion. About one third of the funds they manage are invested in actively managed funds.

One of Vanguard’s challenges is to select investment managers for its funds. Individual investors can learn from Vanguard’s process and apply the same logic to selecting their own personal financial advisor.

McNabb outlined Vanguard’s five-step selection criteria and I will comment on how it applies to finding the right financial advisor.

One – people. Ultimately it is the people you deal with who have the ability to deliver your financial objectives, so this is the logical starting point.

Regardless of whether a mutual fund investment manager or a personal financial advisor is being hired, it boils down to people. There has to be a good fit, which includes a mix of personality, skills, and professional qualifications.

Two – process. The process is important because it leads to the selection of specific investments to purchase. Success is determined by the returns of those investments. A logical, consistent, process provides the best chance of achieving consistently successful outcomes. When looking for a financial advisor know your priorities and objectives to make sure their investing philosophy matches your needs.

Three – portfolio. The selection process of choosing specific investments results in the total portfolio. Understanding the strategy of the entire portfolio is essential because a diversified portfolio combines the objectives of achieving a good long-term investment return, while at the same time managing risk.

Individual investors manage the risk-return challenge by determining what percent of their portfolio will be made up of stocks versus bonds. The risk-return balance is important because of the normal volatility that occurs in the investment world.

Four – price. The first three items: people, process, and portfolio are what you are paying for. You need to know if you are getting value for your money. Assume Vanguard found an excellent manager but their fees were too expensive, then the value of what Vanguard would be paying for, versus what it was getting, is out of line. The same is true for individual investors.

When choosing a financial advisor, keep in mind that research shows a correlation between investment fees and investor returns. Funds with the highest investment fees have lower investment returns and vice versa. The single most important reason why conventional mutual funds perform poorly is many funds have investment fees that are too high.

Five – performance. The final criteria that Vanguard uses to select a manager is performance. Evaluating performance is multi-faceted and needs to consider all aspects of the portfolio, keeping in mind that past performance is not an indicator of future performance.

My own observations over the years is that many individual investors consider short-term performance the most significant factor, and that is their only consideration when deciding what to purchase. This is not an optimal strategy. An advisor should consider a client’s short term financial needs, while investing for the long term.

There is a strong parallel of how a large investment management firm selects investment managers, to how individuals should select their financial advisor.

Do your due diligence and interview several financial advisors to find the one best suited to your needs.