The Three Essential Qualities of a Trustworthy Financial Advisor

Several years ago, a college student working on a class assignment approached me. She was writing a paper on financial planning and was interviewing several professionals. The young woman started with some basic questions about retirement planning, things like how much to save, what to invest in … nothing too surprising. Then she started digging into some tougher issues about the industry in general. Most of her interrogation was thought-provoking but not tough enough to throw me off.

But then she launched a question that made me literally take a step back and swallow hard. She asked, “What percentage of financial advisors would you recommend to your mom?”

I had to think long and hard before I could answer because that percentage was much lower than I wanted it to be. I had to acknowledge that the list of advisors I’d recommend was a very, very short list. And that did not feel good.

So I squirmed. I didn’t want to answer. I knew that my unvarnished, honest response would seem … well … negative. But I could see that this bright young woman wasn’t going to let me off the hook.

I took a deep breath, looked her square in the eye, and answered her question. “Two percent,” I said.

“Only two? That’s one in fifty! Why?” she asked.

“There are very few advisors who have the three qualities that are absolutely necessary to do the job right.” I replied. “Lots of advisors have one or two of those qualities, but I wouldn’t recommend them to my mom unless they have all three.”

And it’s true. But what are the three essential qualities of a top-2% advisor?

As it turns out, the things you look for in someone who’ll manage your money during your retirement years are the same qualities you’d look for in any professional. Stellar candidates possess certain core characteristics no matter what field they’re in. That’s true of a tax preparer, a doctor, a financial advisor, a realtor, or anyone else who’s in a position to provide advice and expertise. The true stars in any field possess the following three qualities:

1. They have expertise in your area of need.

To be clear, the emphasis is on your area of need. If you need a hand surgeon, you shouldn’t go to a general practitioner. If you run a small business, a CPA who specializes in small businesses and their specific challenges is preferable to someone who primarily handles taxes for individuals. Any professional you hire should also have appropriate professional credentials that indicate a certain level of competence in—I’ll say it again—your area of need.

2. You can trust them.

This is always a tough one. Most people are on their best behavior when you first meet them. Only later will you find out their true colors. But there are some clues to look for. Do they tell you only the sunshine positive stuff, or are they honest enough to tell you the downside of things and what potential negative outcomes you should be prepared for? Are they up front about how they’re compensated and how much their fees are likely to be? Do they have any conflicts of interest? These can take many forms. Selling products created by the companies they work for is one. Earning commissions or bonuses for selling you certain investment products is, in some cases, another. What’s most important is that they disclose any potential conflicts to you in advance.

3. They genuinely care about you.

This is another area that can be tough to assess in the beginning. But again, there are clues. Does the professional ask questions about you and your needs during the first meeting? That’s the only way to determine whether he can actually provide the services you’re looking for. Does he take time to explain the process you’ll engage in, in a way that’s easy for you to understand? Also, don’t underestimate the value of trusting your gut. If you get the feeling the professional takes a sincere interest in you, that’s a good sign.

Three Characteristics of a Top 2% Financial Advisor

Now let’s look at how those qualities apply to a financial advisor who will manage your retirement account.

1. He Has Expertise in Your Area of Need

According to the Bureau of Labor Statistics, there are 271,900 financial advisors in America4. Do they all have the kind and amount of expertise you’re looking for? Decidedly not. Here are some things to look for.

A. Experience. How long has the advisor been in business? Everyone has to start somewhere, and when you were a fresh young investor yourself, it might not have been as important to find someone with extensive experience. If things don’t go as planned when you’re 25 years old, you have lots of time to make up for it. Not so when you’re ready to retire. You need someone who has been at this long enough to have seen good and bad markets, someone who knows how to manage your account through both. You also want someone who’s likely to be around for the long haul. Lots of people get into this business and within a few years decide to try something else. Heck, that’s true of any business. But you’ll be happier if the advisor you choose now is the one who’s by your side 10, 20, or 30 years from now. Look for someone who has been doing this work for at least five years. Longer is better.

B. Certifications. Personally, I think a CERTIFIED FINANCIAL PLANNER™ (CFP® professional) or a Certified Public Accountant with a Personal Financial Specialist credential (CPA/PFS) is a minimum requirement. None of those credentials guarantees expertise, but they all require the applicant to pass tough exams, fulfill continuing education requirements, and meet rigorous standards that are probably not required of other advisors.

C. Education. It helps if the advisor’s education is in a field that complements what they do. Yes, I am sure that degree in early French literature was tough to complete, but I don’t think it is going to be very helpful for a financial advisor. Look for an MBA or other degree in business, finance, or accounting. A master’s degree is nice, but a bachelor’s will do.

D. Expertise in managing accounts for retirees. Your needs today are different from what they were 20, 30, or even 10 years ago. For starters, you’re no longer putting money into your account—you’re taking it out. That means you need a very different investment strategy to make sure your money will last as long as you need it to. (More about this see here.) It also means there’s a whole new set of tax regulations that affects you. And, of course, your personal and professional goals have changed. You’re probably not saving to buy your first house, but you might be thinking about how to set up an estate for your kids. Only an advisor who specializes in helping clients like you will have the experience and training to handle those important issues properly.

2. You Can Trust Him

Certainly you want a professional you can trust, but how can you tell? When it comes to a financial pro, there are some key clues you can look for.

A. He offers you a free initial consultation. The only way to determine whether he can provide the services you need is to sit down and have a conversation. If he wants to charge you a fee before he knows if he can help, his motivations are likely skewed.

THE ADVISOR WHO CAN CAUSE YOU THE MOST TROUBLE—AND YOU MAY NEVER SEE IT COMING

Grant is a great guy, the most honest person you know. He wouldn’t even pick up a pencil from the sidewalk if it wasn’t his. Before he became an advisor, he was a police officer, highly decorated and well respected. A good man. He retired early with a great pension and wanted to do something with the rest of his life. “I’ve got to be doing something,” he tells you.

The XYZ product company approached him. “Come with us!” they told him. “You can help people and make a lot of money.” They wined and dined him. They were a big-name company and certainly seemed reputable. So Grant signed up.

He attended sales meetings (they were called “business development” meetings), where they told him how to sell a certain type of product. He learned, he got excited, and he went forth! He reached out to people he knew, people who trusted him, and told them what they should buy. He had learned the sales pitch well, and he hit his clients’ hot buttons.

Unfortunately, the products were expensive and totally inappropriate for many of those clients. They paid a steep price … and they never saw it coming. Neither did Grant. Eventually he realized his mistake, but it was too late for all those people who had trusted him, and who were devastated by their loss. Grant was devastated, too.

This is the worst kind of advisor—one who is nice, caring, and honest, but incompetent. You never see it coming.

B. He tells you the whole truth about how you should expect your portfolio to perform—the good, the bad, and the risky. If he paints a rosy picture that seems too good to be true, or fails to mention the risks involved, or promises to consistently buy low and sell high, beware.

Perhaps the most blatant of these is the fellow who claims to be an “advisor,” but who’s actually running a Ponzi scheme. Almost every year we hear of someone duping investors out of their life savings this way. The latest big one was Bernie Madoff. A big tip-off is that these advisors promise you returns that are better than what the market generates, with little or no risk. In fact, these guys not only promise big returns—they “validate” them by putting you in touch with clients who made money, and who can even show you the statements to prove it (or so it would seem).

But here’s what’s actually going on. In most cases, the advisor isn’t investing money at all—he’s just shuffling it around from one client to the next, sending out false statements that seem to indicate fantastic earnings. When a client wants cash out of his account, no problem; the advisor sends money he’s taken from another investor. New investors keep coming because existing clients tout the great returns they think they’re getting. And on and on it goes … up to a point. Eventually, the house of cards comes crashing down because the returns are entirely fictitious.

You can protect yourself, to a certain extent, by making sure the advisor uses a third-party custodian—that is, a bank or similar entity other than the advisor, and outside the advisor’s firm, that oversees the money. You should require it.

Never, never, never write a check out to the advisor or his firm. Never.5

C. He discloses any material conflicts of interest. Better still, he doesn’t have any. An advisor whose income comes solely from fees paid by you directly to him (as in a flat rate, hourly fee, or a percent of assets he manages for you) is most likely to be beholden solely to you. That’s the ideal scenario, because if you’re not happy, his income goes away.

On the other hand, if an advisor’s income is based on commissions from selling investment products, his primary interest may be in meeting quotas and earning fat commission checks—not in making sure your portfolio performs at its best. This payment arrangement means he has a built-in incentive to buy and sell investment products, so he may do so even if it would be in your best interest to leave your portfolio as it is. It’s a strategy we call “churn and burn.” If he seems more interested in telling you about the great products he has to sell than learning about your circumstances and needs, beware. To add another layer of complication, if the advisor offers products created by the company he works for, he likely owes a certain amount of loyalty to the company. Again, that may be in conflict with what’s best for you.

What’s even worse, some advisors don’t even need to tell you what they’re doing. Believe it or not, some accounts are set up specifically so the advisor can buy and sell products in your account without your permission and without notifying you when he does it. It’s called a “discretionary authority account.” You should avoid this type of arrangement, especially if the advisor earns a commission when he buys and sells products, in which case he’d be able to churn your account and make lots of money for himself—not for you. A discretionary authority account may be acceptable if your advisor is paid by fee only, and if transactions are done within the guidelines of the Investment Policy Statement you sign when you hire him. (The Investment Policy Statement provides guardrails, so to speak, regarding how your advisor will invest your money. See here under the list of signing documents in Step Five.) But even with a fee-only advisor, you should be notified before he initiates any transactions that are outside the parameters of the written Investment Policy Statement. In any case, you can protect yourself by insisting that the Advisory Agreement—another document you sign when you hire an advisor (see Step Five, here)—stipulates that your monthly (or quarterly) statements will include a complete list of all transactions made within your account. Then it’s up to you to monitor your statements and make sure you understand how your account is being handled—and why. All of this is another example of the benefits attached to working with a fee-only advisor. That doesn’t necessarily mean a commission-based advisor is a bad or dishonest one. But the arrangement carries an abundance of potential for trouble, and using one would require an added layer of oversight by you. In any case, if an advisor has any relevant conflicts of interest, he should disclose those to you upfront. Very few do.

D. He’s transparent about how he’s compensated. The advisor should reveal all avenues of compensation without you having to ask. If you have to pay a sales load, or fee, when buying or selling products, keep in mind that some of that money goes to the advisor as a commission. If he doesn’t voluntarily disclose that, consider it a red flag. He should also disclose any “soft” compensation—things like vacations, golf trips, or fancy dinners offered as bonuses for meeting sales quotas. If he doesn’t offer up the information without being pressed for it, it’s a reason to question his trustworthiness.

E. He operates independently. This is another way of determining whether there are conflicts of interest. Is he able to recommend products generated by companies other than the one he works for? If not, how can you be sure what he recommends is in your best interest? You need to know.

F. He is a fiduciary on all accounts, including retirement accounts and taxable accounts. A fiduciary must, by law, put your interests first instead of his own or those of the company he works for. This must be an absolute requirement for any advisor you hire. Ask the question, and have the answer verified in writing.

G. His compensation is structured so that the longer he keeps you happy and the better your investments perform, the more he gets paid. If he makes more money by selling you more products, his goals may be decidedly different from yours. It’s not a deal breaker, but it’s a point you need to keep a close eye on.

3. He Cares about You

As with any professional, it’s tough to assess this one early in a relationship. Most of these people are good at making a great first impression. But there are signs and signals you can watch for.

A. He begins your first meeting by getting to know you and what you’re looking for, rather than with a sales pitch about his skills or his products.

B. He seems interested in establishing a mutually beneficial, long-term relationship. He asks about your long-term goals, wants to know about your kids and grandkids, and shows signs of anticipating what your needs will be years from now.

C. Meeting with clients on a regular basis is built into his services. When you begin working together (and sometimes indefinitely) he expects to meet with you quarterly, or at least twice a year, to go over your portfolio and get updates on any changes in your life that affect your finances. If he balks at the idea when you suggest it, or seems to think you’ll sign on the dotted line and then leave the rest to him, he’s probably not willing to invest the time to tailor his services to your unique circumstances. If he cares about doing the best job he can for you, he’ll know frequent review meetings are a necessary part of the process.

D. Everyone on his staff makes you feel welcome. The way the receptionist greets you may seem like a small matter, but that Director of First Impressions is the face of the advisory firm and is usually a good indicator of the corporate culture. Does he seem happy and genuinely interested in helping you? Or does he behave as though you’re just another intrusion on his afternoon? If the business culture is one of caring, management will likely hire caring people all the way down the chain of command.

Those are the essential qualities you need in a financial advisor: expertise, trustworthiness, and a caring attitude. How will you find someone who possesses all three? The five-step process in this book is designed to help you do exactly that.

But before you begin, I’d like to go through some of the reasons your expert, trustworthy, caring advisor needs to have particular expertise in working with people during their retirement years. The more you know about why your needs are different from someone who is building his retirement account, the better equipped you’ll be to find that top-2% financial advisor you’re looking for.