Unpack Your Financial Baggage

How to Choose a Financial Advisor

Episode Notes

In our third episode,  RJ King of D Business Magazine asks Lou Melone of Melone Private Wealth how to choose a financial advisor.

The relationship is important from both sides, and Lou explains the difference between a "customer" and a "client."

From the investor perspective, think of it as a four step process:

  1. Think of the person or team who will advise you
  2. Think of the type of company they work at.
  3. Understand how the advisor is compensated
  4. What is their planning strategy?

There's a veritable alphabet soup of financial designations, and Lou tells the story of "chauffeur knowledge" vs. "Planck knowledge" (link below).

Lou breaks down four of the main financial designations:  CHFC, CFA, CIMA, and CFP.  When it comes to choosing an advisor, the Certified Financial Planning Board recommends asking 10 questions, which we explain.

There is a very big difference between asset management and comprehensive planning.  And due to certain rules and regulations, an asset manager can appear to be a comprehensive planner - even when they are not.  This is why it's important to do your research and ask questions.   This includes learning about the fiduciary standard.

RJ also asks Lou about big Wall Street brokerage houses, and if there is still an advantage to using a larger firm over a smaller one.   Also, should an investor consider some Do-It-Yourself online tools?

We cover costs and fees and the different ways financial advisors are paid.  Lou talks about the differences, and why they are crucial to understand.

Finally, what is the value of a financial planner?  Lou cites articles from Vanguard and Russell Investments that quantify how important it can be to work with a planner - and why.

In our next episode, Lou and RJ will cover how to build a portfolio for retirement that matches your financial plan.


Lou Melone's book, "Unpack Your Financial Baggage:" https://www.amazon.com/Unpack-Your-Financial-Baggage-Misconceptions/dp/1948237776

Melone Private Wealth Website: https://www.meloneprivatewealth.com/

D Business Magazine Website: https://www.dbusiness.com/

Mentioned in this episode:

Lou's article on the Alphabet Soup of Credentials and "Chauffeur Knowledge:" https://www.meloneprivatewealth.com/blog/alphabet-soup-of-credential-and-chauffeur-knowledge

Charlie Monger's USC Commencement Address: https://jamesclear.com/great-speeches/2007-usc-law-school-commencement-address-by-charlie-munger

Ron Rhoades article in Think Advisor: https://www.thinkadvisor.com/2019/06/21/ron-rhoades-sec-reg-bi-is-greatest-securities-fraud-in-history/

Russell Investments Value of an Advisor: https://russellinvestments.com/us/resources/financial-professionals/value-of-advisor

Vanguard Value of an Advisor:https://advisors.vanguard.com/insights/article/IWE_ResPuttingAValueOnValue

Episode Transcription

Jon: Welcome to Unpack Your Financial Baggage, where we help you answer one simple question. Will you outlive your money or will your money outlive you? Here are your hosts, Certified Financial Planner and Managing Partner of Melone Private Wealth, Lou Melone, and editor of D Business Magazine, RJ King. 

RJ: Welcome everyone to our third episode of Unpack Your Financial Baggage, conversations with Lou Melone.

Now so far, we've covered behavioral investing and the anatomy of investor returns. Today we're covering the topic, how to choose a financial advisor. It's a topic filled with anxiety and a lack of resources, although it may be the single most important decision people make regarding their retirement and for generations to come.

Now, no pressure on this question, Lou, but many people are wondering how to choose the financial planner who best matches their retirement goals. 

Lou: It's a topic that at some point will be, uh, I think it's probably gonna be at the forefront of everyone's mind. However, the match between planner and client actually goes both ways.

It may sound strange, but the elite planners are also deciding who's the correct fit for their practice as well. 

RJ: What do you mean by that? 

Lou: In our industry it's viewed like this. Do you want a customer or a client? 

RJ: What's the difference?

Lou: To me, a customer is temporary, always searching for the highest return, which doesn't exist as you know.

There's no guarantee of the persistence of performance, historically speaking. However, they're consistently jumping from firm to firm, searching for kind of like the fountain of youth. 

RJ: Is this what the term chasing performance means? 

Lou: Yeah. Always chasing last year's winner, which you know, by the way, is the perfect recipe for a lifetime of under performance. That's why in our prior podcast we discussed the investor behavior cap. 

RJ: So then how do you define a client?

Lou: Well, I think a client is one who trusts the planner's philosophy and the planning process. They adhere to the principles and practices that have historically, both, I would say, created and preserved long term generational wealth. Now this takes patients and discipline to accomplish. 

RJ: Sounds like the elite planners spend a lot of time with each client. 

Lou: Absolutely. We view it this way. You most likely know the story of Noah's Ark. In the same way there's only so many openings on the ark, financially speaking as a firm, obviously. So we choose wisely.

RJ: What about the other planners? 

Lou: Well, let's just say that they're likely to take anyone who can put a mist on a mirror, so in turn, they need a lot of customers. 

RJ: I've never heard it explained that way, but it makes sense. The starting point of the relationship I'm imagining has a lot of anxiety for anyone looking for a financial planner.

The anxiety can come from a fear of selecting the wrong person, not knowing the types of credentials, the financial world's endless supply of buzzwords, the sheer volume of choices. Everyone around them knowing someone. Guarantees from so many people, the current economy and the list just seems to go on and on.

Lou: Yeah, exactly. It can be a lot to take in for anyone. And quite honestly, I'm exhausted just listening to your list. There are many ways to start a search, but essentially I'd suggest thinking about it as a four step process. First, think of the person or the team who'll advise you. Now, of course, there are the intangibles of do you like and trust the person, but you'll also want to know what their credentials are.

Second, the type of company they work at. Meaning is it a brokerage firm? Is it an independent planner or an RIA, which is a registered investment advisory firm. Third, understand how they're compensated. And finally, what's their planning strategy? It isn't necessarily a straight line, which adds to the confusion, meaning you can find similar credentials of all types at brokerages or independent planners or RIAs.

So for example, what's confusing, is the type and compensation model. So the larger brokerage firms may employ someone who makes money two ways. So one is selling product, which may or may not be in the best interest of the client, and the second way is acting as a fiduciary where they must do what's in the best interest of the client.

The challenge is understanding when the advisor is selling product or acting in the best interest of the client. 

RJ: That sounds like it can be confusing to the average person. Perhaps we take a close look at the four areas you spoke about. The first one you mentioned was the person and their credentials. There seems to be no shortage of credentials.

It's tough for anyone to have a clear understanding of what these titles are, from CFP to senior VP to CHFC to CFA, or retirement planning specialist.

Lou: RJ, our industry does a terrible job of simplifying qualifications for the public. We have written an article, and I call it the alphabet soup of credentials.

And a story from Charlie Munger, who is Warren Buffet's business partner, of what he called "Chauffeur Knowledge," probably will help explain it. So the story goes like this. Essentially at the 2007 commencement of the USC law school,, Charlie Munger explained what he called "chauffeur knowledge" this way, telling the fictional story about how Max Planck, after winning the Nobel Prize, went around Germany giving the same standard lecture on the new quantum mechanics. So over time, his chauffeur memorized the lecture and he said, "Would you mind, professor, because it's so boring staying in our routine. What if I gave the lecture in Munich? And you just sat in the front wearing my chauffer hat?" 

Plank said, "Sure, why not?" And the chauffer got up. So he gets up and he gave this long lecture on quantum mechanics, after which a physics professor stands up and asked a perfectly ghastly question. The real chaufferur, unable to answer, said, "Well! I'm surprised that in an advanced city like Munich, I'd get such an elementary question. I'm gonna ask my chauffer to reply to that."

So Munger continues by saying to the class, in this world we have two kinds of knowledge. One is Planck knowledge, the people who really know. And then we've got chauffer knowledge, which is they've learned the talk. They may have a big head of hair, they may have fine temper, timbre in their voice, and they'll make a hell of an impression.

But in the end, all they have is chauffeur knowledge. I think I've just described practically every politician in the United States, he said, And you're going to have the problem in your life of getting the responsibility into the people with Planck knowledge and away from the people with chauffeur knowledge.

RJ: That's a great story. Lou, what are some of the credentials people have and why they might choose them? 

Lou: Well, unfortunately, there's an unlimited number of designations that advisors may have. The key is understanding if they're earned internally from their firm, like, Vice President, Senior Vice President, which by the way, this is a function.

Those titles are a function of how much commission the advisor has generated for its brokerage firm. Or are they earned by an outside independent organization, which usually requires additional education? Now, for anyone in our industry who may be listening, I know there are more designations than the ones that I'm going to be discussing here, but we'll all agree these are the most recognized.

So the four are the CHFC, the CFA, the CIMA,, and CFP. So, going back, the CHFC, which is called a Chartered Financial Consultant, that's generally used by insurance professionals in our industry. If you look the CFA, which is a Chartered Financial Analyst designation ,that's generally used by Wall Street analysts, strategists, and actual portfolio managers who run the mutual funds.

Then we have the CIMA, which is the Certified Investment Management Analyst. Now, these are generally used by advisors who focus on portfolio asset management or asset allocation, and then you have the CFP, which is a Certified Financial Planner, which is generally used by advisors who focus on comprehensive financial planning.

Now, all of these designations are from an independent third party, and they require additional education and coursework. In addition, in order to get these designations, they need prior industry experience before sitting for the exams. And once they pass those exams, they have required continuing education to maintain those credentials.

RJ: So Lou, what kind of questions should people ask regarding the team they'll work with? It's a big decision as we know. Are there any standard questions or sources of information?

Lou: Yeah. You know, I'd like to lean on the Certified Financial Planning Board suggestions when it comes to asking the questions of advisors and they really, what they do is they recommend about 10.

The first one is, what experience do you have? What are your qualifications? What financial planning services do you offer? What's your approach to financial planning? What are the type of clients you typically work with? Will you be the only financial planner I work with? How will I pay for you?

For your financial planning services, how much do you typically charge? Do others stand to gain from the financial advice you give me? And finally, have you ever been publicly disciplined for any unlawful or unethical actions in your. 

RJ: Tell me more about that, Lou. What financial planning services do you offer? Why is it important? I've seen a lot of different services from some places. 

Lou: Well, you know, we're trying to define what the planner truly specializes in, is really by the services they offer. Meaning are they more focused on insurance? Asset management or comprehensive planning? 

RJ: Can you go into that a little bit more with a further explanation?

Lou: Sure. You know, it's not uncommon for a person, for example, to meet with an advisor who represents themselves as a planner, but essentially they're an asset manager or an insurance agent. Now, that's not a negative. If that's the primary purpose for that perspective client's needs. But if they're under the impression that they're meeting with a financial planner for a retirement or a comprehensive plan only to eventually realize that's not what the advisor specializes in, it can go sideways pretty quickly.

RJ: I'm curious about the word planner specifically. Financial planner, Is there an agreed upon definition or a legal definition? 

Lou: Well, recently there's been a lot of debate and attempt in our industry to define what a financial planner is. People may be surprised, but not everyone calling themselves a financial planner provides or even offers financial planning services.

So currently, The Financial Planning Association Board of Directors believes there should be a legal recognition of the term financial planner through what's called title protection. In acknowledging that everyone proclaiming to be a financial planner actually meets minimum standards that protect the consumers, and also it'll further advance the financial planning profession.

So, The FPA, again, the Financial Planning Association, is a professional organization for financial planners, and they're based in Denver. This organization, hopefully they can get it done, but we'll see if they can. It's really not an easy task as you may think. This should be easy, but not in all cases.

RJ: Thanks Lou. That really clears up the selection process now. What are the specific traits you should expect your planner to have? 

Lou: Well, again, I'm gonna defer to the Financial Planning Board, is they believe there are seven key traits a financial planner should have, which are competence, objectivity, integrity, clarity.

They should be diligent, compliance as well as privacy. So, these are the seven areas, but just for sake of time, looking at one like objectivity, your needs should be at the core of all your planner's recommendations. Your financial advisor should consider your situation carefully, giving you advice that best meets your goals, 

RJ: Lou, that makes a lot of sense. I think a person would assume this is always being provided. 

Lou: Unfortunately, not always. What's the old saying? Trust but verify. 

RJ: That's right. So the right traits, the right credentials, the right questions. I understand all of that, but none of this means much without a planning strategy.

Now, what should someone look for regarding their planning strategy? 

Lou: This is where it can be or become. I would call it a smoke and mirror scenario. 

RJ: What do you mean by that?

Lou: Earlier I mentioned knowing what the firm does, you know, in the services that they offer. I've seen many people meet with a firm expecting the firm to be planning driven.

However, the firm is truly an asset manager or an insurance organization. Again, no issues if they are that organization, whether it's, again, asset management and insurance, as long as they hold themselves out to be doing that to their perspective client. But what ends up happening often is that the firm prints off some, I dunno, some four page nothingness as a financial plan.

Only to get the assets moved to them, then they place it in the product that they're selling and the plan is never viewed again. So when thinking about the philosophy of the firm, discuss with the firm how they approach wealth management and financial planning. The alignment between your beliefs and the firms is critical to a relationship which is gonna be based on trust.

And you know, for an example, We subscribe to behavioral investing. We've talked about behavioral investing in previous episodes, but personally, I see our role as their financial behavioral coach. What we're doing is we're guiding them during times of both euphoria as well as fear, and we're helping to make decisions based on their family's long term financial plan, not today's most recent media manifested crisis.

RJ: You also mentioned firm types. Lou, I don't think people know or realize that there are a variety of firms to choose from. What are some of the choices and differences? 

Lou: Well, the last two, the firm type and compensation model are really tied together. 

RJ: I would imagine these last two are for many ,the most interesting. 

Lou: Yeah, they certainly can be. 

RJ: Now, what about the big brokerage houses? What are they and how do they operate? Who might they be good for?

Lou: I think the first thing people should understand is that Wall Street firms are brokerage firms, and they call 'em the big Wall Street brokerage houses.

They do not follow the fiduciary standard for their advisors. They adhere to what's called the Best Interest regulation. And they fought hard for this reduction in standard rather than the fiduciary standard, which is the highest level of oversight. So traditionally, it has come from those who hold themselves out as fiduciaries to other clients.

So unfortunately, what is happening here is this SEC, Securities Exchange Commission, that has recently implemented the best interest regulations. So the best way to explain the difference between the two things I'm talking about is really a quote from Ron Rhoades. He's a fiduciary law expert, who was interviewed in the June 2019, Think Advisor magazine as saying that the SEC has committed, in his words, the greatest securities fraud in history.

By adopting this regulation best interest, which he said is making broker dealers...he calls 'em pretend fiduciaries... who think their duty of care can be satisfied by just disclosing conflicts of interest, a belief that he feels is just ludicrous. In other words, he feels this regulation best interest that the brokerage houses follow is not enough to ensure that the advisor will adhere to all six of the duties outlined by that higher standard, which is the fiduciary standard. 

RJ: What is the alternative to a broker dealer? 

Lou: Well, you also have what's called registered investment advisory firms. We call 'em RIAs. An RIA acts in a fiduciary capacity, so RIAs are required to file a, it gets a little technical here, but file a form ADV.

With the Securities Exchange Commission and state security authorities in the state or any states that they operate. So among the information that's in this form ADV, what it's going to do, it's gonna disclose how the firm is compensated, the types of services provided, whether any disciplinary actions were or are taken against the firm.

RJ: Now, you mentioned this earlier, what is the fiduciary standard and why is that important? 

Lou: There's six core fiduciary duties. This is by the Institute for the Fiduciary Standard. And again, this is the highest level you can get when advising is this fiduciary standard. So number one is serving the client's best interest.

Then you go act in the utmost good faith, act prudently with care and skill and judgment of professionals. Avoid conflict of interest. You wanna disclose all material facts, and you also wanna control investment expenses.

RJ: How about resources for investors? Don't the large firms have greater resources than a smaller firm?

Lou: You know what? I think large or small, it's important to find a firm that fits your goals and objectives. Advances in technology and information essentially have leveled the playing field regarding any of the resources. 

RJ: Do people even need a firm? Since there are multiple online investment tools I can use myself?

Lou: You know, we suggest that people do their due diligence when investigating any online, what we would call do it yourself investment platforms when comparing them to, the different investment firms you can choose from. Make a list of what they offer as opposed to working with a team of financial planners or wealth managers with the years of experience that they may have.

If what they offer is all that's needed, then it may make sense just to use those, do it yourself online platforms.

RJ: And now to the common questions, fees, cost. Or the more commonly asked, how much will all of this cost me? 

Lou: Right. Right. This is usually what it comes down to. So, you know, there are a few different types of ways in our industry to pay for services, and I'll give you three of them.

They are the most common. One is called fee only. The next one is fee based, and the third one is commissions only. So when you do fee only, essentially you're covering what's called asset based fee, hourly or a flat fee. Many financial advisors charge a percentage of the assets that they manage in your or the portfolio.

When you go to a fee based, some advisors will charge a flat fee and receive a portion of the commissions you pay when you buy or sell the financial products that they recommend. Then the last one, Is going to be commissions only. Again, the commissions only, like I mentioned, that's sales commissions on investments the advisor buys or sells for you.

Again, you gotta think of it. It may give the advisor an incentive to recommend that something that you buy or sell more often. You never know. 

RJ: After all of this, Lou, where do you and your firm fit? 

Lou: We are a goal focused, planning driven firm. We're CFPs, certified financial planners. My firm is an RIA. We're a fiduciary, and we're fee only.

Our firm does well when our clients do well, and we simply must do the right thing for our clients all the time, not just some of the time. 

RJ: One more question, and Lou, this may be the elephant in the room. What's the value of a financial planner? Can it be quantified? What can someone expect? Is there a study that explains why having a financial planner may be a good choice?

Lou: There's really two studies that have been done on this because it's a great question and it's hard really to quantify what it is, right? A lot of the things that a planner can add really is the intangibles. But there's two firms, actually. One is the largest, everyone knows, is Vanguard. They actually did a study if there is value to hiring a financial planner.

The other one was Russell Investments. They also did a, very similar study. So instead of going through all the detail, I've written, a few papers on it and broken it down in detail. But essentially, Russell Investments said the value, the total value of an advisor by using them if they adhere to all these components, which I'll break down piece by piece, is 4.8% per year versus on average.

If you think about if you're getting 4.81%, let's call it 4.8 for just simplicity. If you're getting 4.8% per year in value by using that person, And the typical advisor charges on average, depending on where they're at, but let's call it 1%, that's a pretty good trade off. So how does that number break down briefly?

You have some components. One is the annual rebalancing of portfolio they found. That just by rebalancing your portfolio or having your advisor force you in ways to just automatically rebalance every 12 months, it adds 0.32% per year to performance. The next one is your behavioral mistakes. So if they can become that behavioral coach, like we're talking about, on average it's been just over 2% added to the portfolio. 

Well, what do I mean by that? Well, real simple. Like a time like today, when the markets are doing what they're doing, making sure clients don't behave themselves out of their portfolio and keep them invested for the longer term. That has traditionally added about 2% per year. The next one is the cost of investment only management, meaning that's about 0.29%.

Planning services is another one. Building a financial plan adds close to three quarters of 1%. And then the last one they put in there was called Tax Smart planning, meaning that choosing the best portfolios. Meaning is it a tax deferred, tax advantaged? Rebalancing, making sure you're keeping an eye towards the tax side of it, the tax management side.

So if you add all those up from Russell, it came up to about 4.8%. Now if you actually go into the study from Vanguard, it's not as high. They're about three, call it about three and a half percent is what they feel an advisor brings per year in value over and above. So one is portfolio construction. 

They say it's a little over 1%. The second one is just managing the wealth properly, which is just over 1%, and that the last one is behavioral coaching, which added the most, which is about in their calculation over 1.5% per year. This is a study they did back in 2014, by the way. So what you can see here, both sources, and I guess we'll stick with the Vanguard since it's the lowest value. So I'm not trying to cherry pick here. 

So essentially, As Vanguard, they're saying, Listen, if you do and adhere to what a planner's doing, and I'm talking about all the pieces, right? I'm talking about full blown planning, behavioral coaching, making sure you have low expense ratios on your mutual funds or ETFs.

If you're adhering to all those, you're gonna get about 3% to 3.5% annually returned. That intangible. On the other side of that, finally, if you are not gonna do that in all your interests that you have as an investor, is just building a portfolio I call asset management or asset allocator, and you're just trying to pick the stuff and that's it.

You know what? It may be the best thing just to go to an online service. That may be the best direction for you. So that's what they. 

RJ: Great. Now we've covered a lot of ground, but the four areas to look at when hiring a financial planner are team firm type, planning, strategy, and compensation model.

The right questions and curiosity can go a long way to hiring the right individual to manage your financial plan and your retirement strategy.

Lou: Exactly. 

RJ: So Lou, what are we going to cover in the next podcast?

Lou: Based on where we're at and I guess you could say, and what's going on in the economy and what's happening in the markets, I think the best topic to cover next would just be building the portfolio for retirement to match your plan, and more importantly, how do we take withdraws from that portfolio? So again, your money outlives you and you don't outlive your money. 

RJ: Great to talk with you again, Lou. 

Lou: Good to be here.

Jon: The information provided is for educational, informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.

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All investments include a risk of loss that clients should be prepared to bear. The principle risks of MPW strategies are disclosed in the publicly available form ADV, Part 2A. Generally among asset classes, stocks are more volatile than bonds or short term instruments. Government bonds and corporate bonds have more moderate short term price fluctuations than stocks, but provide lower potential long term returns. US Treasury bills maintain a stable value if held to maturity, but returns are generally only slightly above the inflation rate. This has been the Unpack Your Financial Baggage Podcast. Feel free to share this episode with someone you think it may benefit.

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