07 Oct How to Choose the Right Active Manager
If you’ve read our blog “Invest Better: Active vs. Passive Strategies” and have decided that active investing is the right approach for you, you will need to ask yourself one question, “should I do it myself or should I hire an advisor?” The answer to this question will primarily depend on your level of investing experience and the amount of time you can dedicate to investment research. But successfully investing in the stock market is difficult, even for professionals. Therefore, for active investing, we think hiring an advisor is the smarter choice. But finding the right investment advisor can be a daunting task, especially if you don’t know what to look for. So, how can you find a great advisor? We suggest focusing on four criteria:
– First, look for an advisor you can trust. It’s important to ask if an advisor is a fee-only advisor or a commission-based advisor because fee-based advisors are considered fiduciaries. That means they are legally required to act in your best interest. But commission-based advisors are only required to act in the best interest of the company’s they work for. This means they often have incentive to put you in more investments and trade more frequently than is necessary in order to increase their commissions. It’s also essential to choose an advisor you feel comfortable with. They should be able to answer any questions you have in clear, simple to understand language. If you walk away from a meeting with an advisor confused or unsure about anything, it could be a sign that they are either confused themselves or don’t have your best interest at heart. – Second, look for someone who has an investment approach that makes sense to you. For instance, find out if your advisor invests for the short-term or the long-term? Do they invest in mostly stocks or bonds? Do they invest in mutual funds and ETF’s or individual stocks? Are their investments focused on large companies, small companies or both? Do they invest domestically or internationally? Are they diversified or concentrated? Why or why not? In other words, your advisor should have a well articulated strategy to reduce risk and maximize potential returns in your portfolio. – Third, try to find an advisor with competitive fees. Most firms charge fees based on a percentage of assets under management (i.e., the size of the portfolio they’re managing). And typically this fee is 1% – 2% per year. But if your advisor uses mutual funds or exchange-traded funds you’ll also be responsible for the costs associated with those funds. And the average cost of a mutual fund is 1.25%. Simply put, if you use a traditional investment advisor you could be paying out anywhere from 2.25% – 3.25% of your portfolio every year. And if you’re invested in one of the 84% of funds that under-performs, those fees are excessive. Which brings us to the final criteria… – Fourth, look for an investment advisor with a solid track record of performance. Ask to see the composite returns of your advisors discretionary accounts, net of fees and relative to a benchmark for as many years as possible. If you have trouble understanding the report, ask the advisor to explain it clearly. While past performance is not a guarantee of future results, the report should give you a sense for whether the advisor has maximized returns for their clients and earned their fees in the past. And that’s it. You now have the tools you need to find a great investment advisor. If you’re ready to start your search, check out this article for tips on where to look: How to Find and Choose a Financial Advisor.