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TheStreet Open House

How to Compare Financial Advisers the Right Way

By Rick Kahler

NEW YORK ( AdviceIQ) -- Comparison-shopping is important before choosing a new refrigerator or lawn mower. It's even more essential before choosing an investment adviser. But don't believe you can compare investment returns, because you can't.

At any retail store, you can spot comparison shoppers a few aisles away. They are the ones carrying articles from Consumer Reports, badgering the salesperson with a million and one questions. People who manage money well are usually big fans of comparison shopping.

Unfortunately, there is no easily available consumer's report on advisers. Even more frustrating, those selling financial products often have incentives not to be forthcoming with the information that is crucial for comparison.

One aspect of shopping for an investment adviser is knowing what questions to ask. One common mistake is to focus on investment returns. Shoppers may ask for the average recent returns of the adviser's portfolios or may want to know whether the adviser's returns beat the market averages.

There are several problems with focusing on returns. First, the numbers mean nothing without also knowing how much risk the adviser took to produce the return. It's like someone on a diet focusing only on fat grams without regard to total calories. Consuming 10 soft drinks in a day may give you zero fat grams, but you could easily exceed your daily calorie limit before eating one bite of food.

Second, any unscrupulous adviser can put together a portfolio consisting of the hottest investment classes over the past 10 years and show you how fantastically they did.

Third, whether an adviser beats the market is overrated. Why? In 2012, only 63% of large-stock funds beat the Standard & Poor's 500 index, a shortfall that occurs year after year.

Just finding an adviser who has done so means you found one who confounds these overwhelming odds. If you find such an adviser, realize that few funds repeatedly beat the market. Logically, few advisers can either.

Fourth, some financial advisers may show you a phenomenal track record for the short term (under 10 years). Since wise investing focuses on the long term, beating a market benchmark like the S&P 500 over a short term isn't necessarily significant.

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