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.

If so many games can be played around returns, what questions should a savvy comparison shopper ask? Focus on one word: transparency. You want to find out if the returns, costs and risk (standard deviation) of your portfolio are clearly displayed and contrasted against appropriate benchmarks.

Here is how to accomplish that goal. Most advisers have model portfolios. Ask them to show you the standard deviation and the expense ratio of their model over five and 10 years. Ask them to contrast the return of the portfolio against a similar benchmark. For example, if the portfolio has U.S. stocks, U.S. bonds, and foreign stocks, have them compare it to a benchmark of indexes that cover those asset classes.

Next, either ask the adviser to run a similar analysis on your existing portfolio or have one done independently. You may even have done better than the adviser's model.

Ask the adviser to disclose all fees, in addition to the expense ratios charged by mutual fund or sub-account managers. You need to find out how the adviser is paid and how much. Ask whether there are any wrap fees, transaction costs, administrative fees, mortality fees, redemption fees, annual 12b(1) fees, surrender charges or up-front sales charges.

Don't be surprised if you get a bit of resistance when you ask for all this information. Brokerage firms, life insurance companies and many commission-based advisers don't have much incentive to give you this data and may not even be able to.

If you don't get clear disclosure on fees and costs, keep asking. If you persist and still don't get understandable answers, you may need to do more comparison-shopping before you choose an adviser.

-- By Rick Kahler, CFP, president of Kahler Financial Group in in Rapid City, S.D.

AdviceIQ is a network of financial advisors that writes insightful articles for the public about investing and wealth management. All articles are edited by AdviceIQ's editor in chief, Larry Light. AdviceIQ certifies that all its advisors have no regulatory infractions.

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AdviceIQ is a network of financial advisors that writes insightful articles for the public about investing and wealth management. All articles are edited by AdviceIQ's editor in chief, Larry Light. AdviceIQ certifies that all its advisors have no regulatory infractions.

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