Top 5 ways to keep your financial advisor, stock broker or money manager honest

Posted on August 11, 2008 at 1:43 PM PST by

I believe that everyone, no matter how much investment experience they have, should learn how to take control of their investing, buy a well diversified portfolio of index funds, periodically rebalance their portfolio, and allow their money to compound without fees. So do Warren Buffett (read what he wrote about fees), John Bogle, David Swensen, and other investment industry luminaries. This is because the fees charged by the financial industry, over time, decimate investment returns.

But many people just want investment advice. Most people will spend more time shopping for a car on the weekend to save $1000, than to understand the true cost of the investment advice they are receiving on the nest egg that they’re spending their entire working lives building. If you must, here are some tips that I think will help you minimize the damage and give you a shot at having a successful relationship with your stock broker, financial adviser or investment manager.

1. Show Me The Fees. If your financial adviser is charging a fee to oversee your investments, he is probably investing your money in mutual funds that also have fees. Ask for a comprehensive list of all the fees you are paying each year including each fund, its fees, and his fees. Try to get these aggregate fees below 2% per year. My friend has a $6 million account with one of the largest four brokers and to make my
point, I calculated his mutual fund fees, loads, and fees to his advisor. Last year he paid about $138,000! He is considering switching to index funds and where he would pay $18,000 per year.

2. Get Invoiced. Most financial advisors “debit” your account either in advance of the quarter or month. Ask them to send you an invoice and write them a check. That way you’ll stay aware of the cost for these services.

3. Show Me The Commissions. Ask your adviser to disclose the exact amount of commissions, credits
or any form of compensation he or she is paid as an incentive for having you invest in a certain financial product like a mutual fund, annuity, or life insurance product. Also ask for the cost of an index fund alternative so that you can understand exactly what it is costing you to be “sold” a particular product and so that you can justify its price in the future.

4. What’s The Tax? The average turnover for a mutual fund is 70% a year. That means nearly all stocks in a portfolio are sold each year and traded for other stocks. Turnover can create taxable income at year end. Each February, after these taxes are known, give your financial advisor your federal and state tax rates and ask him to calculate the taxes generated turnover from your funds. Then sell down these accounts in the amount you need to pay the taxes so you will be able to know the true after tax returns. After all, that’s what you keep.

5. Benchmarking — Compared to What? Many investors are happy when they make money in a fund. But that’s how amateurs think. Endowments and elite institutions manage their money managers against a benchmark who, net of fees, should outperform a comparable index fund which charges almost no fees. Have your financial advisor pick a benchmark for each fund and measure your adviser’s fund picking skills against how well that fund did against the benchmark. For example, the largest diversified emerging market funds have been up between 25.3% – 35.06% over the last five years. Vanguard’s Emerging Markets Stock Index (VEIEX) was up 29.24% including fees of .35%. So if you are happy that you’ve compounded for 5 years at 25.3% with American Funds New World (NEWFX), you shouldn’t be because you lost 4% paying someone trying to beat the market including the 1% you paid in fees.

If your stock broker fashions himself as a stock picker, ask him for a benchmark by which to judge his performance. For example, if he or she is picking large cap US stocks, then buy a token amount of the S&P 500 Index Fund (NYSE:SPY) in the account and measure his yearly returns against the yearly returns of this index.

If the requests I’m suggesting that you make of your adviser or stock broker make you uncomfortable, that’s no reason not to make them anyway. These are reasonable ways to hold your advisers accountable. Just think of the discomfort you’ll feel if in 15 years, a good chunk of your retirement nest egg has been siphoned away in fees!