Editor's Note: The following is part two of a guest post (you can read part one here) from Ryan McPherson, CFP®, EAa financial advisor and the founder of Intelligent Worth, a fee-only fiduciary planning firm in Atlanta, GA. He works with young(er) professionals, focusing on attorneys, starting in the early and expansion stages of their careers and adult lives. Additionally, he is a member of NAPFA and the XY Planning Network. I've had a couple of phone conversations with him and felt like he understood the role of a modern financial advisor, so I asked him for the warning signs to look out for when someone is interviewing/talking with a potential financial advisor. His article does not disappoint. It's so good that I decided to break it up into two parts. Ryan and I have no financial relationship.
When managing your money, your advisor should use a third-party custodian. Custodians have numerous protections in place to safeguard your assets. Your advisor should not take custody of your investments.
When transferring assets for your advisor to manage, the transfer paperwork (and/or check, if applicable) should be made out to the custodian which the advisor uses. TD Ameritrade, Charles Schwab, and Fidelity are three of the more commonly used custodians.
You should receive physical or electronic statements at regular intervals from the custodian. Also, you may call the custodian holding your accounts directly at any time to verify your investment balances.
(It’s important to note that using one custodian over another does not impact the performance of your underlying investments and does not safeguard against investment losses.)
11 – Unclear on overall process
An advisor should be able to easily describe her process for onboarding and working with clients. While the presence and priority of many items will be client-specific, the framework for analyzing your financial life should be well-defined.
Before becoming a client, ask the advisor for a template or generic outline of how she works with clients.
12 – Investments only
While investments comprise an important part of your financial picture, they’re merely one component.
If conversations focus on investments when you’ve raised other relevant issues, e.g., six figures of student loan debt and/or cash flow planning surrounding a job change – find an advisor who readily incorporates these non-investment topics.
Also, stay away from advisors who base their value propositions on investment performance (Biglaw Investor: Stay far, far away). This often indicates they do little beyond investment management.
13 – Murky investment process
Avoid anyone who cannot or will not explain their investment process thoroughly.
Additionally, if an advisor waivers between differing investment philosophies, attempting to appease current or prospective clients, find someone else. You want to hear conviction to a viewpoint.
An advisor should be able to articulate her investment management process (at least in summary) quickly and crisply. You should come away knowing:
- Types of investment vehicles used (individual stocks and bonds, mutual funds, and/or ETFs);
- Underlying philosophy driving her strategy (active, passive, evidence-based, or something else);
- Rebalancing frequency;
- Range of internal expense ratios for her models – this is in addition to any advisory fees; and
- Presence and frequency of any additional fees or charges.
Investment processes will naturally vary among advisors. Just be sure you understand and are comfortable with how your money will be managed.
14 – “I’m an old school stock picker.”
Just say no.
You’ll hear this less now than you did 10-15 years ago, but some advisors still build portfolios with individual stocks and bonds.
You do not want your advisor picking stocks. Even if you fully believe in active investment management, you want your advisor to utilize professional fund managers. A financial advisor does not have the team, infrastructure, time, training, or other resources needed to operate a security selection business.
15 – Doesn’t work [well] with other professionals
Luckily, this is becoming rarer as most advisors understand the need to share information and coordinate with their clients’ other professionals.
Your advisor should serve as your financial manager or quarterback, engaging subject matter experts in student loan analysis, law practice management, taxation, asset protection and transfer, lending, and insurance, among other topic areas, as needed.
If an advisor refuses to collaborate with others or is even hesitant to do so, find someone else.
16 – Neglecting your career
For most early to mid-career attorneys, your largest asset is the earning power afforded by your law degree. Your potential lifetime income, especially for those in Biglaw environments, can easily stretch into the mid-to-high 7-figures.
Your advisor should help you assess your compensation to ensure you’re being paid fairly for your experience and the geography in which you’re practicing. She should also help you understand the financial impact of switching to a smaller firm or going in-house.
(Biglaw Investor: While maybe not the kind of things that rise to “red flag” level, Ryan also has a list of yellow flags that should give you nearly as much pause as the first 16 he listed.)
1 – Asset-based fees, net worth and income-based fees, and hourly fees
a – Asset-Based Fees or Assets Under Management (AUM) Fees
Under this arrangement, an advisor charges a certain percentage on the investments she manages for you. Logistically, a 1.00% annual fee would be charged in quarterly increments of 0.25%.
Asset-based fees come with a conflict: your advisor is incentivized to gather and retain assets to generate fees. Withdrawing money from investments to pay off high-interest debt, invest in a business, or for any reason will reduce an advisor’s revenue and thus compensation. This may yield skewed recommendations.
Further, advisors using asset-based fees may be motivated to have you roll over old 401(k)s for them to manage (and charge on). This prevents you from taking advantage of backdoor Roth IRA contributions due to the IRS’ pro rata rule.
Even with the best advisors, asset-based fees often place too much emphasis on investment management when other areas of your financial life require and deserve more attention.
b – Net Worth and Income-Based Fees
Using net worth and income as proxies for complexity, these fees attempt to incorporate more of your financial life than just investments into setting your fee. This is a step in the right direction.
Unfortunately, these fees end up compensating advisors for progress for which they are not responsible. For example, if you own a house/condo, over the course of a year your monthly mortgage payments will reduce the principal balance of your mortgage. Holding the value of your home constant, your home equity should rise, increasing your net worth. Further, Biglaw raises and bonuses may substantially boost your income. So, in this example, your net worth and income have risen (which is great!), except that your advisor gets paid more.
This doesn’t make much sense. You didn’t pay your mortgage because of your advisor. You paid it because you didn’t want to lose your home. Your performance at work, factoring into your raise and bonus, also has nothing to do with your advisor.
c – Hourly Fees
You’re all experts here. The pitfalls of hourly billing present in law, consulting, and accounting exist when financial advisors use this fee structure as well.
2 – The exception client
This one can be tough, because your ego gets involved.
Here’s what happens…a prestigious wealth management company in your area, focusing on clients with at least a few million dollars to invest, invites you to become a client. Maybe some of the equity partners at your firm are clients. It’s exciting…the wealth management firm is making this exception, because they see so much promise in you.
You’re flattered because you’re still hammering away at your law school loans, just maxed out your 401(k) for the first time, and are about 7-figures away from having the net worth of this firm’s usual client.
However, behind the scenes, this doesn’t create a great situation. As a client, you generate a small fraction of the revenue as one of the firm’s average clients. This often leads to less responsive and less comprehensive service, as the firm’s larger (and more profitable) clients receive more attention.
Further complicating matters, such firms are usually geared toward the needs of later career or retired clients…not those with student loans who are contemplating their first home purchase and the financial impact of having their first child.
You don’t want to be the exception here. You want to be an advisor’s normal or ideal client.
3 – Publicly-traded firms
To drive their stock prices higher, publicly-traded companies strive to surpass analysts’ quarterly and annual earnings estimates. This is largely accomplished via a combination of cost cutting and revenue boosting initiatives.
An advisor working within a publicly-traded firm will eventually feel this, even if tangentially. Cost cutting may remove an advisor’s assistant or overburden the assistant with supporting multiple advisors. Either way, this will negatively impact responsiveness and administrative processing times. More overtly, certain companies will motivate advisors with favorable bonus arrangements to sell proprietary products and/or cross-sell home and auto loans.
You don’t want these pressures influencing your advisor.
No worries, I know you’re busy.
If you’re looking for an advisor, find one via NAPFA (National Association of Personal Financial Advisors) or the XY Planning Network. Both require that members are credentialed, operate fee-only practices, and sign fiduciary oaths. From there, use an advisor who understands attorneys and charges a fixed or flat fee.
(Biglaw Investor: Thanks again to Ryan McPherson for such a detailed write-up. I know a lot of lawyers are going to benefit from this list.)
Joshua Holt is a practicing private equity M&A lawyer and the creator of Biglaw Investor. Josh couldn’t find a place where lawyers were talking about money, so he created it himself. He spends 10 minutes a month on Personal Capital keeping track of his money. He's also exploring real estate crowdfunding platforms like Fundrise which are open to both accredited and non-accredited investors.