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financial advisor teamOver the last few years, many investors have re-examined not only their investment assumptions, but also their relationships with their advisors. Volatility in the market often leaves many investors uncomfortable with the idea of simply staying the course with their current plan (if they have a plan).

In our experience, investors tend to make three common mistakes when evaluating their advisors: 1) getting too caught up in past performance; 2) failing to understand the scope of your relationship with your advisor and the fees you pay; and finally, 3) ignoring what really matters—your net return.

If you are considering changing or revisiting your investment strategy, or just value a second opinion on your current strategy, we hope this article will prove helpful. We will expand on the missteps made by many investors and provide suggestions on how to avoid making the same errors.

  1. The Dangers of Reviewing a Firm’s Past Performance
    A common mistake many investors make when evaluating or selecting their investment advisors is to overrate the importance of an advisor’s recent returns. There are several reasons why this approach is flawed:The time frame may be too short. When looking at an investment’s track record, many clients will ask for gross returns (already a mistake – see below) on a one-, three- and five-year basis. This is simply not enough data to make any concrete conclusions about skill versus randomness or even luck. In fact, ten years may not be enough. An in-depth examination of this issue is well beyond the scope of this short article. However, if you are truly interested in learning more about why such measurements must be looked at over decades, and why most investment performance claims may be based in luck, we recommend you read the best-selling book Fooled by Randomness by Nassim Taleb.Comparisons of results are likely not apples to apples. Even the common question, “how did your portfolio perform (last year)?” can lead to misleading answers in cases where portfolios are designed for individual clients. For example, many of our clients have customized portfolios — based on their risk tolerance, age, time horizon, tax bracket, objectives and a variety of other considerations. Because of this customization, it is entirely possible that Client A could see returns of 3 percent and Client B could have a portfolio gain of 20 percent over the same period. Both investors could be equally satisfied (or dissatisfied) and neither of these results may give you any helpful advice about your particular situation. Only in situations when two investors have very similar goals, circumstances and objectives is any comparison worthwhile.Past performance is no guarantee of future results. Anyone who has ever watched an investment firm’s commercial on television, listened to an advertisement on the radio or read one in a newspaper or magazine is familiar with the phrase “past performance is no guarantee of future results.” While this can be easily discarded as legalese by consumers, it is fundamental for investors to understand.Performance chasing can be detrimental to an investment portfolio. You cannot tell which asset class will have the highest returns, or the lowest, by simply looking at recent historical data. This alone makes a strategy of chasing asset class-focused funds and managers based on their past results dubious at best.
  2. Failure to Reassess and Objectively Evaluate the Relationship with Your Advisors.
    It is easy to gravitate towards advisors who are friends and family or friends-of-friends. It is also easy to become complacent in an advisor relationship and stay with someone longer than you should. Below we identify the most important factors in evaluating your relationship with your financial advisors.Two-way communication is a fundamental element of client service. When polled, most clients of any professional advisor –attorney, CPA, or financial advisor – name “timely and effective two-way communication” as an essential element of a fruitful working relationship. Still, many investment advisors seem to focus more on returns. Even for those advisors who value customer service, certain business models within the investment business make such communication almost impossible.As an example, consider the entire mutual fund industry, which many utilize for a substantial portion of their investment portfolios. What communication does one get from such a fund – prospectuses, monthly and annual statements, perhaps a newsletter? Is there any individual consultation with investors on the portfolio mix or the tax impact of the buying/selling within the fund or the impact sales could have on an investor’s tax liability? Generally, the answer is no. This is because the fund industry is built on a low-cost low-service model where two-way communication with the fund managers is cost prohibitive and rarely permitted.When choosing an investment advisor to manage your portfolio, even if this choice involves finding assistance in the management of mutual funds or ETFs within a portfolio, one should expect much more communication as a fundamental element of client service. This doesn’t simply mean that the advisor calls you when there is a hot new buy (as stockbrokers are notorious for). Rather, one should expect a defined communication process throughout the year that is independent of trade suggestions.A transparent and client-aligned business model is a must. Given the troublesome conflicts of interest that have come to light in the investment industry over the past few years, we feel that all investors should work with financial firms that use a transparent business model and one that aligns the firm’s interests with that of their clients. There are key elements to look for in such an arrangement:

    • Independent Custodian: Ideally, an investment firm does not act as custodian (i.e., hold) its clients’ investments in the firm. Rather, the firm should have arrangements with several of the largest independent custodians (such as Charles Schwab, TD Ameritrade, etc.) to hold their investments for safekeeping, while the investment firm manages the accounts. The inherent checks and balances of this type of arrangement prevent the insular secrecy that allowed Madoff, Stanford and other criminals to operate.
    • Client-Aligned Fee Model: Many investors today are realizing that a clear fee-based model works best for them. Under such an arrangement, advisors charge a transparent, clearly-defined fee on assets they manage. Contrast this with the traditional convoluted transaction-charge model that most brokers utilize where a client pays based on trades in the account, regardless of whether the trade added value or not. In a fee-based model, not only do clients understand exactly what the fee is, but they also understand that the firm’s interest is the same as theirs – seeing the portfolio increase in value. The annual management fee the investment firm earns is a percentage of the assets you have in your account with them. The more money you have, the more money the firm earns. Ask yourself: do you feel more comfortable paying advisors a set fee or commissions based on the number and size of the trades they make?
  3. Ignoring What You Keep—Your NET Returns.
    Many investors focus primarily on management fees and expenses when evaluating advisors. For most investors, the annual fees might range from 50 basis points (0.5 percent) on the low end (very large portfolio in a fee model) to 300 basis points (or 3.0 percent) on the high end (mutual funds can be this high, as can broker transaction costs). Though this huge expense range (600 percent variability!) is one reason why we are so adamant about the AUM-based fee model above, this is not an investor’s largest expense. Rather, taxes usually are.The cost of federal and state income and capital gains taxes on a portfolio depends on many factors – the underlying investments, the turnover, the structure in which the investments are held, the other income of the client, the client’s state of residence, and more. For higher income investors, taxes will nearly always be high. To gain perspective of how much taxation reduces your returns, consider this: Over the period from 1987-2007, stock mutual fund investors lost, on average, 16-44-percent of their gains to taxes.The nine-year recovery of the U.S. stock market has exacerbated this problem for investors in the top tax bracket. All-time highs in the S&P 500 mean mutual funds are no longer carrying losses to offset gains, and many funds passed on significant capital gain distributions to investors in 2017. High net worth investors should expect significant capital gain distributions from many funds in the fourth quarter of 2018. Mutual funds will release an estimate of the anticipated capital gain distribution, prior to disbursing the payment. Investors (or their advisors) should be looking for this information in October or November each year.Given that some investors are losing between one sixth and nearly half of their gains to taxes, one would think this would be a focus of value-added investment firms. Unfortunately, mutual funds themselves provide no tax advice to their investors. They provide only 1099 tax statements in January. Even stockbrokers, money managers, hedge fund managers and financial advisors at the nation’s largest or most prestigious niche firms do not offer tax suggestions – and their compliance departments are glad they don’t – because they are prohibited from doing so. Tax advice could include specific techniques for limiting tax consequences of transactions or more general tax diversification in portfolios. Because of these limitations, most investors are not getting the tax suggestions they want.But don’t investors want this tax focus from their investment firms? What is more important to you: the gross return your investment firm boasts in its marketing materials or your net after-tax return? Unless you want to give more to state and federal governments than you need to, the net after-tax return is the only measure that should truly matter.With full disclosure, our firm is one that understands the focus on after-tax returns, and that is one reason we have a CPA on our team. Since capital gains taxes remain the same under the 2017 Tax Cuts and Jobs Act, we would expect more investors to look for tax expertise in their investment team.

We advise you to remain vigilant and to continuously monitor and evaluate your plan and your advisors. We trust that if you focus on the right factors, you can make intelligent, well-informed decisions. The authors welcome your questions.

Visit our online bookstore to secure a copy of Wealth Management Made Simple, Wealth Planning for the Modern Physician, or one of our other books.

Jason M. O’Dell, MS, CWM is a financial consultant and author of more than a dozen books for physicians, including For Doctors Only: A Guide to Working Less and Building More. He is a principal of the wealth management firm OJM Group (, where Andrew Taylor, CFP® is a wealth advisor. They can be reached at 877-656-4362,, or