Investment Advisor
Key Points
• “Investment advisor” (sometimes spelt “adviser”) is a legal term which refers to any person or organization who makes recommendations or provides analyses on investments in return for compensation.
• Investment advisors’ primary objective is to create investment portfolios that are calibrated to their clients’ financial goals.
• Investment advisors tend to be paid according to an assets-under-management (AUM) fee — usually around 1% of their clients’ portfolios.
• Those who benefit most from investment advisors are those with large, complex asset pools, who want to be sure their money is working as hard as it possibly can.
• Trust and compatibility are the most important elements of a client-advisor relationship.
“Investment advisor” (sometimes spelt “adviser,” as in The Investment Advisers Act of 1940) is a legal term which refers to any individual or organization that makes recommendations or provides analyses on investments in return for compensation. This is the definition as set forth in the aforementioned legislative act, put into law during Franklin Delano Roosevelt’s time in office, largely in response to the unethical behavior that contributed to the stock market crash of 1929 and consequently the Great Depression. The law was designed to prevent future wrongdoing, including insider trading and investment advice that did not meet strict regulatory criteria.
Legislation from around the same time established the Securities and Exchange Commission (SEC), the regulatory body which oversees investment advisors. As of the time of writing, investment advisors must register with the SEC at the point when they manage assets which collectively total $100 million or more (investment advisors with smaller totals must only register with state regulators). Upon completing this registration, investment advisors classify themselves as Registered Investment Advisors (RIAs), an important distinction that connotes an adherence to ethical standards.
Investment advisors often assume discretionary authority over their clients’ investment portfolios, meaning they have the power to buy and sell securities without receiving separate permission from their clients for each transaction. Because of how consequential this level of authority can be, investment advisors are held to the fiduciary standard. The fiduciary standard stipulates that all recommendations, decisions, and transactions be entirely in the clients’ best interests, never leading to any conflicts of interest between the client and the advisor. If an investment advisor is found to have violated this agreement in any way, they can be subject to steep penalties. Discretionary authority is typically granted during the initial onboarding process; fiduciary guidelines ensure that this authority is put to good use.
Investment advisors are usually paid according to an assets-under-management (AUM) fee. This means that they receive some percentage of a client’s total assets — around 1%, in most cases — in yearly compensation. Because investment portfolios tend to grow at an average rate of 7% per year, this arrangement works out well for both clients and advisors, both of whom benefit more than they would otherwise. AUM fees are distinct from commission or transaction fees, by which certain other financial advisors are paid. These financial advisors — called “fee-based” advisors, distinct from “fee-only” advisors — are held to the much less stringent suitability standard, which permits room for conflict of interest. As a result, many clients favor fee-only investment advisors and financial advisors.
Those two terms — investment advisor and financial advisor — sound similar, but have important distinctions. “Investment advisor” is a legal term which implies the regulatory oversight detailed above. “Financial advisor” is a generic term which does not necessarily imply any regulatory oversight or additional certifications. Many financial advisors opt to receive additional certifications — especially in recent years, as these certifications have become much more desirable among clients — but it is not legally required of them. To determine whether an investment advisor is registered with regulatory bodies, consult the Financial Industry Regulatory Authority’s BrokerCheck.
What is it Like to Work with an Investment Advisor?
As with other professionals who provide advice on financial matters, investment advisors’ first objective is to understand what their clients want to get out of their investment portfolios. It may seem like all investors want basically the same thing — to make more money — and while, on some level, this is true, the choices people make about their investment allocations should be based on specific personal and professional financial goals. Depending on a person’s family dynamic, career stage, homeownership objectives, and more, investment allocations may differ considerably.
For example, a single person in their early thirties will probably invest very differently from a married person in their mid-fifties. Generally speaking (it’s important to remember that no investment advice is universally applicable, and to take each general rule with a grain of salt), younger people allocate their investment portfolios more aggressively, taking on more risk in return for more possible reward in the long run. People nearing retirement often invest more conservatively, shifting their assets to low-risk, fixed-income vehicles that are subject to less volatility. People in the early stages of their careers want to grow their assets as much as possible because they will not need to access them for a long time. People in the latter stages of their careers want to conserve their assets, as they will soon have to access and live off the money in those accounts.
Because of how dramatically people’s investment priorities can differ, the first step in working with an investment advisor is for the client to lay out, in definite terms, their financial objectives. Sometimes, they may not have a clear idea of their objectives beyond that generic goal of growing their portfolios. That’s okay — investment advisors are trained to ask questions that guide a person through their various options, sussing out which path is most aligned with their goals.
Upon arriving at this level of comprehension, investment advisors will draw up a plan for allocating the client’s assets. This plan will be calibrated to the client’s stated level of risk tolerance. The client will have an opportunity to review this plan before it goes into effect, asking clarifying questions or making requests to adjust certain of its facets. Once the client approves the advisor’s plan, the advisor begins to implement the changes.
As with all types of financial advising, the relationship between a client and their investment advisor and is an ongoing, evolving one. At the very least, the two will meet on an annual basis to review the investment allocation plan, determining whether it is performing in the way they hoped/expected it to. More likely, clients and advisors will speak more frequently than that, whether to address questions about market fluctuations or review lifestyle changes (marriage, homeownership, kids going to college, etc.). Investment advisors work most effectively when they have an intimate, current understanding of their clients’ lives.
Do I Need an Investment Advisor?
Whether or not you need an investment advisor depends largely on the complexity of your financial situation. Investment advisors excel at dealing with large asset pools, and determining which among thousands of potential investment approaches is superior. So, if you have a relatively small — say, sub-$200k — pool of assets, you likely won’t be able to reap the full reward of working with an investment advisor, and the fees may not justify the upside. However, if you have a fairly large asset pool, high income, and want to be sure your money is working as hard for you as it can, you will likely benefit more from an investment advisor than from handling it all on your own.
A primary value proposition of investment advisors is that they have years of investment training and experience, and sophisticated financial technology at their disposal that allows them to project the implications of different investment choices over the span of several decades. Mobile apps and other DIY investment services give the false impression that all investment is tantamount to gambling — that investors pick stocks on little more than a hunch, and pray that, over time, the stocks perform well. This is a false and damaging understanding of how investing works. While there is always an element of uncertainty in investing, this can be reduced significantly by taking a diversified, well-informed approach to asset allocation. Investment advisors who spend their lives understanding market behavior as well as the virtues and vices of different asset classes are most qualified to build these kinds of portfolios.
How Do I Choose an Investment Advisor?
Individuals who intend to hire investment advisors should look for a few main criteria:
• Experience. Does this investment advisor often work with people like you? While many investment advisors are broadly trained and capable of working with a range of clients, investment advisors who tend to work with people in your demographic will be that much better prepared to address your investment goals.
• Certifications. Does this investment advisor have any certifications that evidence their ethical stringency and knowledge base? While possessing a certification does not necessarily mean one investment advisor is superior to another, it does at very least demonstrate a deep commitment to the profession, and a willingness to invest an enormous amount of time and energy in developing expertise.
• Compatibility. Perhaps most importantly of all: Do I like this investment advisor? Many investment advisors possess similar levels of experience, similar certifications, and similar technological tools. What defines good client-advisor relationships is mutual admiration and trust.