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Checking out an Investment Adviser: Form ADV Part II

Editorial note: We discussed this topic a couple years back, but a few reader emails have made me realize it’s time to cover it again.

When researching a registered investment adviser (RIA), in my opinion the single best first step you can take is to read the RIA’s Form ADV Part 2.

Form ADV is a form that investment advisers have to file with the SEC. Part 2 of the form contains most of the important information that you’d want to know about an investment adviser. For example, you can see:

  • How the adviser charges for his/her services (hourly, fee-for-service, percentage of assets under management, etc.),
  • How much the adviser charges for his/her services (e.g., if it’s hourly, what is the hourly rate?),
  • What services the adviser offers (e.g., if you’re paying 1% per year, are you getting comprehensive financial planning? Or is it just portfolio management, and you would have to pay extra for other financial planning services?), and
  • The adviser’s investment philosophy (i.e., how they pick investments and how they allocate between those investments).

What’s nice about this form is that it’s a way to get the relevant information quickly, without having to filter through a bunch of sales talk (as you would often have to do if you visited the adviser’s website), and without having to give the adviser your contact information.

How to Find an RIA’s Form ADV Part 2

Downloading an RIA’s Form ADV Part 2 is easy:

  1. Go to the SEC’s Investment Adviser Search website.
  2. Look up the adviser by firm name.
  3. Click “get details” then “Part 2 Brochures.”
  4. If necessary, click the link for the most recent brochure filed.

How About an Example?

Let’s say you recently read Allan Roth’s book How a Second Grader Beats Wall Street, you liked it, and you’ve decided to include Allan’s firm Wealth Logic as one of several firms you’re considering. But first you want to find out a bit more about his practice, how much he charges, and so on. So you look up Wealth Logic on the SEC site and download the ADV Part 2 brochure.

With regard to how Allan’s firm charges clients, you find the following plain-English statement:

“All fees are hourly or fixed dollar to minimize any conflicts of interest. No additional profits can be made as a result of the advice rendered. The hourly rate is currently $350. This rate is both negotiable and can be capped for a period of time. All fees are due within 30 days of the billing date and a retainer amount may be requested.”

It’s clear and to the point. And if, for example, Wealth Logic instead charged a fee based on the amount of assets under management, there would be a table showing exactly how that fee is calculated.

With regard to what types of investments Allan’s firm recommends to clients, you’ll find the following statement:

“Minimizing expenses and emotion, and maximizing diversification, are core methods Wealth Logic applies in designing portfolios. Broad index funds of mutual fund and ETF categories are those most often used in the practice, as well as Bank and Credit Union CDs going directly to those institutions insured by the FDIC or NCUA.”

Again, it gets right to the point with very little fluff.

Looking up a registered investment adviser’s Form ADV Part 2 should certainly not be the only research you do on an adviser. But it’s an excellent first step to quickly check for things that would eliminate the adviser from consideration (e.g., an important conflict of interests, fees that you think are too high, a minimum asset level that you don’t meet, or an investment philosophy that’s markedly different from your own).

Professional Financial Advice: How Much Should Investors Pay?

I recently had email discussions with two different financial advisors regarding how much investors should be willing to pay for financial advice.

  • The first advisor asserted that an annual fee of 1-1.5% is justified because advisors are likely to improve their clients’ investment results by at least that much by helping them build better portfolios and avoid mistakes.
  • The second advisor argued that, based on simple economics, if customers are willing to pay a given fee, that means that his services are worth that amount of money. (In other words, if the market will support a given fee level, it’s justified by definition.)

Those arguments might make sense from the perspective of an advisor trying to set his/her fees. But from the perspective of the investor, the answer is more obvious: Why pay any more than you have to?

The Do-Everything Advisor

Many financial advisors charge annual fees of 1% (or more) of your portfolio balance per year. In exchange, they provide portfolio management services as well as ongoing financial planning advice.

Such an arrangement can make sense if you need both services. Otherwise, it’s often less expensive to break the services out and pay for them separately.

Help Building a Portfolio

If all you need is help with putting together a portfolio, it’s hard to beat Vanguard’s financial planning service. If you have more than $500,000 in assets with Vanguard, the service is free once per year. If you have $50,000-$500,000, it costs just $250.

If you have less than $50,000, it costs $1,000. At that level, I think that most people who don’t want to build a portfolio on their own would probably be better off just using a simple all-in-one fund rather than paying the $1,000 fee.

Hands-Off Portfolio Management

If you don’t need comprehensive financial planning, but you’re looking for a professional to handle the actual management of your portfolio for you (e.g., rebalancing and tax-loss harvesting as necessary), you’ll want to find somebody who offers exactly that service, without charging you for services you don’t need.

For investors with $500,000 or more, I’m not aware of any lower-cost providers than Rick Ferri’s firm Portfolio Solutions, which charges 0.25-0.5% per year depending on account size.

For investors with $100,000-$500,000, Betterment could be a good choice, charging 0.15% per year for their service. (My understanding, however, is that they do not tax-loss harvest, so their service may make less sense for investors who have a significant portion of their portfolio in taxable accounts.)

For most investors desiring a hands-off solution who have portfolios of less than $100,000, my suggestion would again be a simple low-cost all-in-one fund rather than professional portfolio management.

As-Needed Financial Planning

If you’re seeking help with tax planning, estate planning, or retirement planning, but you don’t really desire assistance with the day-to-day management of your portfolio, the least expensive option will typically be to find a professional who provides advice on an hourly or fee-for-project basis. That way you will only be paying for the advice you need, and you’ll only be paying for it in years that you need it. (For example, you probably don’t need to do a thorough estate planning session every single year.)

One good place to look for such professionals is the Garrett Planning Network.

In short, depending on the circumstances, the typical 1-1.5% annual advisor fee may be justified, or it could be a very poor value. When seeking the services of a financial professional, the best way to get a good value for your money is often to determine what service(s) you need, pay a reasonable price for those services, and not pay for any services you won’t need.

How to Leave Your Broker

A reader writes in, asking:

“I have a few accounts with a broker at Edward Jones. He was recommended by a family member, and he hasn’t tried to cheat me in any way. But I don’t think the service I’m receiving is sufficient to justify the commissions I’m paying. Having read about Vanguard and index funds, I think that’s where I’m headed.

But I don’t actually know how to move my money. Do I just call my Jones guy and tell him I’m leaving? I don’t relish the thought of that conversation.”

To transfer an account from one brokerage firm to another, you don’t actually have to call your current advisor/broker first. In fact, you may not have to call him at all. And to the extent possible, I’d suggest avoiding it. The receiving brokerage firm (in this case, Vanguard) has an incentive to be as helpful as possible, whereas the company you’re leaving has an incentive to make things difficult and/or give you a sales pitch to get you to stay.

What you’ll want to do is originate the process at the receiving brokerage firm. Either open an account online (choosing during the application process that you have an account you want to transfer over), or give them a call and explain what you want to do.

The receiving brokerage firm will give you the appropriate paperwork to sign. Once you sign it and send it back in, they forward it to your old brokerage firm and handle the process from there.

Getting a Medallion/Signature Guarantee

Some brokerage firms (including Edward Jones) will require a “signature guarantee” (sometimes called a “medallion guarantee”). This is not the same thing as having your signature notarized, as it has to be done by certain employees of a financial institution such as a bank or brokerage firm. Most places will only provide a signature guarantee if you have an account with them, but I’ve heard of some credit unions offering to do it for anybody.

Before heading to your bank, I would suggest that you call ahead, because it’s often the case that only a certain manager can provide a signature guarantee, and you wouldn’t want to make the trip only to learn that the right person isn’t at work that day.

Transfer “In Kind” or Liquidate Everything First?

As part of the transfer process, the receiving brokerage firm will typically ask if you want to:

  1. Bring things over “in kind,” or
  2. Have your old brokerage firm liquidate everything and send it over as cash.

If the account is an IRA and there are no fees to sell any of the holdings, it’s probably simplest to have everything liquidated and moved over as cash.

Conversely, if the account is an IRA and there will be fees to sell any of the holdings, it’s usually best to compare the cost at each brokerage firm and do it wherever it will be less expensive.

Finally, if you’re transferring a taxable account, you’ll probably want to bring things over “in kind,” because liquidating everything would result in capital gains/losses. After everything is transfered over, you can go through the holdings one by one to see which ones should be sold immediately, which ones should be sold later (after a short-term capital gain has become a long-term capital gain, for instance), and which ones should be kept.

When to Use a Financial Advisor

Jeff writes in,

“Until recently, I had a financial advisor who I’d used for several years. He helped me create and manage my portfolio. At least that’s what I thought he was doing. After having my eyes opened by a few books, I now see that he was just recommending expensive investments that paid him a fat commission.

I’ve since moved my portfolio to Vanguard and invested in what I think is a sensible asset allocation.

But given how simple it is to manage a passive portfolio, I’m starting to doubt that I need an advisor at all. What do you think, for passive investors is there really any need for an advisor?”

I think Jeff is right that, at its most basic, the implementation of a passive portfolio is rather simple:

  1. Choose an asset allocation that fits your risk tolerance,
  2. Create a portfolio that meets that asset allocation in the lowest-cost way possible, and
  3. Rebalance every once in a while.

If you’ve taken the time to educate yourself about these things, then it’s likely that you can handle them without an advisor.

Still, you may want to use one.

For instance, you might be having trouble settling on an asset allocation. Or perhaps you have settled on an allocation, but between you and your spouse, you have so many different accounts that you’re having trouble determining the lowest-cost, most tax-efficient way to implement that allocation.

It may be worth sitting down with an advisor who charges an hourly fee or a flat fee-for-service sort of advisor to get some help with either of those questions.

Help Implementing the Plan

Alternatively, you may have no difficulty creating an investment plan, but still find it worthwhile to have somebody else handle the actual implementation of that plan.

For example, if much of your portfolio is in a taxable account, it’s beneficial to have somebody checking regularly for tax-loss harvesting opportunities. If you don’t want to take the time to do that yourself, it may be worth using an advisor.

Or perhaps you find it difficult to convince yourself to rebalance into stocks during bear markets or out of stocks during bull markets, despite the fact that your investment plan calls for exactly that. In such cases, it can be helpful to have somebody who is emotionally detached from the portfolio who can handle the rebalancing.

For such services, a low-cost annual-fee advisor could be a good fit.

Help with Tricky Questions

And finally, there are some aspects of investing and retirement planning that can still be rather complicated, even when you’ve made a point of keeping your portfolio as simple as possible.

For example, deciding when you and your spouse should each claim claim Social Security isn’t a very intuitive process. In addition, the change in marginal tax rates that results from starting Social Security can often result in tax planning opportunities. A CFP skilled in such areas could be well-worth his/her fee.

Ditto for the question of how to spend down your accounts in retirement. By strategically planning how much to spend from taxable accounts, tax-deferred accounts, and tax-free accounts every year, you can save a lot of money over the course of your retirement. If that’s not something you want to take the time to research and think through, hiring a tax-savvy advisor may be an efficient use of your money.

In short: Yes, passive investing is mostly straightforward. Still, depending on your circumstances, an advisor may be able to offer you a value that significantly exceeds his/her fee. And remember, it doesn’t have to be an all-or-nothing decision. You can be a mostly-DIY investor, who still meets with an advisor every few years when life circumstances change or tricky planning situations arise.

Where to Find Financial Advice? Probably Not Your Brokerage Firm

Jason writes in to ask:

I met with an investment counselor at my bank. I liked him personally, and he was very respectful of my investment goals.

He came up with a portfolio of five different American Funds offerings–a mix of domestic stock, international stock, and bond funds. The downside is that American Funds requires me to pay an up-front fee equal to 3.5% of my investment.

I’ve read about the advantages of index funds, which I can purchase cheaply through an online brokerage. I am leaning toward that type of strategy, but can online discount brokerages advise me on how to use index funds to put together a portfolio? Or will I be on my own? Or is there somewhere else I should seek advice?

Avoiding Commission-Paid Brokers

American Funds are definitely not the worst thing a person can invest in. That said, I’d generally recommend staying away from sales-loaded mutual funds and the brokers who sell them.

For example, based on Jason’s statement that he’d be paying a 3.5% sales load, it appears that we’re talking about an amount between $100,000 and $250,000. That means that, at a minimum, he’s looking at an up-front cost of $3,500 for this advice. You can get a good financial plan for significantly less than $3,500.

Separating the Advice from the Transaction

Jason raises a good point about discount brokerage firms: They generally don’t offer financial advisor services.

But that’s fine. In fact, even if your brokerage firm does offer such services, I’d generally steer clear. As I’ve mentioned before, brokerage firms have a vested interest in getting you to do what’s profitable for them, rather than what’s profitable for you.

As such, I think it’s usually a good idea to invest with one company (a discount brokerage firm of your choosing) and get your advice from a different company. In my opinion, hourly-fee advice from an independent advisor is the least-biased available.

Exception: Vanguard CFPs

There is one noteworthy exception to my suggestion to avoid advice from your brokerage firm: Vanguard. Vanguard has CFPs on staff who can help with managing your portfolio.

There are two reasons I’d be far more willing to accept investment suggestions from Vanguard than from any other brokerage firm or fund company:

  1. As we’ve discussed before, Vanguard is (indirectly) owned by clients, so there’s not much of an incentive for them to recommend anything other than what they believe is best for you.
  2. Their funds are always among the cheapest in each category (especially if you request that the CFP stick to index funds).

Also, the price is quite affordable:

  • For people with accounts of $500,000 or more, the service is free.
  • For people with accounts between $50,000 and $500,000, it costs a flat $250.

For people with less than $50,000, it costs $1,000, though in most cases a portfolio of less than $50,000 shouldn’t be terribly difficult to manage on one’s own.

My understanding is that it’s a relatively basic plan–not as comprehensive as you could get by sitting down with an independent CFP, for instance. Though at $250, that’s still a bargain. At $0, well, that’s even better. 🙂

Researching a Financial Advisor: Form ADV Part II

One thing I’d suggest doing before enlisting the services of a financial advisor is getting a copy of the advisor’s Form ADV.

Form ADV is a document that Registered Investment Advisers (RIAs) are required to file with either their state or with the SEC. It’s broken down into two parts.

ADV Part I includes:

  • Identifying information about the firm,
  • How many clients they have,
  • Total amount of assets they manage,
  • Whether or not they’re a broker-dealer or a registered representative of a broker-dealer (That is, are they paid commission to recommend certain investments?), and
  • A whole list of other (less interesting) tidbits.

ADV Part II includes (among other things):

  • What type of services they offer,
  • How they charge their clients (hourly fees, percentage of assets under management, fixed fees, commissions, etc.),
  • What type of analysis they perform when selecting securities for a client, and
  • The RIA’s education and career background.

Finding an Advisor’s Form ADV

There are two ways to get a copy of an RIA’s Form ADV:

If you look it up online, you can search by name of the firm or by name of the advisor. Unfortunately, RIAs aren’t currently required to submit Part II electronically, so you’ll have to ask the RIA for it.

Note: If a financial advisor doesn’t have a Form ADV, that means that he or she is not a Registered Investment Adviser. It’s likely that this person is either a commission-paid stockbroker or insurance agent, in which case my suggestion would be to look elsewhere for advice.

How About an Example?

It would surely be useful, but I don’t have the heart to make an example of an RIA whose Form ADV sets off all kinds of red flags. Instead, let’s take a look at an RIA whose ADV shows pretty much everything I’d look for.

Dylan Ross is an RIA and CFP who regularly reads and comments on this blog. His ADV Part II is publicly available on his website. From it, we can see that:

  • He charges hourly or fixed fees rather than commissions or AUM fees (and if you scroll through to Schedule F, you can see the specific fees for each service),
  • He counsels clients on long-term investing rather than short-term trading,
  • He provides advice in the areas of cash flow, debt management, risk management, college funding, retirement planning, estate planning, tax planning, asset allocation and investment selection.

And we can see the following about his investment selection process:

“Adviser believes that the appropriate allocation of assets across diverse investment categories (e.g. stock vs. bond, foreign vs. domestic) is the primary determinant of portfolio returns and critical in the long-term success of one’s financial objectives; therefore, Adviser advocates the use of passive, low-cost, broad-market index investments.”

Why Not Just Ask?

Wouldn’t an RIA would be willing to share any of the above pieces of information if you asked? Yes, almost certainly. Still, I’d suggest getting the official documentation for two reasons:

  1. It may call your attention to a potential red flag that you would not have thought to ask about, and
  2. It doesn’t allow for any wiggle room. Rather than getting a carefully-worded answer that conceals an unpleasant piece of information, you get a check in a box: “yes” or “no.”
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