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How to Avoid Choosing the Wrong Investment Advisor


Declines in market values and uncertainty about the future of healthcare has caused many physicians to question whether it's time to find a new financial advisor. Before you switch investment firms, here are some important considerations.

Over the last few years, many physicians have re-examined both their investment assumptions and their relationships with their investment advisors. Declines in market values often cause investors to rethink their investment strategies, and uncertainties about the future — particularly within the healthcare industry – has sparked the need for physicians to re-evaluate whether they’re on the right track.

Today’s investors have an even greater concern in terms of trust. The unraveling of Ponzi schemes by Bernie Madoff and Allen Stanford made headlines nationwide. And many investors were shocked at the collapse of Bear Stearns and Lehman Brothers, as a result of their own mismanagement. Then in April 2010, the U.S. Securities and Exchange Commission filed fraud charges against Goldman Sachs for actions that allegedly cost their investors more than $1 billion.

The volatility of the market returns along with the cracking of the Wall Street foundation has left many physicians uncomfortable with the idea of just “staying the course.” Before you switch firms, or advisors, here are some important considerations.

The Dangers of Reviewing a Firm’s Past Performance

A common mistake individual investors make when evaluating or selecting a financial advisor is to overrate the importance of an advisor’s past performance. There are reasons why this approach is flawed. Let’s examine some briefly:

The Time Frame May Be Too Short. When looking at an investment “track record,” many clients will ask for gross returns on a 1-year, 3-year and 5-year basis. This is simply not enough data to make any concrete conclusions about an advisor’s skill vs. randomness or even dumb luck. Even 10 years of data may not be enough. If you are 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 to read the best-selling book "Fooled by Randomness," by Nassim Taleb.

Comparisons of Results 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 clients have customized portfolios based on their risk tolerance, age, time horizon, tax bracket, objectives and a variety of other factors. As a result, it is entirely possible that Client A could see returns of 3%, while Client B could boast a gain of 20% over the same period. Both of these investors could be equally satisfied -- or not -- 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 TV, listened to an ad 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 is required by the firm’s legal compliance department, and can be easily discarded as “legalese” by consumers, it is crucial for investors to understand. To illustrate one aspect of this principle, examine the chart below showing the returns of leading investment asset classes over the past 28 years.

Factors for Choosing a Financial Advisor

So what should you focus on when interviewing propective investment advisors? When polled, most clients name “timely and effective two-way communication” as a crucial element of a fruitful working relationship. Despite this valuable piece of information, investment advisors seem to focus more on returns. Indeed, an investment firm’s business models may make such two-way communication between client and advisor almost impossible.

As an example, consider the mutual-fund industry, which many physicians 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 and 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 folks actually managing the fund is cost prohibitive and rarely allowed.

When choosing an investment advisor to manage your portfolio, even if this choice involves finding assistance in the management of mutual funds or exchange traded funds 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 with a hot stock tip (as stockbrokers are known to do). Rather, one should expect a defined communication process throughout the year that is independent of trade suggestions. Finally, we would recommend that the firm offers a reasonable policy of timeliness of returning phone calls and emails.

Next, you need to find firm that has a transparent business model. Given the troublesome conflicts of interest that have come to light in the investment industry over the past few years, individual investors should work exclusively with financial firms that use a transparent business model, and one that aligns the firm’s interests with that of their clients. There are a number of elements to look for in such an arrangement:

Independent Custodian. Ideally, an investment firm does not custodian, or hold, its clients’ investments in the firm. Rather, the firm should have arrangements with a number 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. This “checks and balances” arrangement prevents the insular secrecy that allowed Madoff, Stanford and other criminals to operate.

Client-Aligned Fee Model. In addition to a transparent business model, you want to look for a firm that has a clear fee schedule. With an “assets under management” (AUM) model, advisors charge a clearly defined fee (typically a percentage of AUM). Contrast this with the traditional, convoluted transaction-based 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 they’re paying, they also know the firm’s interest -- seeing the portfolio increase in value -- is the same as their own. The more money in your portfolio, the more money the firm earns.

Your Biggest Expense? It's Not Fees

Many investment clients focus primarily on management fees and expenses when evaluating advisors. While such costs are important, for most physicians, the annual fees might range from 50 basis points (0.5%) on the low end to 300 basis points (or 3.0%) on the high end. Instead of haggling over fees, individual investors need to focus on their largest expense: Taxes.

The cost of federal and state income taxes, 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 taxpayer’s other income and state of residence, and other issue. For higher-income investors such as physicians, taxes will nearly always be high. To gain perspective of how much taxation reduces your returns, consider this one statistic: Over the period from 1987-2007, stock mutual-fund investors lost, on average, 16% to 44% of their gains to taxes, according to a report on CNN.

Given that some investors are losing up to half of their gains to taxes, you’d think this would be a focus of value-added investment firms. Unfortunately, you’d be wrong. Mutual funds provide no tax advice to their investors, apart from the 1099 tax statements they issue in January. In fact, stockbrokers, money managers, hedge-fund managers and financial advisors typically don’t offer tax advice 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. As a result of these limitations, most investment clients are not getting the tax advice they need.

With the unraveling of some of the country’s leading investment firms behind us and volatility and tax increases ahead of us, many physician investors are wisely re-examining their financial advisor relationships. If you are one of these physicians, be sure to focus on the right factors in evaluating potential new advisors so you make intelligent, well-informed decisions.

Kim Renners, MBA, CPA (inactive) and Terry Allman, CPC, QPA, QKA, CPRC are members of OJM Group’s Investment Team in Cincinnati, Ohio, who specialize in physician clients. They can be reached at 877-656-4362. For a free copy (plus $5 shipping and handling) of “For Doctors Only: A Guide to Working Less and Building More,” please call (877) 656-4362.

OJM Group is an SEC registered investment adviser with its principal place of business in the State of Ohio. This article is limited to the dissemination of general information pertaining to its investment advisory and management services. For information pertaining to the registration status of OJM Group please contact us or refer to the Investment Adviser Public Disclosure website. For additional information, including fees and services, send for our disclosure statement as set forth on Form ADV using the contact information herein. Please read the disclosure statement carefully before you invest or send money.

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