Getting Advice: Whom Can You Trust?
Investing is complex, and beginners and novices alike should get independent advice every once in a while. It's important to make sure that, as an amateur investor, you're not missing something important that professional investors might know. Money exerts very powerful psychological influence on investors, so it's often smart to ask the opinion of someone who's not emotionally involved with your portfolio. With all the investment advisors out there, whom should you trust?
Resources at Work
Most companies with retirement plans have administrators or human resources staffers available to answer your questions about investing in the plan and how to choose an asset allocation. These folks are generally onsite at your workplace on a regular basis and are very helpful in explaining the plan investments and details about the account itself, including how to log in to the plan's website and how to modify your investment choice. Their expertise is usually limited to the employer plan itself, so you'll need to find another advisor for an opinion on your other accounts.
Many companies retain employee assistance programs (EAPs) that provide access to investment and financial planning professionals. These programs are offered at no cost to employees by the employer as a part of their benefits package. Through your EAP, you may have access to a financial advisor to help with your investments. Just because your employer is making the referral to the EAP advisor, don't assume that the employer has interviewed the advisor; you should still ask the advisor all the important questions about expertise and conflict of interest that you would ask any professional before engaging him.
Many advisors who work for programs through employers are compensated by salary, so they have no conflict of interest in the advice they give you. Others may have a bonus program based on the amount the employees invest in a particular fund. Be sure to ask your advisor how he is paid.
Investment Advisors' Effect on Asset Allocation
Don't be afraid to ask questions of your investment advisor, especially if you're a new investor. Regardless of your experience, your advisor has been doing this longer than you and may feel more comfortable with an asset allocation that is riskier than you would be comfortable with. Be sure to ask how much the investments could gain or lose in a period of time. The advisor should be able to show you historical research on how much similar investments have gone down over time frames of three months, one year, and five years. Do the math with your own portfolio and decide if you would be comfortable with a similar decline. Remember, asset allocation only works if you can stick with it. If you can't sleep peacefully knowing the loss potential, select a more conservative allocation with fewer stocks. Later, you may feel comfortable with more risk.
Make sure you understand what your advisor is recommending to you. Now, that might sound obvious, but investing is complex and it can be easy to just take the advisor's word for it. This isn't always smart. Many people have gotten caught investing in assets that were riskier than they understood. Don't feel as if you need to give your advisor the third degree each time she makes a recommendation — after all, you're paying for her expertise. Instead, try these simple steps to help make sure you understand her recommendations:
Read financial and investing websites and magazines.
Save clippings or web articles to discuss with your advisor.
Get opinions from several resources — e.g., your accountant, lawyer, and financial planner.
Talk to your friends whose financial opinions you trust.
Talk to your advisor about how she is paid. There are three basic financial advisor compensation schemes: commission, fee based, and fee only. Some advisors may offer a choice or a combination, but in most cases the advisor will fall into one of the three categories.
Commission advisors are paid by the company whose financial product you buy from them. Fee-based advisors are often focused on providing investment services and are compensated as a percentage of the account you maintain with them — often called an assets under management, or AUM, fee. Fee-only advisors typically charge by the hour or on an annual retainer basis. Since their compensation is not focused on your investment account size or the products you buy, their practice can range from holistic financial planning advice to offering expert advice in a specific area such as retirement or college planning. Talk to any advisor you choose about potential conflicts of interest that her compensation scheme might create.
Investment Clubs
Investment clubs can be a fun way to learn about investing. Usually created by a group of friends, your investment club will assign each member a particular stock to research. Most club-support organizations provide educational resources for members to follow and help with bookkeeping and record-keeping. Members deposit a monthly investment amount into a pooled account that is then invested by the group.
Your investment club will need to decide what type of business entity suits it best. Many clubs become general partnerships by default because they are easy to create and require no paperwork or special tax knowledge. A limited liability company (LLC) might be a better option because it adds a measure of liability protection for the members.
You probably won't get rich investing in your investment club, but these clubs are a great way to learn and to cultivate a group of friends that you can talk to about investing and other financial planning issues. Check Appendix B for websites that can help you get started.
