In light of recent scandals and market turbulence investors frequently can draw invalid conclusions when interviewing a potential investment advisor. This article is designed to shed some light on topics that in my experience tend to be among the most misinterpreted by potential clients:
1. Fee's: There is a very common misconception that the lower the rate of management fee's charged by the manager the better deal for the client. This is a very common mistake since generally the best managers, the managers who have provided them can provide a superior rate of return will almost always charge more. In the long run you'll probably be better off with the superior manager despite the fee.
2. Portfolio Turnover is a bad thing: Back in the days of the secular Bull Market from 1982 to 1999 this was a common mistake that almost every manager had to cope with. Extremely few investors can truly mimic the philosophy of Warren Buffet by buying and holding for years. We're not billionaires where a million here or there makes no difference to our standard of living. Typically, a superior adviser will have a higher than average portfolio turnover, but hopefully they can provide documentation that proves the turnover is a valid strategy.
3. Trade Transparency: This is an issue bought to light due to the Madoff scandal. Bernie Madoff created the largest Ponzi scheme in history but there were two important features that allowed the scandal to continue for years without raising issues from most investors. First, Madoff was both the adviser and account custodian who held the assets, a very bad situation prior to conflicts of interest. Secondly, in statements given to clients it was not possible to understand exactly how the money was made. A reputable adviser will show transparency in client statements provided by the broker. In other words, you'll see that shares of ABC corp were purchased on March 7 at $ 8 a share and sold on June 29th at $ 12.
4. Client Referrals: This is perhaps the most delicate of issues. Investors simply think its good business to ask for referrals without understanding that its frequently against state and SEC regulations for advisers to provide such information. The reasoning is pretty simple, odds are the advisor will choose a client that has done well that giving potentially the wrong impression. In our case, we do not provide referrals anymore as client privacy is much too important. Generally, we try to explain to the prospect of how they would feel if their investments were made public via a referral to a stranger? That usually solves the issue.