Never take advice from anyone in a tie. They'll bankrupt you. Don't ask a general for advice on war, and don't ask a broker for advice on money.
- Nassim Nicholas Taleb
In life and in investing, there are some risks that are worth taking - and others which are not.
When investing the greatest risk is the selection of the advisor - which includes the risk of an investor choosing to become their own advisor. It's the greatest risk because the advisor ultimately determines whether the investor will engage in other destructive investing behavior.
I've enclosed 4 ways you can know if your advisor is giving bad advice:
1) Your advisor is paid by commissions
Let's be honest - even the best people are influenced by commissions. If an advisor is paid by commissions they are salesmen (brokers). The client's interests may take a back seat to whether the advisor's spouse needs a new car...
2) Your advisor regularly changes stocks/funds
There's a game which is regularly played on Wall Street: If a client is frustrated then the advisor suggests a change in their portfolio. The selection of new funds/stocks which are now highly rated. For many clients this game happens every year - with advisors continually chasing what worked in the past...
3) Your advisor tries to time markets
You ask your advisor what is going to happen in the future and he actually believes he knows. Be it geopolitics or geo-economics, the future is inherently unknowable. An advisor who thinks they have a crystal ball and doesn't acknowledge what they don't know is dangerous. Their false confidence manifests itself by either taking too much or too little risk in your portfolio based on an arrogant guess of what the future holds
4) Your advisor changes allocations
While related to other bad behaviors this is slightly different. Asset allocation or the mixture of assets targeted to your circumstances and risk tolerance will ultimately determine your returns. If you work with an advisor who thinks you should make bets on certain asset classes moving, the are suggesting asset concentration (more risk) and loss of discipline.
A Healthy Relationship?
A healthy relationship with an advisor will focus on things that really matter. What are they?
- customized asset allocation
- take worthwhile risks: (equities, value, small, earnings)
- asset location
- tax management
- withdrawal strategies
The advisor will also manage the costs which an investor bears such as fund management fees, taxes, transaction costs and advisory fees. He is passionate to make sure the amount of risk an investor takes is appropriate to their goals and their tolerance for risk. In short - he utilizes Science - Not Speculation