The investment of money in securities is unique among business operations in that it is almost always based in some degree on advice received from others. The great bulk of investors are amateurs. Naturally they feel that in choosing their securities they can profit by professional guidance. Yet there are peculiarities inherent in the very concept of investment advice.

If the reason people invest is to make money, then in seeking advice they are asking others to tell them how to make money. That idea has some element of naïveté. Businessmen seek professional advice on various elements of their business, but they do not expect to be told how to make a profit. That is their own bailiwick. When they, or nonbusiness people, rely on others to make investment profits for them, they are expecting a kind of result for which there is no true counterpart in ordinary business affairs.

If we assume that there are normal or standard income results to be obtained from investing money in securities, then the role of the adviser can be more readily established. He will use his superior training and experience to protect his clients against mistakes and to make sure that they obtain the results to which their money is entitled. It is when the investor demands more than an average return on his money, or when his adviser undertakes to do better for him, that the question arises whether more is being asked or promised than is likely to be delivered.

Advice on investments may be obtained from a variety of sources. These include: (1) a relative or friend, presumably knowledgeable in securities; (2) a local (commercial) banker; (3) a brokerage firm or investment banking house; (4) a financial service or periodical; and (5) an investment counselor.^* The miscellaneous character of this list suggests that no logical or systematic approach in this matter has crystallized, as yet, in the minds of investors.

Certain common-sense considerations relate to the criterion of normal or standard results mentioned above. Our basic thesis is this: If the investor is to rely chiefly on the advice of others in handling his funds, then either he must limit himself and his advisers strictly to standard, conservative, and even unimaginative forms of investment, or he must have an unusually intimate and favorable knowledge of the person who is going to direct his funds into other channels. But if the ordinary business or professional relationship exists between the investor and his advisers, he can be receptive to less conventional suggestions only to the extent that he himself has grown in knowledge and experience and has therefore become competent to pass independent judgment on the recommendations of others. He has then passed from the category of defensive or unenterprising investor into that of aggressive or enterprising investor.

Investment Counsel and Trust Services of Banks

The truly professional investment advisers—that is, the well-established investment counsel firms, who charge substantial annual fees—are quite modest in their promises and pretentions. For the most part they place their clients’ funds in standard interest- and dividend-paying securities, and they rely mainly on normal investment experience for their overall results. In the typical case it is doubtful whether more than 10% of the total fund is ever invested in securities other than those of leading companies, plus government bonds (including state and municipal issues); nor do they make a serious effort to take advantage of swings in the general market.

The leading investment-counsel firms make no claim to being brilliant; they do pride themselves on being careful, conservative, and competent. Their primary aim is to conserve the principal value over the years and produce a conservatively acceptable rate of income. Any accomplishment beyond that—and they do strive to better the goal—they regard in the nature of extra service rendered. Perhaps their chief value to their clients lies in shielding them from costly mistakes. They offer as much as the defensive investor has the right to expect from any counselor serving the general public.

What we have said about the well-established investment-counsel firms applies generally to the trust and advisory services of the larger banks.^*

Financial Services

The so-called financial services are organizations that send out uniform bulletins (sometimes in the form of telegrams) to their subscribers. The subjects covered may include the state and prospects of business, the behavior and prospect of the securities markets, and information and advice regarding individual issues. There is often an “inquiry department” which will answer questions affecting an individual subscriber. The cost of the service averages much less than the fee that investment counselors charge their individual clients. Some organizations—notably Babson’s and Standard & Poor’s—operate on separate levels as a financial service and as investment counsel. (Incidentally, other organizations—such as Scudder, Stevens & Clark—operate separately as investment counsel and as one or more investment funds.)

The financial services direct themselves, on the whole, to a quite different segment of the public than do the investment-counsel firms. The latters’ clients generally wish to be relieved of bother and the need for making decisions. The financial services offer information and guidance to those who are directing their own financial affairs or are themselves advising others. Many of these services confine themselves exclusively, or nearly so, to forecasting market movements by various “technical” methods. We shall dismiss these with the observation that their work does not concern “investors” as the term is used in this book.

On the other hand, some of the best known—such as Moody’s Investment Service and Standard & Poor’s—are identified with statistical organizations that compile the voluminous statistical data that form the basis for all serious security analysis. These services have a varied clientele, ranging from the most conservative-minded investor to the rankest speculator. As a result they must find it difficult to adhere to any clear-cut or fundamental philosophy in arriving at their opinions and recommendations.

An old-established service of the type of Moody’s and the others must obviously provide something worthwhile to a broad class of investors. What is it? Basically they address themselves to the matters in which the average active investor-speculator is interested, and their views on these either command some measure of authority or at least appear more reliable than those of the unaided client.

For years the financial services have been making stock-market forecasts without anyone taking this activity very seriously. Like everyone else in the field they are sometimes right and sometimes wrong. Wherever possible they hedge their opinions so as to avoid the risk of being proved completely wrong. (There is a well-developed art of Delphic phrasing that adjusts itself successfully to whatever the future brings.) In our view—perhaps a prejudiced one—this segment of their work has no real significance except for the light it throws on human nature in the securities markets. Nearly everyone interested in common stocks wants to be told by someone else what he thinks the market is going to do. The demand being there, it must be supplied.

Their interpretations and forecasts of business conditions, of course, are much more authoritative and informing. These are an important part of the great body of economic intelligence which is spread continuously among buyers and sellers of securities and tends to create fairly rational prices for stocks and bonds under most circumstances. Undoubtedly the material published by the financial services adds to the store of information available and fortifies the investment judgment of their clients.

It is difficult to evaluate their recommendations of individual securities. Each service is entitled to be judged separately, and the verdict could properly be based only on an elaborate and inclusive study covering many years. In our own experience we have noted among them a pervasive attitude which we think tends to impair what could otherwise be more useful advisory work. This is their general view that a stock should be bought if the near-term prospects of the business are favorable and should be sold if these are unfavorable—regardless of the current price. Such a superficial principle often prevents the services from doing the sound analytical job of which their staffs are capable—namely, to ascertain whether a given stock appears over- or undervalued at the current price in the light of its indicated long-term future earning power.

The intelligent investor will not do his buying and selling solely on the basis of recommendations received from a financial service. Once this point is established, the role of the financial service then becomes the useful one of supplying information and offering suggestions.

Advice from Brokerage Houses

Probably the largest volume of information and advice to the security-owning public comes from stockbrokers. These are members of the New York Stock Exchange, and of other exchanges, who execute buying and selling orders for a standard commission. Practically all the houses that deal with the public maintain a “statistical” or analytical department, which answers inquiries and makes recommendations. A great deal of analytical literature, some of it elaborate and expensive, is distributed gratis to the firms’ customers—more impressively referred to as clients.

A great deal is at stake in the innocent-appearing question whether “customers” or “clients” is the more appropriate name. A business has customers; a professional person or organization has clients. The Wall Street brokerage fraternity has probably the highest ethical standards of any business, but it is still feeling its way toward the standards and standing of a true profession.^*

In the past Wall Street has thrived mainly on speculation, and stock-market speculators as a class were almost certain to lose money. Hence it has been logically impossible for brokerage houses to operate on a thoroughly professional basis. To do that would have required them to direct their efforts toward reducing rather than increasing their business.

The farthest that certain brokerage houses have gone in that direction—and could have been expected to go—is to refrain from inducing or encouraging anyone to speculate. Such houses have confined themselves to executing orders given them, to supplying financial information and analyses, and to rendering opinions on the investment merits of securities. Thus, in theory at least, they are devoid of all responsibility for either the profits or the losses of their speculative customers.^†

Most stock-exchange houses, however, still adhere to the old-time slogans that they are in business to make commissions and that the way to succeed in business is to give the customers what they want. Since the most profitable customers want speculative advice and suggestions, the thinking and activities of the typical firm are pretty closely geared to day-to-day trading in the market. Thus it tries hard to help its customers make money in a field where they are condemned almost by mathematical law to lose in the end.^† By this we mean that the speculative part of their operations cannot be profitable over the long run for most brokerage house customers. But to the extent that their operations resemble true investing they may produce investment gains that more than offset the speculative losses.

The investor obtains advice and information from stock-exchange houses through two types of employees, now known officially as “customers’ brokers” (or “account executives”) and financial analysts.

The customer’s broker, also called a “registered representative,” formerly bore the less dignified title of “customer’s man.” Today he is for the most part an individual of good character and considerable knowledge of securities, who operates under a rigid code of right conduct. Nevertheless, since his business is to earn commissions, he can hardly avoid being speculation-minded. Thus the security buyer who wants to avoid being influenced by speculative considerations will ordinarily have to be careful and explicit in his dealing with his customer’s broker; he will have to show clearly, by word and deed, that he is not interested in anything faintly resembling a stock-market “tip.” Once the customer’s broker understands clearly that he has a real investor on his hands, he will respect this point of view and cooperate with it.

The financial analyst, formerly known chiefly as security analyst, is a person of particular concern to the author, who has been one himself for more than five decades and has helped educate countless others. At this stage we refer only to the financial analysts employed by brokerage houses. The function of the security analyst is clear enough from his title. It is he who works up the detailed studies of individual securities, develops careful comparisons of various issues in the same field, and forms an expert opinion of the safety or attractiveness or intrinsic value of all the different kinds of stocks and bonds.

By what must seem a quirk to the outsider there are no formal requirements for being a security analyst. Contrast with this the facts that a customer’s broker must pass an examination, meet the required character tests, and be duly accepted and registered by the New York Stock Exchange. As a practical matter, nearly all the younger analysts have had extensive business-school training, and the oldsters have acquired at least the equivalent in the school of long experience. In the great majority of cases, the employing brokerage house can be counted on to assure itself of the qualifications and competence of its analysts.^*

The customer of the brokerage firm may deal with the security analysts directly, or his contact may be an indirect one via the customer’s broker. In either case the analyst is available to the client for a considerable amount of information and advice. Let us make an emphatic statement here. The value of the security analyst to the investor depends largely on the investor’s own attitude. If the investor asks the analyst the right questions, he is likely to get the right—or at least valuable—answers. The analysts hired by brokerage houses, we are convinced, are greatly handicapped by the general feeling that they are supposed to be market analysts as well. When they are asked whether a given common stock is “sound,” the question often means, “Is this stock likely to advance during the next few months?” As a result many of them are compelled to analyze with one eye on the stock ticker—a pose not conducive to sound thinking or worthwhile conclusions.^*

In the next section of this book we shall deal with some of the concepts and possible achievements of security analysis. A great many analysts working for stock exchange firms could be of prime assistance to the bona fide investor who wants to be sure that he gets full value for his money, and possibly a little more. As in the case of the customers’ brokers, what is needed at the beginning is a clear understanding by the analyst of the investor’s attitude and objectives. Once the analyst is convinced that he is dealing with a man who is value-minded rather than quotation-minded, there is an excellent chance that his recommendations will prove of real overall benefit.

The CFA Certificate for Financial Analysts

An important step was taken in 1963 toward giving professional standing and responsibility to financial analysts. The official title of chartered financial analyst (CFA) is now awarded to those senior practitioners who pass required examinations and meet other tests of fitness.¹ The subjects covered include security analysis and portfolio management. The analogy with the long-established professional title of certified public accountant (CPA) is evident and intentional. This relatively new apparatus of recognition and control should serve to elevate the standards of financial analysts and eventually to place their work on a truly professional basis.^†

Dealings with Brokerage Houses

One of the most disquieting developments of the period in which we write this revision has been the financial embarrassment—in plain words, bankruptcy or near-bankruptcy—of quite a few New York Stock Exchange firms, including at least two of considerable size.^* This is the first time in half a century or more that such a thing has happened, and it is startling for more than one reason. For many decades the New York Stock Exchange has been moving in the direction of closer and stricter controls over the operations and financial condition of its members—including minimum capital requirements, surprise audits, and the like. Besides this, we have had 37 years of control over the exchanges and their members by the Securities and Exchange Commission. Finally, the stock-brokerage industry itself has operated under favorable conditions—namely, a huge increase in volume, fixed minimum commission rates (largely eliminating competitive fees), and a limited number of member firms.

The first financial troubles of the brokerage houses (in 1969) were attributed to the increase in volume itself. This, it was claimed, overtaxed their facilities, increased their overhead, and produced many troubles in making financial settlements. It should be pointed out this was probably the first time in history that important enterprises have gone broke because they had more business than they could handle. In 1970, as brokerage failures increased, they were blamed chiefly on “the falling off in volume.” A strange complaint when one reflects that the turnover of the NYSE in 1970 totaled 2,937 million shares, the largest volume in its history and well over twice as large as in any year before 1965. During the 15 years of the bull market ending in 1964 the annual volume had averaged “only” 712 million shares—one quarter of the 1970 figure—but the brokerage business had enjoyed the greatest prosperity in its history. If, as it appears, the member firms as a whole had allowed their overhead and other expenses to increase at a rate that could not sustain even a mild reduction in volume during part of a year, this does not speak well for either their business acumen or their financial conservatism.

A third explanation of the financial trouble finally emerged out of a mist of concealment, and we suspect that it is the most plausible and significant of the three. It seems that a good part of the capital of certain brokerage houses was held in the form of common stocks owned by the individual partners. Some of these seem to have been highly speculative and carried at inflated values. When the market declined in 1969 the quotations of such securities fell drastically and a substantial part of the capital of the firms vanished with them.² In effect the partners were speculating with the capital that was supposed to protect the customers against the ordinary financial hazards of the brokerage business, in order to make a double profit thereon. This was inexcusable; we refrain from saying more.

The investor should use his intelligence not only in formulating his financial policies but also in the associated details. These include the choice of a reputable broker to execute his orders. Up to now it was sufficient to counsel our readers to deal only with a member of the New York Stock Exchange, unless he had compelling reasons to use a nonmember firm. Reluctantly, we must add some further advice in this area. We think that people who do not carry margin accounts—and in our vocabulary this means all nonprofessional investors—should have the delivery and receipt of their securities handled by their bank. When giving a buying order to your brokers you can instruct them to deliver the securities bought to your bank against payment therefor by the bank; conversely, when selling you can instruct your bank to deliver the securities to the broker against payment of the proceeds. These services will cost a little extra but they should be well worth the expense in terms of safety and peace of mind. This advice may be disregarded, as no longer called for, after the investor is sure that all the problems of stock-exchange firms have been disposed of, but not before.^*

Investment Bankers

The term “investment banker” is applied to a firm that engages to an important extent in originating, underwriting, and selling new issues of stocks and bonds. (To underwrite means to guarantee to the issuing corporation, or other issuer, that the security will be fully sold.) A number of the brokerage houses carry on a certain amount of underwriting activity. Generally this is confined to participating in underwriting groups formed by leading investment bankers. There is an additional tendency for brokerage firms to originate and sponsor a minor amount of new-issue financing, particularly in the form of smaller issues of common stocks when a bull market is in full swing.

Investment banking is perhaps the most respectable department of the Wall Street community, because it is here that finance plays its constructive role of supplying new capital for the expansion of industry. In fact, much of the theoretical justification for maintaining active stock markets, notwithstanding their frequent speculative excesses, lies in the fact that organized security exchanges facilitate the sale of new issues of bonds and stocks. If investors or speculators could not expect to see a ready market for a new security offered them, they might well refuse to buy it.

The relationship between the investment banker and the investor is basically that of the salesman to the prospective buyer. For many years past the great bulk of the new offerings in dollar value has consisted of bond issues that were purchased in the main by financial institutions such as banks and insurance companies. In this business the security salesmen have been dealing with shrewd and experienced buyers. Hence any recommendations made by the investment bankers to these customers have had to pass careful and skeptical scrutiny. Thus these transactions are almost always effected on a businesslike footing.

But a different situation obtains in a relationship between the individual security buyer and the investment banking firms, including the stockbrokers acting as underwriters. Here the purchaser is frequently inexperienced and seldom shrewd. He is easily influenced by what the salesman tells him, especially in the case of common-stock issues, since often his unconfessed desire in buying is chiefly to make a quick profit. The effect of all this is that the public investor’s protection lies less in his own critical faculty than in the scruples and ethics of the offering houses.³

It is a tribute to the honesty and competence of the underwriting firms that they are able to combine fairly well the discordant roles of adviser and salesman. But it is imprudent for the buyer to trust himself to the judgment of the seller. In 1959 we stated at this point: “The bad results of this unsound attitude show themselves recurrently in the underwriting field and with notable effects in the sale of new common stock issues during periods of active speculation.” Shortly thereafter this warning proved urgently needed. As already pointed out, the years 1960–61 and, again, 1968–69 were marked by an unprecedented outpouring of issues of lowest quality, sold to the public at absurdly high offering prices and in many cases pushed much higher by heedless speculation and some semi-manipulation. A number of the more important Wall Street houses have participated to some degree in these less than creditable activities, which demonstrates that the familiar combination of greed, folly, and irresponsibility has not been exorcized from the financial scene.

The intelligent investor will pay attention to the advice and recommendations received from investment banking houses, especially those known by him to have an excellent reputation; but he will be sure to bring sound and independent judgment to bear upon these suggestions—either his own, if he is competent, or that of some other type of adviser.^*

Other Advisers

It is a good old custom, especially in the smaller towns, to consult one’s local banker about investments. A commercial banker may not be a thoroughgoing expert on security values, but he is experienced and conservative. He is especially useful to the unskilled investor, who is often tempted to stray from the straight and unexciting path of a defensive policy and needs the steadying influence of a prudent mind. The more alert and aggressive investor, seeking counsel in the selection of security bargains, will not ordinarily find the commercial banker’s viewpoint to be especially suited to his own objectives.^†

We take a more critical attitude toward the widespread custom of asking investment advice from relatives or friends. The inquirer always thinks he has good reason for assuming that the person consulted has superior knowledge or experience. Our own observation indicates that it is almost as difficult to select satisfactory lay advisers as it is to select the proper securities unaided. Much bad advice is given free.

Summary

Investors who are prepared to pay a fee for the management of their funds may wisely select some well-established and well-recommended investment-counsel firm. Alternatively, they may use the investment department of a large trust company or the supervisory service supplied on a fee basis by a few of the leading New York Stock Exchange houses. The results to be expected are in no wise exceptional, but they are commensurate with those of the average well-informed and cautious investor.

Most security buyers obtain advice without paying for it specifically. It stands to reason, therefore, that in the majority of cases they are not entitled to and should not expect better than average results. They should be wary of all persons, whether customers’ brokers or security salesmen, who promise spectacular income or profits. This applies both to the selection of securities and to guidance in the elusive (and perhaps illusive) art of trading in the market.

Defensive investors, as we have defined them, will not ordinarily be equipped to pass independent judgment on the security recommendations made by their advisers. But they can be explicit—and even repetitiously so—in stating the kind of securities they want to buy. If they follow our prescription they will confine themselves to high-grade bonds and the common stocks of leading corporations, preferably those that can be purchased at individual price levels that are not high in the light of experience and analysis. The security analyst of any reputable stock-exchange house can make up a suitable list of such common stocks and can certify to the investor whether or not the existing price level therefor is a reasonably conservative one as judged by past experience.

The aggressive investor will ordinarily work in active cooperation with his advisers. He will want their recommendations explained in detail, and he will insist on passing his own judgment upon them. This means that the investor will gear his expectations and the character of his security operations to the development of his own knowledge and experience in the field. Only in the exceptional case, where the integrity and competence of the advisers have been thoroughly demonstrated, should the investor act upon the advice of others without understanding and approving the decision made.

There have always been unprincipled stock salesmen and fly by-night stock brokers, and—as a matter of course—we have advised our readers to confine their dealings, if possible, to members of the New York Stock Exchange. But we are reluctantly compelled to add the extra-cautious counsel that security deliveries and payments be made through the intermediary of the investor’s bank. The distressing Wall Street brokerage-house picture may have cleared up completely in a few years, but in late 1971 we still suggest, “Better safe than sorry.”

Do You Need Help?

In the glory days of the late 1990s, many investors chose to go it alone. By doing their own research, picking stocks themselves, and placing their trades through an online broker, these investors bypassed Wall Street’s costly infrastructure of research, advice, and trading. Unfortunately, many do-it-yourselfers asserted their independence right before the worst bear market since the Great Depression—making them feel, in the end, that they were fools for going it alone. That’s not necessarily true, of course; people who delegated every decision to a traditional stockbroker lost money, too.

But many investors do take comfort from the experience, judgment, and second opinion that a good financial adviser can provide. Some investors may need an outsider to show them what rate of return they need to earn on their investments, or how much extra money they need to save, in order to meet their financial goals. Others may simply benefit from having someone else to blame when their investments go down; that way, instead of beating yourself up in an agony of self-doubt, you get to criticize someone who typically can defend him or herself and encourage you at the same time. That may provide just the psychological boost you need to keep investing steadily at a time when other investors’ hearts may fail them. All in all, just as there’s no reason you can’t manage your own portfolio, so there’s no shame in seeking professional help in managing it.¹

How can you tell if you need a hand? Here are some signals:

Big losses. If your portfolio lost more than 40% of its value from the beginning of 2000 through the end of 2002, then you did even worse than the dismal performance of the stock market itself. It hardly matters whether you blew it by being lazy, reckless, or just unlucky; after such a giant loss, your portfolio is crying out for help.

Busted budgets. If you perennially struggle to make ends meet, have no idea where your money goes, find it impossible to save on a regular schedule, and chronically fail to pay your bills on time, then your finances are out of control. An adviser can help you get a grip on your money by designing a comprehensive financial plan that will outline how—and how much—you should spend, borrow, save, and invest.

Chaotic portfolios. All too many investors thought they were diversified in the late 1990s because they owned 39 “different” Internet stocks, or seven “different” U.S. growth-stock funds. But that’s like thinking that an all-soprano chorus can handle singing “Old Man River” better than a soprano soloist can. No matter how many sopranos you add, that chorus will never be able to nail all those low notes until some baritones join the group. Likewise, if all your holdings go up and down together, you lack the investing harmony that true diversification brings. A professional “asset-allocation” plan can help.

Major changes. If you’ve become self-employed and need to set up a retirement plan, your aging parents don’t have their finances in order, or college for your kids looks unaffordable, an adviser can not only provide peace of mind but help you make genuine improvements in the quality of your life. What’s more, a qualified professional can ensure that you benefit from and comply with the staggering complexity of the tax laws and retirement rules.

Trust, then Verify

Remember that financial con artists thrive by talking you into trusting them and by talking you out of investigating them. Before you place your financial future in the hands of an adviser, it’s imperative that you find someone who not only makes you comfortable but whose honesty is beyond reproach. As Ronald Reagan used to say, “Trust, then verify.” Start off by thinking of the handful of people you know best and trust the most. Then ask if they can refer you to an adviser whom they trust and who, they feel, delivers good value for his fees. A vote of confidence from someone you admire is a good start.²

Once you have the name of the adviser and his firm, as well as his specialty—is he a stockbroker? financial planner? accountant? insurance agent?—you can begin your due diligence. Enter the name of the adviser and his or her firm into an Internet search engine like Google to see if anything comes up (watch for terms like “fine,” “complaint,” “lawsuit,” “disciplinary action,” or “suspension”). If the adviser is a stockbroker or insurance agent, contact the office of your state’s securities commissioner (a convenient directory of online links is at www.nasaa.org) to ask whether any disciplinary actions or customer complaints have been filed against the adviser.³ If you’re considering an accountant who also functions as a financial adviser, your state’s accounting regulators (whom you can find through the National Association of State Boards of Accountancy at www.nasba.org) will tell you whether his or her record is clean.

Financial planners (or their firms) must register with either the U.S. Securities and Exchange Commission or securities regulators in the state where their practice is based. As part of that registration, the adviser must file a two-part document called Form ADV. You should be able to view and download it at www.advisorinfo.sec.gov, www.iard. com, or the website of your state securities regulator. Pay special attention to the Disclosure Reporting Pages, where the adviser must disclose any disciplinary actions by regulators. (Because unscrupulous advisers have been known to remove those pages before handing an ADV to a prospective client, you should independently obtain your own complete copy.) It’s a good idea to cross-check a financial planner’s record at www.cfp-board.org, since some planners who have been disciplined outside their home state can fall through the regulatory cracks. For more tips on due diligence, see the sidebar below.

Getting to Know You

A leading financial-planning newsletter recently canvassed dozens of advisers to get their thoughts on how you should go about interviewing them.⁴ In screening an adviser, your goals should be to:

• determine whether he or she cares about helping clients, or just goes through the motions
• establish whether he or she understands the fundamental principles of investing as they are outlined in this book
• assess whether he or she is sufficiently educated, trained, and experienced to help you.

Here are some of the questions that prominent financial planners recommended any prospective client should ask:

Why are you in this business? What is the mission statement of your firm? Besides your alarm clock, what makes you get up in the morning?

What is your investing philosophy? Do you use stocks or mutual funds? Do you use technical analysis? Do you use market timing? (A “yes” to either of the last two questions is a “no” signal to you.)

Do you focus solely on asset management, or do you also advise on taxes, estate and retirement planning, budgeting and debt management, and insurance? How do your education, experience, and credentials qualify you to give those kinds of financial advice?⁵

What needs do your clients typically have in common? How can you help me achieve my goals? How will you track and report my progress? Do you provide a checklist that I can use to monitor the implementation of any financial plan we develop?

How do you choose investments? What investing approach do you believe is most successful, and what evidence can you show me that you have achieved that kind of success for your clients? What do you do when an investment performs poorly for an entire year? (Any adviser who answers “sell” is not worth hiring.)

Do you, when recommending investments, accept any form of compensation from any third party? Why or why not? Under which circumstances? How much, in actual dollars, do you estimate I would pay for your services the first year? What would make that number go up or down over time? (If fees will consume more than 1% of your assets annually, you should probably shop for another adviser.⁶ )

How many clients do you have, and how often do you communicate with them? What has been your proudest achievement for a client? What characteristics do your favorite clients share? What’s the worst experience you’ve had with a client, and how did you resolve it? What determines whether a client speaks to you or to your support staff? How long do clients typically stay with you?

Can I see a sample account statement? (If you can’t understand it, ask the adviser to explain it. If you can’t understand his explanation, he’s not right for you.)

Do you consider yourself financially successful? Why? How do you define financial success?

How high an average annual return do you think is feasible on my investments? (Anything over 8% to 10% is unrealistic.)

Will you provide me with your résumé, your Form ADV, and at least three references? (If the adviser or his firm is required to file an ADV, and he will not provide you a copy, get up and leave—and keep one hand on your wallet as you go.)

Have you ever had a formal complaint filed against you? Why did the last client who fired you do so?

Defeating Your Own Worst Enemy

Finally, bear in mind that great financial advisers do not grow on trees. Often, the best already have as many clients as they can handle—and may be willing to take you on only if you seem like a good match. So they will ask you some tough questions as well, which might include:

Why do you feel you need a financial adviser?

What are your long-term goals?

What has been your greatest frustration in dealing with other advisers (including yourself)?

Do you have a budget? Do you live within your means? What percentage of your assets do you spend each year?

When we look back a year from now, what will I need to have accomplished in order for you to be happy with your progress?

How do you handle conflicts or disagreements?

How did you respond emotionally to the bear market that began in 2000?

What are your worst financial fears? Your greatest financial hopes?

What rate of return on your investments do you consider reasonable? (Base your answer on Chapter 3.)

An adviser who doesn’t ask questions like these—and who does not show enough interest in you to sense intuitively what other questions you consider to be the right ones—is not a good fit.

Above all else, you should trust your adviser enough to permit him or her to protect you from your worst enemy—yourself. “You hire an adviser,” explains commentator Nick Murray, “not to manage money but to manage you.”

“If the adviser is a line of defense between you and your worst impulsive tendencies,” says financial-planning analyst Robert Veres, “then he or she should have systems in place that will help the two of you control them.” Among those systems:

• a comprehensive financial plan that outlines how you will earn, save, spend, borrow, and invest your money;
• an investment policy statement that spells out your fundamental approach to investing;
• an asset-allocation plan that details how much money you will keep in different investment categories.

These are the building blocks on which good financial decisions must be founded, and they should be created mutually—by you and the adviser—rather than imposed unilaterally. You should not invest a dollar or make a decision until you are satisfied that these foundations are in place and in accordance with your wishes.