Looking for a financial adviser? Here's what to seek out, and red flags to avoid

You’re looking for a financial adviser . In addition to the usual laundry list of attributes, let’s explore what to avoid. In investing, as in life, the phrase “winning by not losing” comes to mind. While there are certainly empirical markers one can look for and while empathy and bedside manner are often crucial, there are nonetheless several serious red flags — although difficult to reliably quantify — that constitute serious impediments to financial progress.

It has been a decade since some jaw-dropping information about financial advice was released in an academic paper that looked at how advisers’ faulty perspectives could result in bad advice. In 2016, a working paper entitled The Misguided Beliefs of Financial Advisors looked at 14 years of trading and portfolio data from more than 4,000 advisers and nearly 500,000 clients at Canadian financial institutions. In 2020 the peer-reviewed Journal of Finance published it.

This may be the first time you heard about it and you can’t protect yourself against bad industry practices if you’re oblivious to them.

The paper detailed the three things Canadian mutual fund registrants overwhelmingly did wrong: they chased past performance; ran concentrated positions and didn’t concern themselves with product cost. All three transgressions run contrary to basic personal finance principles. If you ever find yourself in front of an adviser who does any of these things, leave the office immediately.

Specific examples of these transgressions include:

Recommending funds with high management expense ratios (MERs) when cheaper comparable funds are available; Recommending two or three funds in one asset class as a means of diversification; Making large bets on a sector (such as cryptocurrency, cannabis, artificial intelligence); Recommending funds based on one-, three-, five- and/or 10-year returns.

Those are the kinds of things people should avoid as obvious tells that the adviser is not inclined to make recommendations based on evidence or best practices.

Instead, look for a financial adviser to whom you can talk about hopes and dreams. Solving specific problems is always great. Offering alternatives (for instance: CPP now or later? Keep the pension plan or take the commuted value?) is also critical, since so much of financial life involves sound decision-making. To that end, the explanations you get for the recommendations are also a great way to differentiate good advice from the kind that’s not so good.

You should also try to find someone who is a good fit. For instance, is it important to you that the adviser be local? Do you want someone from your community (which can be defined by geography, religion, ethnicity or other factors) or someone who is decidedly outside of it (for confidentiality purposes)?

How complex are your needs? How complex are they likely to be down the road?

There are different types of advisers and the fit is often critical. For instance, people in small towns might have to make do with a mutual fund registrant — either through an independent firm or through a local bank branch. If you want more and have enough by way of assets, you could likely find a good securities licensed adviser in any medium-sized city. If you’re an accredited investor, you may want to work with a portfolio manager , who works on a discretionary basis and has a fiduciary obligation to clients.

It should be obvious, but I should add that the types of training that advisers get varies primarily by registration. Obviously, there’s a case-by-case situation that needs to be explored but having at least one industry-specific designation also shows a commitment to continuing education and professionalism. The most widely accepted and respected of these is the CFP (Certified Financial Planner) designation, which is held by about 17,000 Canadians. Some CFPs work on an advice-only (fee for service) basis where they cannot sell products but charge by the hour or by the deliverable and send investors off to do the portfolio management elsewhere (often, that’s what do-it-yourself investors opt for).

There are many other tests of what to look for. However, instead of fretting over the elements that are nice to have, it is often easiest to screen for the obvious red flags that should be avoided at all costs.

Most advisers are well-intended and decent people. Alas, some of them are so misguided that they themselves fail to recognize their own biases and wayward behaviours. It’s great if you can win by finding a proverbial adviser who is perfect for you. However, there is much to be said by satisficing and choosing the option that meets your acceptable criteria. Avoid the lemons and you’ll likely be fine. At a minimum, you should aim to win by not losing.

John De Goey is a portfolio manager with Designed Securities Ltd., regulated by the Canadian Investment Regulatory Organization and a member of the Canadian Investor Protection Fund.

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