Thread by @MichaelKitces

Just got the infamous (for advisors) question that prospects often ask: "what % return should I expect to get if I hire your firm?"

Feeling compelled to take a few minutes & explain why this is NOT what any consumer should ever ask when trying to vet a financial advisor... (1/?)

First & foremost, the reality is that returns are determined by the market, not the advisor. At best, an advisor may say they can beat the market BY a certain amount (1% or whatever?), but that's still relative to whatever the market turns out to deliver. (2/?)

In other words, advisor might get 6% where the market delivered 5%, or 16% when the market was 15%, or -19% when the market was -20%. All beat by 1%. But whether the market returns 5% or 15% or -20%, the truth is no one knows for any particular year. (3/?)

At best, some market fundamentals can give guidance over the next 5-10+ years that returns will be better (above-average) or worse (below-average), but even brilliant managers fail to beat the market routinely in any particular year (b/c no one knows year to year). (4/?)

But here's why it matters. Back in 2004 we had a prospective client ask this year - when real estate was booming but rates were really low and valuations were already getting high. As memory serves, we told the client 6% - 7% was all we could expect over 10 years. (5/?)

Meanwhile, second advisor was telling the prospect he'd get 8% returns. So the prospect picked them. 8% beats 6%. Except it really was a low-return environment (10-yr returns ended up ~6%), so 8% was only achievable w/ concentration in high-dividend #FinServ preferred. (6/?)

And so barely 4 years later, along comes the financial crisis. ~30% of his portfolio was in Lehman preferred. He got the promised 8% yields for 4 years... until nearly 1/3rd of his portfolio lost 99% in a few weeks when Lehman went under. (7/?)

Because the return environment was what it was. We were all invested in the same opportunities. But b/c the prospect evaluated advisors by their promised returns, he picked the one w/ the highest %-return promises that really just gave the riskiest portfolio.😪 (8/?)

Key point is that, especially in low-return environments, asking advisors what returns they can get pulls you away from 'good' advisors w/ realistic advice about low returns, & skews towards those who overpromise & then dial up risk trying to make good. Which is NOT good. (9/?)

So what SHOULD consumers ask when they're vetting a financial advisor? Here's the "What I'd tell my mother if she had to find a financial advisor alone after I'm gone" advice I give... (10/?)

1) Incentives matter. Most 'financial advisors' are legally salespeople, not advisors, paid for products they sell (commissions) rather than the advice they give (fees). And when you're paid to sell hammers, every problem looks like a nail. Seek out a "fee-only" advisor. (11/?)

2) Accountability matters. Salespeople have different (lower) standards of care than advisors - in our industry, broker-dealer reps & insurance agents (salespeople) have lower standards than RIAs (advice-givers). You want an advisor who has consequences for bad advice. (12/?)

Fiduciary is the advice standard, w/ real legal consequences for those giving bad advice & don't follow a good process. Seek out an RIA who operates as a fiduciary at all times. (And look them up on BrokerCheck to verify no disciplinary history.) kitces.com/blog/finra-bro… (13/?)

3) Education matters. The bar to put "financial advisor" on your business card & advise on someone's entire life savings is ludicrously low - it's a high school diploma & a 3-hour regulatory exam you can study for in a week or two (& the diploma is actually optional). (14/?)

If you want good advice, demand more competency. That means CFP certification as a bare minimum, and ideally a graduate degree in finanical planning or another relevant field or other advanced designations (esp. if your situation is more complex). (15/?)

Seek out CFP certificants (which inherently includes several years of experience required to earn the marks), and more years of experience & advanced designations for highly complex needs. (16/?)

4) Expertise matters. Education covers the core body of knowledge, while expertise is about applied experience gleaned from helping lots of people in situations like yours. And the wisdom that comes from seeing those client challenges & solving them repeatedly. (17/?)

Educated adivsors run projections to see if you can afford to retire; expertise is knowing pre-65 transition creates pre-Medicare health insurance gap, an HDHP w/ HSA can bridge the gap, but claiming SS early triggers Medicare application & invalidates HSA contributions. (18/?)

Seek out advisors who have experience with (and ideally, a focus in) working with other clients of a similar income/wealth level and age/circumstances to you. (19/?)

5) Communication matters. In the end, open conversation about your money issues w/ your advisor is crucial. Yet money is still one of the most taboo subjects. So even if someone checks the other boxes, if you don't feel the communication click, it's not a good fit. (20/?)

Seek out an advisor that feels comfortable to talk to and communicate with, and trust your gut that if it doesn’t feel right in the first meeting, it’s not going to be a good fit in the long run either. Always vet w/ a final 1-hour conversation to make sure you get along. (21/?)

In practice, the first 3 categories alone eliminate most 'financial advisors'. The Venn diagram of incentives (fees), accountability (fiduciary), and education (CFP+), is already quite small. Refine further from there seeking expertise & communication fit. (22/?)

Obviously there are lots of other nuances w/ particular services & pricing (fit there obviously matters too), but ultimately the whole point of hiring an expert is that you can't fully vet their expertise, so you have to vet what you can. (23/?)

That's why incentives, accountability, & education/expertise matter so much. THOSE you can vet. And if you're well-aligned on THOSE, you should be able to sleep well at night that the "Advicer" is really looking out for you and your interests. kitces.com/financial-advi… (24/?)

Notably, there *ARE* good advisors who don't fit this criteria (not RIAs, don't charge fees, not CFPs, etc.). But VERY hard for consumers to tell, which leads to bad vetting Qs. Thus my 'Advice to Mom' approach: narrow the search to those w/ higher standards to begin with. (/end)