Creating a Smart Wealth Management Plan

Regular everyday investors are often plagued by a myriad of frightening questions: Am I making the right decisions with my investments? Does my financial advisor truly have my best interests at heart? Should I be managing my money on my own? How can I ensure fees aren’t corroding my investment portfolio?

Charlotte Beyer has based her career on answering these questions and providing advice on how investors can effectively work towards achieving their financial goals and improve their relationship with financial advisors. She is the founder of The Institute for Private Investors, which provides peer-to-peer networking and investor education for its members.

Beyer recently sat down with Knowledge@Wharton to discuss her new book, Wealth Management Unwrapped, and how investors can go about finding the right financial advisor and ensuring they are comfortable with their investment plan.

An edited transcript of the conversation appears below.

Knowledge@Wharton: Please tell us about your book, Wealth Management Unwrapped. I understand it came about as a result of your experiences creating an educational community to connect investors and financial advisors.

Charlotte Beyer: Investors and advisors are often put at loggerheads. Investors are often trying to protect themselves, while advisors generally need to sell investments and be perceived as very smart. This means the dialogue between investors and advisors is not as candid and open as it should be for addressing important issues Twitter .

In my work, I taught private wealth management at Wharton and worked with The Institute for Private Investors. This allowed me to try to break down the wall that existed between the two sides and improve the way investors and advisors related to one another.

Knowledge@Wharton: Do investors need advisors in the first place? Or can wealthy investors just be the CEOs of what you call “My Wealth Inc.” and manage their own money?

Beyer: They can choose either path. My book helps investors decide whether to do it on their own or delegate to an advisor.

Let’s use the analogy of a real CEO. Let’s say, as a CEO, you have to buy a telecom system. Do you go down and actually work on the switches and routers yourself? Or do you hire someone else for that job? That’s the distinction. Each investor knows their management style: they are either hands-on or they are more of a smart delegator.

“Let’s say, as a CEO, you have to buy a telecom system. Do you go down and actually work on the switches and routers yourself? Or do you hire someone else for that job?”

Knowledge@Wharton: You also compare it to renovating your kitchen.

Beyer: Yes. When you want to renovate a kitchen, you can go to Home Depot and think, “What size do I need? What am I doing? How can I renovate a kitchen?” Personally, when I walk into Home Depot, I become overwhelmed.

On the other hand, some people know exactly what they are doing. They are almost like contractors or carpenters. They love being in Home Depot. They know exactly what size lumber and cabinets to get.

Knowledge@Wharton: There are people who believe that investing using a passive indexing approach is better than trying to outsmart the market. A passive approach allows you to diversify your risk and your investment performance will track a broader market. What do you think are the pros and cons of this approach?

Beyer: In my book, I describe the danger of picking one investment strategy, putting it on autopilot and going away. That’s called abdicating, not delegating.

Most investment professionals would agree that the key is asset allocation. Even if all your money is in passive investments, you still need to be aware of how you’re allocating your money.

Life changes are also critical. You may have one type of investment allocation at a certain age or in a certain circumstance, but you’ll need a different strategy later in life. That’s where an advisor can potentially come in, or not, depending on your investment needs.

Knowledge@Wharton: Let’s say an investor decides not to abdicate, but to delegate, to an advisor. What are the most important considerations in choosing an advisor? How do you avoid advisors who may be too sales-y in their approach?

Beyer: It’s hard. Some of the best salespeople are very compelling and you may want to work with them, but you don’t want to have the wool pulled over your eyes. A lot of investors are leery of this.

Most importantly, you need to know what kind of investor you are. Then you need to set out your needs and your expected outcomes. Ask yourself, “What do I want to do with this wealth?” Then make a plan for how to judge advisors to find the right person.

All of these exercises are ones that you should do with a number of advisors in an interview process. If you take your time and meet with multiple advisors, you’ll begin to discern who is right for you and avoid the mere salesperson. You need a person that you can understand, who is going to suit your personal needs and goals.

Knowledge@Wharton: You recommend something called a five P exercise. Tell us about that.

Beyer: The five Ps are the components of an advisory firm. It is the firm’s philosophies, processes, performance, people and fees, but you can spell fees like this — PHEES — to keep with the P theme. Investors have to assess these five Ps.

You have to look at all of these areas equally and not place too much importance on one. For example, if you really value a personal connection with an advisor, you may hastily pick a firm filled with people like you. That’s the “People Like Us” Syndrome, which can be harmful. Alternatively, if you are too focused on performance, you may keep hiring and firing advisors who initially have hot investments that suddenly go cold.

Knowledge@Wharton: What’s the best way to protect yourself and choose a suitable advisor?

Beyer: Practice makes perfect. Interview four or five advisors. Have the exact same questions for each advisor to put them on a level playing field.

You could meet an advisor who shows that he has an incredible track record beginning in March 2009. The performance could be compelling. However, the other three firms you interview won’t get the same chance to use that exact timeline, so you cannot compare overall performance for all the firms. This can be deceiving. Having a system and asking the exact same questions each time is much fairer.

“Fees are the explosion waiting to happen in our industry. The more transparency comes to the fore, the more investors lose faith in the industry because fees are kept hidden.”

Knowledge@Wharton: Let’s talk about fees. How can investors figure out the right level of fees they should pay for advice?

Beyer: Fees are the explosion waiting to happen in our industry. The more transparency comes to the fore, the more investors lose faith in the industry because fees are kept hidden.

Therefore, investors should ask advisors: “Are you being paid directly or indirectly for what you’re suggesting I buy?” That ensures investors are more informed.

We did a study with Knowledge@Wharton and State Street Global Advisors about investment fees. It revealed that, if you show fees in context it will help investors decide whether the fees are fair. Investors should see the fees they are being offered, the fees offered by competitors and the levels of fees charged for individuals with different levels of wealth. Asking for a chart of these fees will show a potential advisor that you’re well informed and will give you a wonderful context for realizing whether the fees are fair. Remember, going to the cheapest provider may be alluring, but there is the risk that you will get what you pay for. With the cheapest provider, you may be missing out on some critical advice.

Knowledge@Wharton: In that study, it showed advisors thought that investors trusted them at a certain level, but in reality investors trusted them at a much lower level. What does this tell you about the value of trust, especially in the aftermath of the financial crisis? How can trust be established between investors and advisors?

Beyer: Trust is the glue that holds together any investor-advisor relationship. The way to develop trust is to create metrics for valuing advice, and create a report card so you can track what is discussed, what is agreed upon, and how your goals match up with your investment plan and performance. This builds trust. Trust is something that is shown over time through predictability.

But trust is a two-way street. Professional advisors need to expect investors to be trustworthy and to share information that will help them do a better job for their family. But oftentimes, both sides are being a little less than candid.

Knowledge@Wharton: Do you see trust primarily as a matter of metrics or as a matter of communication, or both?

Beyer: It’s both. It’s communication based on a foundation of real metrics.

The classic error is for an investor to trust an advisor who says, “I will help you sleep at night.” This is a cliché. Investors should come back and ask, “How will you do that?” It’s all about communication. But unfortunately, the investment industry generally speaks a jargon-filled language that can create mistrust.

Knowledge@Wharton: In your book, you identify four major risks that can send an investment strategy off a cliff. What are those risks and how can investors guard against them?

Beyer: This is based on work by Geoff Davey from FinaMetrica in Australia. He said that we too often look at risk in terms of “required risk,” which is the one that we chart and that Wharton professors are always citing. But there are three other risks that are equally important. There is risk tolerance, which is related to an investor’s personality. There’s perceived risk, which is related to how an investor views the world. For example, are they panicked by last week’s market volatility? Then there is situational risk, which is gauged based on who they are and how old they are, along with other lifestyle-related factors.

“The way to develop trust is to create metrics for valuing advice, and create a report card so you can track what is discussed, what is agreed upon, and how your goals match up with your investment plan and performance.”

Knowledge@Wharton: In your book, you told this story: an investor asks his advisor the time, but then the advisor tells him how to make a watch. How should advisors communicate with investors about risk and other investment issues without bombarding them with too much detail?

Beyer: This is where emotional IQ is important. Many investment professionals lack emotional IQ, or EQ. They have a huge amount of IQ. Smart investment firms will find the right advisors to have a dialogue with investors in order to better understand their personality and preferences.

Too often, firms just plop down a big investment manual and say, “Look here.” These professionals don’t realize that each investor has a different interest and curiosity in investment details.

But one thing holds true across all investor types: charts and pictures are critical. Charts present a compelling picture to investors, whether it’s a risk/return chart or a simple graphic explaining performance. Investors respond to this.

Knowledge@Wharton: How should investors measure their advisor’s performance? When do you know that it’s time to let an advisor go?

Beyer: Let’s start with the last question.

An investor came to me right after the financial crisis and said, “My advisors lost so much money. I want to fire him right away. Then I need to hire somebody right away. Can you give me three names for suitable advisors?”

I said, “No, I can’t give you three names. But I will give you a system for looking at how to work through this issue.” The system requires an investor to conduct a competition of sorts for their assets, and the competition must include the current advisor and other prospective advisors.

Using a system of questions that I gave to this investor, he ended up retaining the advisor he was about to fire because the advisor gave him context to understand his past investment performance. He realized that his portfolio performed better than most endowment funds, investors and pension plans. He realized that when he broke down the asset classes and how they had performed versus a benchmark, his performance was not so bad after all.

This begs the question, “Why don’t investors get this information without having to ask?” But it’s all about evolution in the industry — the more investors and advisors communicate, the more advisors realize their client’s wants and needs.

About your first question on measuring your advisor: that’s something to assess before you hire the advisor. It’s all about setting expectations. You have to ask: What is our risk target? What returns are we looking for? When do I want to get a call from you? When do I want to get an e-mail? How often do I want to meet with you? Then at each meeting, you must look at the metrics that were set out before you even hired the advisor. It really starts with the investment policy statement, the statement of goals and the purpose of the money.

Knowledge@Wharton: Let’s assume that we have one investor and one advisor in the room right now. What’s the one piece of advice you would give to each of them about optimizing their working relationship?

Beyer: My advice is: “Dare to say it.” Investors need to be brave and dare to say, “I don’t understand what you’re talking about,” or, “I don’t feel comfortable in this market.”

The advisor needs to be upfront and dare to say, “We’re not always going to agree,” and “I understand you want a custom report, but we cannot customize every report for each client or else we will not be profitable.”

Both sides need an extra dose of courage.

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