When the Bernard Madoff scandal broke in December 2008, investment advisers and brokers really came under scrutiny. Suddenly, we all wondered if we'd checked out our broker or adviser thoroughly enough. In many cases, we found that we hadn't.
Luckily, most of us came out OK -- we went in and asked our advisers a couple of extra questions, requested a statement or looked up his name or firm in SEC's search engine. We found out everything was as it should be and went on about our days. And by now, much of the Madoff hype has died down, at least in the media. But that doesn't mean checking out an investment adviser or broker is any less important today than it was a year and a half ago.
If you haven't gone through the steps to vet the person who's holding your hand when it comes to your investments, consider this a wake up call. And if you're just now considering enlisting some help with your portfolio, here's where to start.
• Understand who you're dealing with. There are a couple distinctions we need to make here. Brokers work for brokerage firms and are paid to buy and sell your investments as you direct. "They generally give what's called nondiscretionary advice, which means the client has to say it's OK before they do anything," says David G. Tittsworth, executive director of the Investment Adviser Association.
Investment advisers, on the other hand, are paid to to provide advice about investing in securities. They must be registered with either the SEC (if they manage more than $25 million in client assets) or their state's securities agency. When you work with an investment adviser, you'll generally sign a contract that says he or she will manage your funds for you, and you don't have to OK every decision.
Sound confusing? Think of it this way: If you want to be hands-off, go with an investment adviser. If you'd rather play an active role and have time to track the market a bit, you may be better suited for a broker.
• Do some research. To check out a broker, go to FINRA, the Financial Investor Regulatory Authority. It offers a tool called Broker Check, which allows you to input a name and get information on licensing, how long they've been in business, and whether there have been any complaints filed against them (this is a major red flag). For a financial adviser, you want to look at their "form ADV," which lists information about their business and whether they've had complaints from regulators or other clients. It will also list their services and fees.
You can find the first part of the ADV form of your adviser on the SEC's Investment Adviser Public Disclosure website, but Tittsworth says you should also ask the adviser for the second part, which isn't yet publicly available. "This is more of a brochure that gives you the background on who the investment professional is and whether there are conflicts of interest that need to be disclosed." This is important, because if an adviser receives income from certain funds, you want to know about it. That way, you'll be able to recognize if he's putting you in certain investments that help his bottom line -- but not yours.
• Shop around. Your research should get you a short list; then, you want to meet with everyone in person. Tittsworth says to ask questions about what services they offer, how long they've been an adviser or broker, what their investment philosophy is, and -- most important -- how they charge. Some work on commission, others charge a percentage of assets under management.
"The good part about paying a percentage of assets that are under management is that their interests are aligned with yours -- if you make more money, they get more money in fees as well," explains Tittsworth. "If your portfolio loses money, they'll take in less in fees." I think you should also ask for references -- and call them.
• Don't hand over the cash. This is, partially, what happened to the Madoff victims – in many cases, they gave him their money directly. "If you come to me, as an investment adviser, and say I have $500,000, let me give you a check, I will say absolutely not," says Tittsworth. "I never want custody of your funds. Instead, I'll tell you to put that money in a third-party bank, or with a broker-dealer who is totally independent from me." Then, you should get statements from that bank or brokerage, as well as from your investment adviser. That way you can compare them and notice any discrepancies right away.
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