Money in your pocket 106: Choosing an investment advisor

[Music Playing]
>>Lori Casey: Financial advisor, financial planner, broker,
wealth manager; confused by all the names and titles? On this edition of Money in Your
Pocket, Dr. Patrick Lach from Eastern Illinois University returns to talk to us about the
confusing world of investment advising. He’ll provide us with some information on what to
look for when choosing someone to manage your money. Don’t go away, Money in Your Pocket
starts right now. [Music Playing]
>>Male Speaker 1: This program is made possible in part by Credit
Union 1, proud to support Money in Your Pocket; Credit Union 1 offers savings and lending
options; additional information on membership available at Loans subject
to approval, accounts are insured up to $250,000; by member’s choice, this institution is not
federally insured.>>Lori Casey:
Welcome back to Money in Your Pocket. This week, Dr. Patrick Lach from EIU School of
Business has returned to talk to us about financial planning. This is going to get a
little bit complicated because there’s a lot of names out there. Let’s start with that.
>>Dr. Patrick Lach: Well, you know, it all comes down to what’s
in a name. There are so many titles out there that people are legally allowed to use that
have no meaning even though many people, I believe, are confused by those titles. For
example, financial advisor, financial planner, wealth manager, those are all titles that
are not regulated; anybody could throw those underneath their name. Really the only title
that’s regulated is registered investment advisor. So, if somebody has a registered
investment advisory firm and it’s a sole proprietorship, they could use that as their title. But generally,
registered investment advisor refers to the firm and investment advisor representative
refers to the individual. So, in my case, Lach Financial, the investment advisory firm
that I own and operate, Lach Financial is a registered investment advisor, I am an investment
advisor representative. So, those two terms are the only terms that are legally regulated.
Everything else, anybody can call themselves whatever they want.
>>Lori Casey: Okay, and we also hear terms like investment
advisor and broker, what are those?>>Patrick Lach:
Yes, well an investment advisor actually it’s a pretty old act that governs all these rules;
it’s the Investment Advisors Act of 1940. So, to be an investment advisor you have to
provide advice regarding securities, be in the business of providing such advice, and
you have to be compensated for receiving the advice. So, if you do those things, you’re
a registered investment advisor. There’s a few exceptions; for example, I’m also a finance
professor at EIU, and when I’m in the classroom and I’m teaching about the difference between
a Roth IRA and a traditional IRA, although that could be considered advice, I’m actually
a teacher and any advice I’m giving is incidental to my job as a teacher. Brokers receive a
similar exemption from the act of 1940 because the law recognizes brokers as being salesmen
in the business of effecting transactions. And any advice they give must be incidental
to their job as a salesman.>>Lori Casey:
Okay.>>Patrick Lach:
The distinction is important because under the investment advisors act of 1940, although
the act mentions nothing about the term fiduciary, which I’ll get to in a minute, courts have
later ruled that if you’re an investment advisor, you owe a fiduciary standard of care to your
clients, which means you must put the client’s interest ahead of your own, you must disclose
conflicts of interest, you must keep these expenses reasonable. So, for many people,
this is my own opinion, I think finding somebody that’s a fiduciary is a no brainer because
a broker, on the other hand, simply has to recommend products that are suitable for you
given your financial situation. They don’t have to keep fees and expenses reasonable,
they could recommend high expense products so long as those products are quote suitable
to the investor.>>Lori Casey:
Okay, so what exactly does this– I don’t even know what to call them, financial person,
financial profession, what is their job? What is their role?
>>Patrick Lach: Well, it depends; a registered investment
advisor is by law required to act in the client’s best interest. And register investment advisor
can provide advice regarding investments or any other type of investment products, could
assist with financial planning, etcetera. A broker, by law, is only allowed to sell
products. If they give advice, it can only be incidental; it can’t be in the business
of providing advice. So, registered investment advisor is a fiduciary, all these other terms,
again, financial advisor is a meaningless term, financial planner’s a meaningless term,
wealth manager’s a meaningless term. They all are usually words that brokers will use
when they’re holding themselves out to the public.
>>Lori Casey: So, at what point in your financial career
do– should sometime seek or would they need a financial person?
>>Patrick Lach: Well, I think you can make a strong argument
that everybody, you know, needs to see a financial advisor– or an investment advisor, I just
caught myself doing it. Everybody needs to see an investment advisor to at least touch
base and see where they are. You know, some people early on might not need a whole lot
of advice, you know, other than they want to sit down with and investment advisor and
for an hourly fee get a plan towards paying off debt. You know, in my opinion, you know,
somebody that has some debt might not even need to see an investment advisor because
going back to the health analogy we talked about on an earlier segment, I think when
it comes to being healthy physically, many people know what they have to do and it’s
an issue of having the self discipline to do it. So, I think with paying off debt, many
people know what they have to do, they’ve got to cut cable, they’ve got to reduce expenses
however they can to get the debt paid off. So, if you’re going through debt, I think
it could be helpful to see an advisor, but in many cases, I think people know what they
have to do to get out of debt. Once you begin investing, I definitely think it can be very
helpful to see an investment advisor.>>Lori Casey:
Do– do the vast majority of people use an investment advisor or are there more people
out there just buying stocks and doing things on their own?
>>Patrick Lach: Well, you know, there are some people that
use an investment advisor, other people go with brokers. There are some people that try
and do it themselves and try to go it alone, usually with not very good results. But they’re
usually, you know, very convinced of their own plan. Often times those people come in
and they’ll ask for my advice and I’ll give them my advice and then they come back and
defend the plan. And I’ll say, now did you come in here for advice or validation? So,
there are some people that try to do it themselves, but frankly the amount of damage that people
could cause trying to do it themselves far exceeds the cost of hiring an investment advisor.
>>Lori Casey: So, you’ve decided this is too much for me;
I need a financial advisor, right?>>Patrick Lach:
Investment advisor.>>Lori Casey:
Investment advisor.>>Patrick Lach:
It’s confusing; it’s confusing.>>Lori Casey:
It is, it’s very confusing. What should I be looking for because you can open up the
phonebook, look online, you can find all sorts of things, so how do you know?
>>Patrick Lach: Well, you know, going back you could find
all sorts of things, there’s also– it’s alphabet soup when it comes to designations. I have
three– or I have nine letters behind my name. I have PhD, I have a PhD in finance from Mississippi
State University; I have a CFA charter, which is Chartered Financial Analyst; and I have
my certified financial planner certificate, CFP. Most people are familiar with CFP, but
there are literally, I think there’s 100– I was reading an article the other day, I
believe the count is now up to 157 financial designations. Some of them like the CFA charter
require rigorous study to get through. The CFA exam, it’s three levels that must be passed–
that must be passed in order, and the average successful candidate reports, I believe, it’s
about 300 hours of study per level, which is about the amount of time that people spend
studying for the bar exam. So, I tell people, in my opinion, the CFA exam is like passing
three different bar exams in a row. It’s incredibly rigorous; on the other hand, some of these
other credentials, all you have to do to get them is have the ability to write a check
for $200 or $300. So, in my opinion, the only designations that matter– in my opinion,
CFA is the gold standard. Again, I have my CFA and CFP. And although most people recognize
the CFP, and this is my own personal opinion having passed both, I believe the CFA is about
four times more rigorous than the CFP; doesn’t guarantee the person is going to be competent,
I’ve beet CF– people with a CFA charter that have investment philosophies that I strongly
disagree with and that empirical, peer-reviewed academic research disagrees with. So, having
somebody with a CFA charter doesn’t guarantee that they’re competent, doesn’t guarantee
that they’re ethical, but it does guarantee that they have something to lose, which I
think is incredibly important in an advisor. The CFP designation, like I said, not nearly
as rigorous as the CFA credential, but personally if I was looking for an investment advisor,
I would want somebody with a CFA charter just because, again, it’s important to have somebody
with something to lose. There’s one other designation that I think is valid and valuable
and rigorous. I don’t have it because you have to have your CPA license to get it, and
that is a– I believe it’s PFS, it’s personal finance specialist. So, in my mind, those
three designations are, in my opinion, the only ones that are valid. I think if you see
somebody with a string of– you know I see people in this business with a string of six
designations behind their name, and I recognize two. So, those are the credentials, CFA charter,
CFP certificate, or the PFS designation, which is part of the CPA program. Those are the
only three designations that I think you should look for.
>>Lori Casey: So, if you find someone and they have the
correct things after their name, you go in and meet them, what are some questions that
you should ask them?>>Patrick Lach:
I think the most important is are you a fiduciary? Because, again, you could– there’s so many
titles people could put under their name. I think you need to ask, “are you a fiduciary?”
and I always tell people, it’s not enough to ask because, you know, I’ve seen advisors
lie to clients via e-mail, a documented means of communication. So, behind closed doors,
one on one, maybe this is the cynic in me given that I’ve seen people– advisors or
brokers lie via e-mail, I would have no doubt that they might be tempted to miss represent
themselves in person. So, ask if they’re a fiduciary, if they say yes, ask them to put
it in writing and sign it. If they refuse, if they say, well it’s a firm policy, we’re
not allowed to put that in writing I think you should find somebody else. Now, in terms
of where to find an investment advisor, there’s a couple places you could go. In my opinion,
two good places to start are the financial planning association, on their site you could
filter, you could look for a fee-only investment advisor, which it’s the advice that consumer
reports gives. Another way you could find a good fee-only investment advisor that consumer
reports does not recommend, at least not last I checked, is NAPFA, which is the National
Association of Personal Financial Advisors. So, NAPFA, is another great site
to look for a fee-only advisor. Now, I’m on the financial planning association site. I’m
not on NAPFA just because NAPFA is a much more rigorous application process and I’m
still trying to find time to go through that process, but I will say NAPFA, they review
all of your materials, you have to write a sample investment plan before you could go
on their site. Financial planning association, to be a fee-only advisor on financial planning
association’s site, it’s self-selected so the advisor could click fee-only and there’s
really no oversight in terms of which boxes that people check. That’s why I prefer NAPFA
over financial planning association.>>Lori Casey:
So, ask if they’re a fiduciary, check out those websites–
>>Patrick Lach: Well not just ask, make sure you get it in
writing.>>Lori Casey:
In writing? Okay, ask and get it in writing. People obviously don’t do this for free.
>>Patrick Lach: Exactly.
>>Lori Casey: They get paid for it, and there’s–
>>Patrick Lach: Exactly.
>>Lori Casey: Talk about the ways in which investment advisors
make their money.>>Patrick Lach:
Well, there’s the commission model, which is where a broker will sell you a product
and they get a percentage of what you invest. The broker and the firm will get a percentage.
Typically with most stock-mutual funds, that percentage off the top is usually 5.75%. And
then on top of that, the mutual fund has expenses that they charge. That’s one model of doing
business. This is just personal preference; I believe that model is fraught with conflicts
of interest. In fact, within the last three years, the United Kingdom has outlawed the
receipt of commissions from the sale of financial products, so has Australia. And also, surprisingly,
so has the Netherlands, a country where drugs are decriminalized and prostitution is legal.
So, that gives you an idea of where the Dutch government views the receipt of commissions
from the sale of financial product. So, again, I acknowledge that’s just my opinion, the
government bodies and United Kingdom, Australia, and the Netherlands, seem to agree with me.
But many brokers will just tell you well that’s just another way of being compensated, but
I think it’s fraught with conflicts of interest. The fee-only route is the route that I prefer;
it’s the route that I recommend to people. It’s the compensation model that consumer
reports recommends to individuals.>>Lori Casey:
Okay, so how does that work, then? Say I come to you and I have $10,000 please invest this.
How much of that do you get?>>Patrick Lach:
Well, there’s three different ways an advisor can charge fees. You could charge fees based
on an annual retainer where the advisor might charge you $3,000 per year. My problem with
that model is it’s $3,000 per year regardless of the future performance of your investments.
So, your portfolio goes up 30% or down 50%, the person is still making his $3,000 per
year. An alternative method is a percentage of assets under management fee. So, with my
firm, one of the two ways that I’m compensated is I charge a 1% fee of assets under management.
So, for example, if somebody walks in with $100,000, to make the math easy, my fee would
be $1,000 per year. The advantage of that is if the market goes up 20%, my fee goes
up 20%; it aligns my interest with the client’s. If the market drops by 50%, so does my fee.
So, there are people out there that argue, you know, the criticism of that model is they’ll
say yeah but are you really spending 10% more effort on a million dollar account than $100,000
account. The bigger the account, typically the more complicated it gets. But to me the
big issue is having somebody with some skin in the game that’s going to feel a 50% drop
right alongside of you. So, that’s why I’m a big advocate of hiring an advisor that’s
charging you a flat percentage of assets under management. An alternative method and this
is the other way that I’m compensated is hourly advice. So, you could go into an advisor’s
office and they might charge, you know, $150, $200, $250 an hour to develop a plan to answer
any questions you have. The downside of that is it’s the responsibility of the client to
implement that plan. So, sometimes, and I’ve seen this in my own experience, sometimes
people don’t implement the plan the way you recommend they implement the plan.
>>Lori Casey: So, you sit down with your investment advisor
and I talk about this from experience, they’ll give you a couple of plans and one is more
aggressive, one’s sort of in the middle, and one’s really conservative. How do you know
which one to pick?>>Patrick Lach:
Well, and this is where my own opinion comes into play, I think the advisor should offer
his opinion on which one he would recommend, because, for example, you know, if you hurt
your arm and you go into the doctor’s office, the doctor doesn’t walk in and say, well do
you want me to get an X-ray, do you want me to do an MRI or should I put it in an cast
right now? The doctor’s going to tell you, you need to get an X-ray and after the X-ray,
he might say you need to get this in a sling. So, I think you want an advisor– now granted,
a lot of it is personal preference. For example, I don’t know what’s more important to you
whether it’s, you know, retiring early is more important to you or whether leaving a
legacy to charities or people near and dear to your heart is more important to you.
>>Lori Casey: And those are all questions that your advisor
should ask you.>>Patrick Lach:
Yes.>>Lori Casey:
What– when you walk in, after you’ve answered those, you’re going to– you should say, well
what do you want?>>Patrick Lach:
Yes, exactly.>>Lori Casey:
What’s your future?>>Patrick Lach:
Exactly.>>Lori Casey:
If they’re not, then that’s probably not a good thing either. So–
>>Patrick Lach: Yes.
>>Lori Casey: If it meets your needs, then that’s– that’s
how you should go about it?>>Patrick Lach:
Exactly.>>Lori Casey:
Okay, let’s talk a little bit about some proposed legislation when it comes to investment advisors
and brokers. We talked about that before we started taping.
>>Patrick Lach: Sure, sure; I’m glad you mentioned that. It’s
really heated up around, I’d say, I believe it was around late February early March. The
Department of Labor, for the longest time, had expressed concern regarding the fact that
of course there are brokers that are held to a suitability standard, they don’t have
to act in the client’s best interest, they don’t have to disclose conflicts of interest,
they don’t have to keep fees and expenses reasonable so you have brokers operating under
a suitability standard. Now, when you’re working for an employer and you have a retirement
plan such as a 401K plan, by law the administrators of that plan must operate under a fiduciary
standard of care, meaning the plan administrator of your 401K or 401A or 403B, whatever type
of retirement plan you have, they, by law, are required to make decisions in the best
interest of the plan participants. So, where the Department of Labor expressed concern,
and where the president of the United States expressed concern, is that while you are employed,
that 401K, they– the administrator held fiduciary standard of care, which is the highest standard.
Well, what often happens is somebody will be working, they’re contributing to the 401K
managed under a fiduciary standard, they switch jobs and then a broker comes along, usually
calling themselves a financial advisor, and they convince that person to roll the 401K
over. And the problem that the Department of Labor and the president of the United States
have with that is that while it’s in the 401K, it’s under fiduciary standard of care, when
you roll it over to a broker it’s now dropped to a suitability standard. And the Department
of Labor has said, we have a problem with that drop in standard of car if it’s rolled
over to a broker. So, the proposed legislation would require that if you want to roll over
a previous 401K that you have to roll it over to somebody acting at– operating under a
fiduciary standard of care.>>Lori Casey:
Which is in your best interest, not in theirs?>>Patrick Lach:
Exactly, they must be operating in the client’s best interest.
>>Lori Casey: Okay, real quick, this may be getting off
subject– when you do– people do change jobs, and they go from one to the other, they had
401K here, 401K there, what do you recommend?>>Patrick Lach:
Typically most 401K plans, although the plan administrators are required to act in the
best interest of the clients, usually the expenses are high, usually diversification
options are very limited, usually international investments you could pick are virtually nonexistent
so a lot of times I recommend somebody roll it over to an IRA just because there’s better
investment options I could use within an IRA. I could pick investment options with lower
costs; I can get more diversification.>>Lori Casey:
How often should you be– once you’re on board with them and you start working, how often
should you be talking to them and revise– maybe revising the plan?
>>Patrick Lach: I like to meet with my clients at least twice
per year just because the way I operate, again, everything I do I base on empirical, peer-reviewed
academic research to the extent that I can. There’s some things were there’s no academic
research, you know, in our previous segment I said I like a 25% debt to income ratio;
there’s no evidence that supports that, but whenever possible I like to use empirical,
peer-reviewed academic research to drive what I’m doing with clients. So, my investment
plans– basically the person’s preferences and where they are in their life is going
to drive their investment plan, which is going to drive their portfolio. And so, I don’t
change the portfolio unless there’s a change in their investment plan. So, I like to meet
with people twice per year, at a minimum, just to see, you know, how are things going
in their life. You know, a lot of times we’ll create goals, you know, how is paying off
the student loans going? How is getting out of credit card debt going? I like to see the
progress they’re making and also meeting with them allows me to see when change has occurred
or when a change is going to occur.>>Lori Casey:
Okay, so how do you break up with your financial advisor if it’s not working? You know, maybe
you’re just not feeling it anymore, how do you get out of that?
>>Patrick Lach: It’s one of those things– it could be difficult
to do. I’ve had clients that, you know, tell me that’s one of their concerns is I’ve had–
you know, I’ve had clients come in and they say, I’m dreading the break up. And I always
tell them, a lot of times breaking up with your advisor is- this is a weird analogy to
use- it’s, in some regards, it’s kind of like un-friending someone on Facebook. They won’t
know– the advisor or broker, usually doesn’t know unless they look up your account. Now,
you know, in some instances they might be notified if there’s an outgoing transfer,
but you know, if you’re working with somebody that’s not a fiduciary that refuses to put
in writing that they’re a fiduciary, I think that’s a perfectly legitimate reason to walk
away. But again, that’s personal opinion.>>Lori Casey:
So, talk about this– as an industry as a whole, you made a very interesting point that
there’s no– and this is why it’s frightening– we’re taking our savings for our retirement
and handing it over to someone. This industry has no minimum education requirements; it’s
a little frightening– or a lot frightening, actually.
>>Patrick Lach: It is, you know, when I walk into my dentist
office, I’ve never asked to see his diploma because I assume he graduated from dental
school; I assume to hold a drill and put it, you know, into my teeth, you have to have
significant training and education. But the reality is, for most Americans, the person
who cuts their hair is held to more rigorous education requirements than the person that
manages their money. Like you mentioned, there is no– in most states, every state’s a little
different, but in most states there is no formal education requirement to get into this
business. Typically, all that’s required is that you pass either the series seven or series
65 or some similar exam, which according to the industries that administer the exam, they’re
only designed for quote entry level positions. So, you know, if you think managing your life
savings is an entry level task, then hire somebody that has the series seven and nothing
else.>>Lori Casey:
I don’t think so.>>Patrick Lacy:
But you’re exactly right; there’s no formal education requirement. The exams that you
have to pass, I haven’t taken them because in the commonwealth of Kentucky where my advisory
firm is based, if you have your CFP certificate or your CFA charter, you don’t need to take
the series exam. So, I’ve never taken the exams. A lot of my students have taken the
exams and, you know, they’ve come back and told me the exams are not very rigorous. So,
that’s why I’m a big advocate of, you know, finding somebody with a CFA charter because
doesn’t guarantee that they’re competent or ethical, it guarantees they have something
to lose because what’s so scary in this business is the education standards are virtually non-existent.
And one of my favorite investment writers for the Motley Fool, Morgan Housel, summed
it up better than anybody I’ve ever read. He said, “there is no other industry in the
United States where people capable of causing so much damage are held to such low standards.”
>>Lori Casey: Very well said, and with that, I think the
point is, do your homework.>>Patrick Lach:
Exactly because you know, many people when they walk into a broker’s office or an investment
advisor’s office, you know, I talk to people that’ve told me, when I tell them there’s
no formal education requirement, you know, you could be a high school drop out, pass
your series seven, and you’re ready to manage people’s life savings. And you know, their
jaws drop to the floor and they said, well I thought you had to have at least a master’s
degree to do that. And so, many people walk into an advisor’s office, they don’t ask about
the person’s education background, you know; there’s a lot of people that don’t have college
degrees or they have college degrees that are not business related. So, it’s important,
like you said, do your homework, you know, ask the person’s education background, ask
what kind of certifications they have, but the most important question is are you a fiduciary
required by law to act in my best interest and number two, will you put that in writing?
>>Lori Casey: All right.
>>Patrick Lach: Those are the first two questions you should
ask. If the answer to both those questions are not yes, I don’t think there’s any reason
to ask any more.>>Lori Casey:
All right, well Dr. Lach thank you so much for coming back on Money in Your Pocket.
>>Patrick Lach: Thank you.
>>Lori Casey: And shedding some light on financial planning
for us; it’s a complicated topic.>>Patrick Lach:
It is.>>Lori Casey:
And you’ve made it a little easier to understand.>>Patrick Lach:
Thanks. m [Music Playing] mm
>>Lori Casey: What’s the bottom line for today’s show? Do
your homework when thinking about using an investment advisor. There’s an alphabet soup
of titles that people can have, so you want to about their education, training, and certification.
Ask and get in writing if they have a fiduciary responsibility for your account, meaning they’re
looking out for your best interest, not theirs. And finally, here’s a few of Dr. Lach’s website
recommendations for researching investment advisors: and
We’re out of time for this edition of Money in Your Pocket, thanks for watching and we’ll
see you next time.>>Male Speaker 1:
This program is made possible in part by Credit Union 1, proud to support Money in Your Pocket;
Credit Union 1 offers savings and lending options; additional information on membership
available at Loans subject to approval, accounts are insured up to $250,000;
by member’s choice, this institution is not federally insured.
m [Music Playing] mm

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