The right adviser is an important member of your financial team, serving as the point person who ensures you reach your goals while minimizing the tax impact and reducing unnecessary risk.
That said, if we learned anything from the fallout of the Bernard Madoff financial scandal, it's that you have to do your own due diligence on any financial adviser you consider hiring.
Madoff, you remember, was arrested in December 2008 and convicted as the architect of a Ponzi scheme that resulted in the loss of billions of dollars of clients' money.
Liz Davidson, founder of Financial Finesse, a firm that provides independent fiscal education to employees, and author of "What Your Financial Advisor Isn't Telling You," says that one of the first steps to understanding the financial advice industry is to distinguish between titles.
Money manager versus financial adviser
Madoff was a money manager, not a financial adviser, although many people believe the two are interchangeable. Money managers manage money. Think of the manager of a specific mutual fund or independent investment. Their purpose is to beat their benchmark, not to oversee your entire portfolio. That's not to say you shouldn't have money managers, but they should be reporting to a point person who is overseeing your total portfolio to ensure you reach your investment goals. That person is the financial adviser.
"What I think people need more than anything is someone who has their back, so to speak, and can take a holistic approach to their money," says Davidson. The adviser coordinates a team of investment managers and keeps the big picture in mind. Many of Madoff's clients saw him as "their financial guy," says Davidson, but criminality aside, they were bestowing broad powers on a person who should have been one member of an adviser's team.
Watch for these 3 red flags
Although he was an expert in deception, in hindsight, there were warning signs that could have tipped off Madoff's clients to wrongdoing.
- He generated his own financial statements. Davidson calls Madoff's ability to generate false statements "mind-boggling" because he used actual stock prices and managed to create believable returns. Investors should look for statements directly from the custodian -- a financial company that holds customers' securities for safekeeping. "They shouldn't be on the money manager's stationery," says Davidson.
- He never had a negative return. "It's crazy," says Davidson. "I knew people who lost money with Madoff and when we looked at the returns, the steadiness of positive returns even in bad years should have been a red flag for clients. It defies all logic." Even revered investor Warren Buffett has down years. And while you don't want an adviser who can't ever beat the market, the key is to look at long-term returns -- Davidson favors 10 years -- to ensure the manager or adviser sticks to the investment strategy, rather than jumping in and out of investments in reaction to the market. Check to see if they consistently beat the benchmark while keeping volatility relatively low.
- He didn't issue investment policy statements. These serve as financial road maps and are developed and agreed upon by the adviser and client. "It's such an important document because it brings you back to 'why am I doing this?' In times of market volatility, when the urge is to flee, the policy statement will remind you that your goals are what's important, not the day-to-day gyrations of the market."
In the end, "no one cares about your money more than you do," Davidson says. "While paranoia is not appropriate, you should be in regular contact with your adviser. Ask questions about the tax liability or how certain strategies fit in with the investment policy statement," she adds. "And when bad things happen, such as a market dip or an investment mistake, your adviser should be proactive about reaching you. Another red flag is that you only hear from your adviser when things are good. In this relationship, transparency is everything."
If you want to check up on your adviser, here are 3 ways to spy on your financial planner.
Get more news, money-saving tips and expert advice by signing up for a free Bankrate newsletter.