How to choose the right financial advisor (and why it’s so hard)

Hiring a financial advisor is a big decision. An advisor can have a powerful impact on your life, so getting it right is crucial. However, folks often don’t know what they’re looking for, or even what’s available to them. A doctor/patient relationship can be a useful analogy to understand why it’s so tough to settle on the “right advisor.”

Trust is the foundation—in both finance and healthcare

For one, there’s a large degree of trust in both the doctor/patient relationship and the advisor/client relationship. If you had to hire a general practitioner, ENT, surgeon, anesthesiologist, physical therapist, etc. by interviewing them and getting their “pitch” on how they would treat whatever health concerns you have, I’m pretty sure you’d be lost.

How could these professionals distill their decades of training and experience into a short meeting with someone unfamiliar with the field? There are tons of nuances and tradeoffs to be considered. Ultimately, you have to trust them. There’s no way around it.

Why financial firms try so hard to earn your trust

Hiring an advisor is similar. At the end of the day, you’re going to have to trust them. Many firms that offer financial products try to instill a sense of trust and permanence with their branding. Have you noticed how many insurance and investment firms are associated with rocks, stones, mountains, or other permanent natural features? They do that to hopefully give you the sense of security you need to trust them—so you’ll buy their product.

The value of financial advice is hard to quantify

If you hire an advisor, you’re going to pay for that service—it’s a product. But you cannot easily quantify the value of your advisor to check if it’s a good deal or not. It’s too nuanced and specific to each situation. The value is lumpy and sometimes not quantifiable at all.

Besides, what are you comparing against? The right comparison is what you would have done without the advisor, but that counterfactual doesn’t exist.

Lots of studies have tried to quantify the value of an advisor. [Here’s one from Vanguard.] And here’s a podcast with an academic who’s researched the topic in depth. If you’re the right person in the right situation, a good advisor can easily be worth the fee.

The limits of the analogy

The analogy I’m making between doctors and advisors eventually breaks down (like all analogies). For one, a medical procedure can be life or death and will give you relatively immediate results along with longer-term benefits.

Investing or financial advice has a very low probability of killing you… and can take much longer to pay off. If a surgeon botches a surgery, you’ll know pretty soon. If you get “bad” advice or a “bad” portfolio, you might not find it out for years—if ever—because financial asset prices are volatile and returns are noisy.

Volatility is the defining characteristic of the industry.

A simple framework for choosing a financial advisor

With all that in mind, here’s a simple framework for choosing an advisor:

• Do you know how they make money and are you okay with that? Every single model has some conflicts and tradeoffs. It’s about understanding what they are and how they are managed.
• What standard do they need to meet (i.e. are they fiduciaries)?
• Do they have the experience and expertise you need? There are specialists in the industry, just like in medicine. You wouldn’t go to an ENT for a broken leg.
• Do you like them personally? An advisory relationship means you’ll spend some time together talking about life and goals. It’s best if you actually like the person sitting across from you.
• Are they proactive or reactive? Do they help you understand why they are making the recommendations they are making?

That’s pretty much the list. There are lots of other things you could look at, but at the end of the day, you have to trust them. If they check the boxes above for you, it’s likely they’re a good fit.