17 July 2019

How to Benchmark Your Financial Advisor

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The most-common way is to compare a portfolio against a popular index like the S&P 500. It also may be the worst way.

Many investors will look to a broad market index to evaluate how their advisor-recommended portfolio performed. This can be a mistake since these indexes are a snapshot of the overall market and may not be an appropriate benchmark for a personal portfolio.

Here are tips on how to evaluate your advisor and portfolio:

Find the right benchmark: For every sector of stocks—or every type of investment—there is likely to be an index that can serve as an appropriate measuring tool. Many times advisors provide these indexes on quarterly reports so that clients can see how they're faring with any portion of their portfolio.

Among the many indexes that are frequently used: MSCI EAFE (tracks international markets in developed countries), Russell 2000 (a U.S. small-cap index) and the Barclays U.S. Aggregate Bond Index (for fixed income).

Go the blended route: Since most portfolios are not constructed purely out of equity or fixed income investments, a blended benchmark may be appropriate. These can generally be custom-designed by advisors or a blend of more than two indexes. The key is to find a benchmark that is relevant to your portfolio.

Use Consistent Measures: Be wary of advisors who suggest you change your benchmark midstream because it could mean they're looking to hide their poor performance, pros say. Unless there has been a significant, permanent shift in the makeup of a portfolio, it does an investor little good to suddenly track a different benchmark.

Consider other yardsticks: While indexes may be useful for measuring basic performance, pros say they don't really get to the key question for investors: Is their portfolio performing in a way that will allow them to meet their goals, be it paying for a child's education or funding their retirement? To that end, many advisors establish a target for the portfolio—say, 6% average annual returns over a set period—and consider that the true "benchmark."

As an alternative to benchmarking, Edward Kohlhepp, an independent advisor in Doylestown, Pa often asks clients this: "Are you on track to retire on schedule?" (If they're already retired he might ask: "Do you have enough money for the rest of your life?")

Factor in the fees: If an advisor beats the benchmark by 1% but charges a 2% management fee, the result doesn't quite equate to a win. So, it is important for investors to know their true costs—or better yet, to have their advisor break it down. Many advisors do this as a matter of course, but it never hurts to ask.

Look at the big picture: Many advisors provide a range of services—from helping clients find a mortgage to helping them create a lifelong financial plan—that go beyond investing.

As such, it may not make sense to judge advisors solely on whether they can beat an index. Rather, "it is a piece of the evaluation," says Jason Lina of Resource Planning Group, an Atlanta advisory firm. And that isn't factoring in the intangibles: Is the advisor quick to respond to a question? Can the advisor refer you to a good accountant or estate attorney? Such things aren't easily "benchmarked" and yet they may be what matters most in the long run, pros say.

Clickhere for the full article from The Wall Street Journal.

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