Advice on Financial Advisors

Welcome to this week’s edition of Cape May Wealth Weekly. If you’re new here, subscribe to ensure you receive my next piece in your inbox. If you want to read more of my posts, check out my archive. The first version of this article was published in March 2024.

In the cold, rational world of investing, one would think that affluent investors decide on a wealth advisor with analytical rigor. They go out, find a number of banks and wealth advisors offering high-quality services and products, diligently compare their investing capabilities, and then decide on them based on technical factors and personal fit.

In reality, things look very different. Most affluent individuals choose a financial advisor that contacts them, not the other way around, or at best are introduced by a mutual friend. There’s little to no in-depth, personalized analysis, with advisors instead focusing on what products they can sell to the client. And even if those products are clearly not a good fit (due to bad performance, high fees, bad fit, or more often than not, a combination of these factors), they stick around - even though they know they might get better performance and/or lower fees elsewhere.

As the democratization of financial markets continues, many argue that financial advisors are a dying breed. While I might be biased, I think the opposite is true: A great financial advisor can offer value far in excess of any fee they might charge. But for this to be the case, you need to choose your advisor and their firm wisely.

Let me help you find the right one for you, and give you a few pieces of advice on how to maximize the benefit from your financial advisor.

Understanding the wealth management advisory model …

To understand how to best work with financial advisors, it’s helpful to understand their business model. 

Wealth advisors try to build long-term client relationships from which they can earn recurring fees based on assets under management (“AUM”). Typically, this is related to either investment-related services, such as managing a portfolio, or in the case of more advisory-focused firms (such as a multi-family office), a type of “supervisory fee” which might come with additional services such as consolidated reporting. While there are also other revenue sources, such as transaction fees or brokerage fees (i.e. helping a client source a mortgage), wealth management firms focus on generating their revenues through AUM-based fees.

Without a doubt, it’s a great business model: Such managed accounts (or in German, a Vermögensverwaltungsmandat) generate revenue on an ongoing basis regardless of whether a client is calling once a week or once a year. As AUM grows with the markets’ long-term growth, so does the management fee. Clients tend to stick around for years and decades if there is no significant underperformance, especially if they trust their financial advisor (or if they provide value beyond asset management services). And while financial advisors like to tell the story of the hard work of their portfolio management team, my experience has been that most only take a deeper look at a client’s investments a week or so before their periodic meeting.

Lastly, it’s important to know that their remuneration model is usually “eat what you kill”: Advisors receive a modest base salary, but substantial upside from a share of the (long-term oriented) fees that they bring in. The cut varies, ranging from 20% for someone employed at a large firm to 90-100% for a self-employed financial advisor.

For the record - I know many financial advisors and private banks that don’t fit this blueprint. (We at Cape May hope to be one of them.) But this bad behaviour of high fees and little service to show for it is something that isn’t just prevalent in small, dubious advisory firms, but is something that I’ve frequently encountered even in the largest, most prestigious private banks out there.

… and how it affects what your financial advisor is selling to you

Why should you, as a client, care about this? Because it’s this business model that drives how most traditional private banks and wealth managers try to generate revenue from you:

First, how you get in contact with a specific financial advisor to begin with. Given their remuneration model, financial advisors typically search the internet and media to find the next big liquidity event before another bank (or advisor in their firm) does. While some advisors centralize sourcing to allocate it to the advisor that might best fit the client needs, many do not - it’s first come, first serve, even when another advisor might be a better fit. In more than one case, clients ended up with a firm they liked, but an advisor they didn’t get along with. I’ve personally encountered my share of odd stories of how clients ended up with their advisor - such as a client who could not get a long-term college friend as his advisor because another advisor, that he had never met, had added the client to the CRM first. (If you ever need at a recommendation for a great advisor at one of the brand-name firms, feel free to reach out.)

Second, how it influences what your advisor tries to sell you. As mentioned above, financial advisors want to sell products from which they can generate predictable, high-margin returns. Ideally, by selling you on a Vermögensverwaltungsmandat, advisors can earn substantial revenues from a portfolio which might cause them little to no work after the initial setup. While most financial advisors I know work hard for their clients, I’ve also seen my share of absolutely shameless pitches: One advisor once proudly told me that he sells their clients one fund, talks to them once a year, and charges 1% p.a., on top of product fees. 

It’s important for me to highlight again that most financial advisors that I know really have their client’s best interest at heart. However, this best interest might be hard to make a reality if the business model doesn’t allow for it. Let me tell you what bothers me the most:

For me, the most important part of working with a client is the beginning of the client relationship. There is the regulatory component, of course - what assets does the client already have, what is their investment experience, which goals do they want to achieve. Equally important, however, is getting to know their goals and needs as a person, outside of their investment portfolio, and taking the time to gently guide them through their initial journey of moving for example from being an entrepreneur to being an investor.

Unfortunately, taking your time is somewhat the opposite of the aforementioned business models. Most financial advisors don’t make money on an hourly fee, but only generate revenue when they sell you a product, and accordingly, can only spend so much time on this important onboarding phase, instead rushing clients to pick specific products right away. It’s sad to say how surprised some of our clients at Cape May are when we tell them that products are typically only Step 3 - and that we first want to make sure that we are even the right firm for what they are looking for.

At Cape May Wealth Advisors, we begin every client relationship with a thorough, personalized analysis of your financial situation, your needs and wishes, and your experience with financial markets. Our fee-based financial planning process ensures that you receive an impartial opinion on your financial situation, and a personalized asset allocation - entirely free of product and asset class biases. Want to find out more? Don't hesitate to reach out. 💡

Three ways to improve your financial advisor experience

For individuals of a certain net worth, there might be few opportunities to get by entirely without financial advisors. And as I said before, a good financial advisor can be of tremendous value to a client, often far in excess of the fee that they charge, and at the very least, it makes sense to diversify your wealth across brokers and banks. So what can you do to improve your experience when it comes to working with your financial advisor?

First, don’t underestimate personal fit. 

While advisors like to tell you otherwise, most of the service offering in the wealth management industry has become somewhat commoditized. Accordingly, personal fit, meaning how well you get along with your financial advisor, is something that you shouldn’t underestimate. You need to be able to trust them fully, and if you dread every call you have with them, there is a good chance your experience (and thus your investing activity) might be sub-optimal.

So when you’re choosing a financial advisor, make sure to have a large selection of advisors to chose from: Different firms, large and small, from the independent advisor to the small regional Sparkasse to the Swiss Private Bank to the American Investment Bank. And if you already work with a firm, but are unhappy with the financial advisor, don’t hesitate to ask for someone else to become your point person. A moment of awkwardness is better than a lifetime of unhappiness, especially in something as important as personal finance.

One affluent individual recently told me that they knew they could switch their advisor - but who should they ask to switch to if they didn’t know anyone else at the bank? There’s two options that I see: Either politely ask to speak to someone in the bank’s management and ask them if they could suggest another advisor, or just tell the advisor directly that you think they might not be the best fit. Admittedly it makes for an awkward conversation, but that short moment is likely better than years of dissatisfaction.

Second, know what you want. 

Especially in the affluent and ultra-high net worth segment, most banks and financial advisors should be able to provide you with access to almost any common asset class. However, if you just give them free reign, don’t be surprised by an opinionated view: In my experience, US banks like PE and US growth stocks, while European banks like gold and European dividend stocks. Accordingly, requesting a portfolio proposal from three different wealth managers without giving them guidance is likely to give you three similar, but perhaps also very different pitches. 

(It’s also why we like our model of fee-based financial planning and asset allocation better: We can build our personalized models based on academic insights, pragmatism, and the client’s specific needs - not on whatever product we think we can sell in the next step. If a client is looking for our support on implementation afterwards, i.e. selecting partners and products, that’s great - but if they want to take our analysis to a big bank, that’s fine too.)

So when you start talking to wealth managers and banks, make sure to take the time first to think about what you want. About your asset class preferences, whether you want to include or exclude illiquid assets, how much active management there should be. It can still be helpful to give the wealth advisor a degree of free reign, but if you give them no guidance whatsoever, expect to receive a proposal that is likely the highest-margin, lowest-effort portfolio the advisor can show you.

Third, make sure to get your money’s worth. 

As I mentioned before, wealth management has become substantially democratized over the last years. You don’t need to work with a high-cost financial advisor to buy your ETF anymore, and you can even invest in asset classes such as private equity without ever talking to a person. Nevertheless, we think that a good financial advisor can add a lot of value.

If you didn’t make your money as an investor but rather as an entrepreneur, there is a good chance that your time is better spent generating return through entrepreneurial activities rather than trying to pick the best stocks. Frequent readers know of my love for the Aspirational Investor Framework, which I think also supports this thesis: Work with a capable financial advisor to help you with your Safety Bucket and Market Bucket in a cost-, time- and tax-efficient way - and instead focus on your activities in the Aspirational Bucket (like your own company or a hands-on direct investment), where success is likely to move the needle much more than if you invested that same time in your brokerage account.

However, in doing so, it’s crucial to make sure that the fee you pay is fair for the service you receive. One frequent issue I see is around self-managed ETF portfolios: Clients typically decide on their own which index funds they want to invest in, but the financial advisors, despite taking no role in selecting the funds nor supervising them, demand custody and/or supervisory fees of >0,50% p.a. despite delivering no value-add to a client’s portfolio at this point whatsoever. Don’t let them fool you into justifying such fees through apparent supervision or management, or even worse, “because they’re helping you”: Any fee you pay to a bank or financial advisor should either be a reasonable ongoing fee, or be coupled to actual value they provide to you. A good financial advisor should understand that they need to earn your assets, and understand, or even recommend, that you move your funds elsewhere where it might be cheaper and/or of higher quality.

And in this regard, it’s good to refer to my advice from the first measure: Talk to as many banks as possible. It’s entirely justified to compare prices (despite attempts to make them hard to understand), and equally reasonable to divide your assets in a way that minimizes ongoing fees. Once again, take the humble index fund: You might’ve picked it as a low-cost investment alternative - so don’t make the mistake and then make up that cost advantage by overpaying on advisor fees. Over the long term, your returns will thank you.

One area that we have yet to address is the art of ‘manager selection’ for liquid portfolios. What parts of your liquid portfolio should you consider entrusting to your financial advisor? Where can they reasonable generate performance after fees, and how high should that fee be? 

More on that next week.

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