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We often have to put somewhat blind faith in the people who serve us---car mechanics, HVAC technicians, doctors, etc. Normally I research things a great deal before making a decision or trusting advice. I've come to realize with my fiduciary advisor that despite my research, I will never have enough knowledge to understand financial products thoroughly. How does an ordinary person know when to trust the advisor's recommendations when we lack deep knowledge of finance? What signs do you look for to know whether to put trust in your advisor?

Eggy
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    Can you clarify what you mean by "fiduciary advisor"? Are you talking about a 'financial advisor' that has a fiduciary responsibility? They are often just referred to as 'a fiduciary'. – JimmyJames Mar 13 '24 at 15:59
  • @JimmyJames. Yes, financial advisor with a fiduciary responsibility. – Eggy Mar 13 '24 at 16:54
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    Personally, I don't have blind faith in anyone like that- doctors make mistakes that could kill you, mechanics and service technicians can make mistakes, do lazy things that cost you money and often get kickbacks for selling you stuff you don't need. If there is an important decision to be made, why not get a second opinion? Or just split your portfolio between two competitive advisors, as much as they would hate that. – Spehro Pefhany Mar 13 '24 at 17:15
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    Unless you see 'finances' as different from any other technical specialisms, why not just ask three or four qualified experts and choose the one first, prepared to take the time and then, able to explain everything in terms that suit your understanding? – Robbie Goodwin Mar 15 '24 at 22:29

5 Answers5

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Easy: If a product is too complicated for you to understand, limit how much you invest in it or leave it out of your portfolio entirely. (See Addendum.)

I believe exotic investments are rarely needed in a portfolio for ordinary people. They might get you a fraction of a percent more return or slightly better safety, but until you're up in the many-millions range that isn't enough difference to actually affect the results much.

Caveat: I'm one who considers investing in single stocks too complicated for my core portfolio, and has gone the index funds route. If you want to work harder for debatable better return, my opinion may not be relevant to your needs.

ADDENDUM: The corollary of this, and the answer to the question you were trying to to ask, is: If your advisor can't explain the product to you in a way that lets you feel confident about it, tell them you want an alternative. They are giving you advice. You aren't obligated to take it, and if you tell them you don't like it, it's their job to find something you are comfortable with even if they don't think it's ideal. If they can't do that, you probably don't want them as your advisor, whether or not they are good for other people with other needs.

If they are suggesting anything complicated to a beginner, I question their advising skill, no matter how good their investment skill is. You don't hand a stunt plane to a beginning pilot; it can do things a more stable plane can't, but it's harder to understand and fly and few of those things are actually helpful for the student.

Start with basics. Refine as you learn... or don't bother since the basics really are good enough for most people.

keshlam
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    Here's the big unanswered question as followup: What if someone doesn't understand an index fund, or a bond? Assume true ignorance of all financial matters - what becomes the base level necessary to do any investing at all, beyond cash in a bank account? – Grade 'Eh' Bacon Mar 13 '24 at 13:46
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    There is a base level required. Investors have to understand normal variation in the market enough to have some level of trust in the system and not overreact to either positive or negative changes. Determining what those essentials are is more than I want to tackle in a comment, but it's probably less than a day's education. More time might be needed to find what people actively misunderstand and correct that. – keshlam Mar 13 '24 at 14:06
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    @Grade'Eh'Bacon That's a good point. When I started investing, I picked up reputable magazines like Money and Kiplinger's. Today's media environment makes it harder to distinguish legit sources from scammers. Probably the best advice is to check with friends and family who have been successful, they should be able to point you in the right direction. – Barmar Mar 13 '24 at 15:30
  • @Grade 'Eh' Bacon: Yes, this is exactly my point. I'm an intelligent person, but the more I read about finances the less I understand. If I only invest in things I understand completely, that's going to limit my opportunities. Hence working with a financial advisor. – Eggy Mar 13 '24 at 16:58
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    @Grade'Eh'Bacon Funnily enough, I expect that many people don't really understand fractional reserve banking. – jpa Mar 13 '24 at 17:07
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    I'm pretty sure a fiduciary putting someone into exotic products would put them on the wrong side of their duty unless the investor is a high-net-worth individual who can afford to lose that money and understands the risks. – JimmyJames Mar 13 '24 at 17:16
  • @JimmyJames a lot of the complicated "exotic" products (e.g. "structured products") are attempts to limit risk, in cost efficient ways (typically by limiting maximum returns). In theory, telling a client to invest in such a product is less risky than telling them to stick everything into the S&P500. – mbrig Mar 13 '24 at 17:43
  • @mbrig Yes, I suppose it depends on what 'exotic' means here. I kind of assumed it meant something a little dicey like triple-leveraged Qs. But I know of an investment product that has 0 downside risk (with a capped upside) on the S&P500 which I can see being called 'exotic' – JimmyJames Mar 13 '24 at 18:02
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    @Eggy Please don't get me wrong - you are doing exactly the right thing by asking this question, and more understanding is good. I am merely lamenting the lack of general education, which means that many people who even think to consider a question like this, will fall victim to scam-level "investment" opportunities. Like, for example, user JPA above implying that secret knowledge is needed to uncover the 'truth' about banking. This is a typical opinion among the bitcoin enthusiasts [based on JPA's past posting in the Bitcoin stack, it seems that applies here]. – Grade 'Eh' Bacon Mar 13 '24 at 19:00
  • Financial products are designed to be hard to understand for the layperson so they will give up and pay someone to "manage" their finances for them, often in expensive and underperforming (over the long term) vehicles. – Slippery Pete Mar 13 '24 at 19:40
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    @SlipperyPete: if you're looking at ones that are hard to understand, they will be hard to understand. There are choices and approaches that are relatively easy to understand and deliver quite reasonable return over the long run. If you want to doore work to try to increase that yield -- generally at the expense of accepting more risk -- that's your choice, not the only reason one. – keshlam Mar 13 '24 at 19:49
  • @keshlam: Of course, which is why I went the index funds route the same as you ;) sorry that wasn't clear. – Slippery Pete Mar 13 '24 at 19:51
  • Sorry -- "do more", of course. And "reasonable". Sigh. – keshlam Mar 13 '24 at 20:21
  • How exactly is an individual stock harder to understand than an average of multiple stocks? – Karl Knechtel Mar 14 '24 at 03:01
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    If you're working with individual stocks, you must get into all the complexities of what makes one stock (maybe) better than another at any particular moment. If you're working with indexes, you average out most of those details and only think about a small number of general categories, and in fact can ignore them for large stretches of time (I used to rebalance about once a year; now that I'm drawing down some of my investments I need to be slightly more aware of how to maintain balance while doing so but most months that means look at five numbers and conclude I don't need to do anything.) – keshlam Mar 14 '24 at 04:02
  • See other answers re how index funds work and why they are worth considering. – keshlam Mar 14 '24 at 04:03
  • @keshlam. Thank you. Your answer is helpful. My advisor did in fact start with the small basics that I could understand. – Eggy Mar 15 '24 at 22:55
  • If they want to introduce something more complicated, it's their job, literally, to teach you about it and why it should be considered. (And your job to decide whether you agree with them, before sinking nontrivial amounts of money in it.) – keshlam Mar 16 '24 at 00:42
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So I agree with Keshlam, but using your analogy, a few years back, I had an HVAC guy tell me that I had a bad relay board on my AC. I could replace the relay board for $650 or since it was so old, I should really replace the AC unit with a new more efficient unit for $8,500.

Me: "Okay let me talk to my wife". What I actually did was took a pic of the relay board, searched or it online, ordered it for $50. Two screws and a plug later (about 5 minutes of work) and the AC was working fine and still was two years after the swap. The HVAC guy was ripping me off. (I already paid a fee for the service call and diagnosis.)

If it was me, I would read about and understand an S&P500 index fund. If you understand that, how it might go up and down in the short term, but overall, you will probably realize an average annual 10% gain, over the life of your investment.

If you dump all your long-term investment money into that you will outperform 95% of most investment advisers and retail investors not pay a fee.

There is no need to understand all the nuisances of balance sheets and what not, simply when you have some extra money dump it in there. It is impossible to time the market.

Grade 'Eh' Bacon
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Pete B.
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    Mostly agree. I'd expect more like 8%, and a mix of index fund categories can fine-tune the balance to better suit your own risk tolerance and timeframe, but I agree that for most people low-fee index funds (important qualification) are as reliable and productive as anything in the market and a hell of a lot less effort to either understand or use. And "market rate of return", compounded for years, really can be good enough. – keshlam Mar 13 '24 at 12:54
  • I'm more interested in the trustworthiness of a financial advisor, not my investment strategies. I really need a financial advisor. If he says a certain product is best for me and I can't fully understand that product, how do I know whether to trust his judgment? So far his recommendations have improved my financial picture. But now things are getting more complicated and I'm out of my depth. I trust my car mechanic based on past experiences with him. If he says I need X and I don't understand how X works, I'm inclined to follow his advice. The stakes are a lot higher with a financial advisor! – Eggy Mar 13 '24 at 17:11
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    @eggy what on earth do you need financially that's harder to understand than an etf? Without that info, we can't help you. Because for most people the answer is: understand an ETF and you're done with it. – DonQuiKong Mar 13 '24 at 20:55
  • @DonQuiKong If I answer your question you will go down the rabbit hole of debating that particular product. Much as I would like to have a definitive answer on the risks of the product, that wouldn't answer my question about the dynamics of the client-advisor relationship, which is something new for me. – Eggy Mar 14 '24 at 00:40
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    @eggy well the thing is - as with everything else - don't just trust someone, understanding what is happening is better. And then we're moving in a circle. You're asking how to trust an advisor without understanding the product. The answer is usually: don't. You'll have a hard time finding a good answer here if people don't understand why you want to go against that usually good answer. – DonQuiKong Mar 14 '24 at 06:35
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    @DonQuiKong: Whether an index fund is accessed via an EFT or traditionally as an account makes relatively little difference, so I would avoid conflating the two.... – keshlam Mar 14 '24 at 13:26
  • @keshlam how do you access an index fund traditionally as an account? I've never heard of that being possible in any useful manner apart from an etf. Buying stock individually to replicate an index is madness. – DonQuiKong Mar 14 '24 at 18:15
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    Yes, trying to replicate an index for one person is madness. Traditional funds are either accessed through a broker, or (my approach) by using the investment company's "house broker", which like a remote bank account can be accessed by mail, by phone, by website or by app. Typically you give them the routing and account numbers for one bank account, and they debit or credit that when you tell them you want to buy or sell. Transactions may be delayed a day or two, but since you shouldn't be trying to time the market anyway that just means you have to plan ahead a bit. Fairly painless. – keshlam Mar 14 '24 at 18:29
  • I was a relatively early sdopter of index funds, since I started investing when IBM first opened their experimental funds. I'm still using those accounts, though the funds have changed slightly as they moved to general availability and to and through several real investment houses (being merged with similar funds along the way). As far as I know, these particular funds have never been accessible as ETSs, but I could be wrong and there are certainly ETFs with similar characteristics. – keshlam Mar 14 '24 at 18:34
  • @DonQuiKong I think the confusion here is that ETF can mean just about anything: ETF refers to the structure, not the underlying asset. It could be an indexed ETF, it could be managed stocks, bonds, commodities, cryptocurrency, etc. So "understand an ETF and you're done with it" isn't really the answer. Perhaps you meant specifically an indexed tracked ETF? In which case your comment makes more sense. – JBentley Mar 14 '24 at 18:52
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Whenever you talk to a mechanic, lawyer, or doctor, the ideal advice from them is not "you should do [thing]" but "You are in situation A. Your priority is B. In these circumstances I recommend C." If in fact your expert is wrong about A or B, this is your chance to correct that. If they are right, then it's not necessary for you to understand why C is a good choice for people in situation A with B as a priority, but there's nothing wrong with asking, either your person or the internet later.

Often we don't understand the words the experts use when they tell us our situation or priorities. It's fine to ask what they mean, or to write them down and look them up later. We might not have known the various categories of investor that advisors divide us into, but we should be able to say "yes, that sounds like me" or "no way, that's not me!" once someone has said you're in a category.

If your advisor is just saying "you should do [thing]" you can totally ask them to phrase it more like "You are in situation A. Your priority is B. In these circumstances I recommend C." If neither A nor B are very precise ("You are looking to invest. You would like your investments to do well for you") then you know the advice won't be very precise either.

You can also ask questions that link back to whatever you have agreed on with this person like "if we do [thing], what will that make our ratio of high and low risk investments?" or "if we do [thing] will our average yield still be [number we talked about before]?" Sometimes this gets you "ah, yes, good point, maybe I should suggest a different option for you" and sometimes it gets you "yes well it's not possible to suggest things that meet the parameters you said, so I'm suggesting things that are close to that." The explanation is as important as the yes/no answer.

Some advisors are not good. I've met a few personally who weren't managing my money (luckily) who just recommended what the person in the next office recommended a lot - which can work if the clients are pretty similar - or who contrary to the rules of their industry recommended what would get them the highest fee. Or what they would want their mother to do even though the client and the mother had different priorities. I am not sure that reminding such a person you have your own situation and priorities will actually make them better; but even if it doesn't it may surface to you the discontinuity and help you evaluate their work, without you having to understand why bonds are better in a given situation, or what a REIT or EFT is.

Kate Gregory
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  • Kate, the way you phrase this is very helpful: "You are in situation A. Your priority is B. In these circumstances I recommend C. . . . If they are right, then it's not necessary for you to understand why C is a good choice." I do feel like my advisor understands my situation and my priorities well. I understood the basics of his recommended product when he explained it to me, but when I researched it online I found that it was much more complicated than how it was explained to me, and most writers recommended that people avoid the product. That has me pretty worried! – Eggy Mar 14 '24 at 01:03
  • well, evaluating the advice from those writers, are they saying people in your situation or with your priorities should avoid it? Eg high risk things. You can find people saying avoid risk. Yet many do not, because there is higher reward there. Being complicated isn't a problem; there being complicated and hard to predict cases where you lose your investment or don't get the tax deduction or whatever is a problem. If you know why some recommend against the product, you can know if that applies to you. – Kate Gregory Mar 14 '24 at 10:47
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You don't give your locale but being a fiduciary means your advisor is legal bound to give you advice that is in your interest. They cannot engage in activities that would present a conflict of interest such as advising you to purchase investments with high fees so they can receive kickbacks. Fee-only advisors are usually recommended to further reduce the temptation to benefit themselves at your expense.

In the US, and I am sure other regions, there are also rules and regulations about what investments are appropriate for investors given their financial and personal situations. In general terms, this means they should not be putting significant amounts of your money into unhedged risky bets. For example, I was listening to an interview with a financial advisor about Bitcoin ETFs and he explained that, currently, financial advisors are not allowed to suggest these products to clients. They must ask him to invest in this.

At the end of the day, you need to figure out why you have a financial advisor. If you aren't looking to gain from the expertise they have but you lack, then it's not clear how you benefit from paying them. You should definitely feel comfortable asking them questions about their advice and discussing any discomfort you may have with it.

JimmyJames
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    They can absolutely steer you to investments that earn them kickback. The language is soft and doesn't prevent high-fee products or products with commissions (at least under federal law). – Hart CO Mar 13 '24 at 21:05
  • @HartCO Can you point to some references? I'm absolutely willing to admit I am wrong on this point but that's not my understanding. I know there was a lot of wrangling around this recently and I thought Dave Ramsey was against requiring advisors having a fiduciary responsibility because it would mess up his kickback schemes. – JimmyJames Mar 13 '24 at 21:33
  • @JimmyJames The way you explain what a fiduciary is is exactly how my advisor explained it. I certainly want to benefit from his expertise and already have. I'm just not used to having to make decisions about things I can't understand thoroughly. I think it's important to acknowledge the limits of our current knowledge and how much more we could learn with study. I'm highly skilled in some things. Finance is never going to be one of them. There must be an awful lot of people like me with a similar question. – Eggy Mar 14 '24 at 00:46
  • @JimmyJames Fiduciary duty is not limited to CFP's but they have a pretty rigid code of ethics which allows for commissions and conflicts of interest so long as they are honest about them: https://www.cfp.net/ethics/code-of-ethics-and-standards-of-conduct – Hart CO Mar 14 '24 at 02:25
  • @Eggy I agree with you. My point here is that you are essentially describing the reason that financial advisor is a job. If everyone knew finance, no one would need their help. For better or worse, these advisors are not free to make any kind investment that they might like. That means your results are highly unlikely to 'moon' but also unlikely to tank. – JimmyJames Mar 14 '24 at 14:33
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None of the following are really determinative in their own right, but after considering all of these things you'll be much better placed to make the call on whether or not to trust an advisor.

Qualifications

What are your advisors qualifications?

For example someone working at a bank might have merely had some internal training, like an "Industry accreditation" or something.

Others in private practice might have / college / bachelor / masters degrees.

Regulatory Standing

Does your advisor personally hold a license, or are they relying on their supervisor's license to provide their services?

Professional Body Standing

This is probably the most relevant, because these guys confirm that the following are in order:

  • Qualifications
  • Regulatory Licenses
  • Professional Indemnity Insurance
  • Ongoing Professional Development
  • Appropriate Quality of Service (through audits)

What I mean is, if an accountant is a CPA, then the Certified Practicing Accountants are responsible for making sure all of the above are in order.

Ask Them

How long has your advisor been working in this profession? How often do they advise clients on matters similar to yours?

This applies less so in financial planning but in accounting or taxation it's not unreasonable to ask whether it's possible to get a testimonial from another similar client.

Gut Feeling

If you feel like your advisor has a very punchable face, just find another one. It's possible they might be good at their job and you're misinterpreting something, but if you don't feel comfortable with an advisor you're not going to be able to develop a rapport with them and ask the right questions.

Levi
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  • Thank you, Levi. All very helpful. I actually really like my advisor. But even if an advisor is fully qualified, don't they sometimes make errors of judgment about a particular product? – Eggy Mar 15 '24 at 19:51
  • Anyone can make errors of judgement. Which is one reason to diversify. – keshlam Mar 16 '24 at 03:40