How to Avoid Your Own “Madoff Moment”

There are five fundamental issues that all investors should understand about their financial advisors and the companies that employ them. I call them the five “C’s”:

1. Character

The most important aspect of an advisor-client relationship is character. Who can we trust? It’s the most critical and the hardest trait to judge in choosing a financial advisor.

Father Todd Belardi, LC, is the Formation Director of the Boy’s School at Pinecrest Academy, a private Catholic school in Cumming, GA that was recently honored as one of the “Top 50 Catholic High Schools” in the country. He is responsible for the integral formation of the boys, so I thought he would have a unique perspective on assessing character.

Father Belardi defines character as “an ensemble of virtues, or the capacity to choose wisely as a matter of habit.” He considers the following aspects in assessing character:

– The presence of a spiritual life
– Family life and priorities: is the person a good husband and dad?
– Genuineness: do they put the interests of other before their own? Is he hard working? Does he have a strong will? Is he faithful to his word? Does he do what he says he’ll do? Does he serve in the community?

Most people choose to trust someone simply because they like them. I fall into that category. I like just about everyone that I meet. But merely liking someone is not a good enough reason to trust them with your life savings.

2. Competency

What skill set does the advisor bring to the table? Most advisors begin their careers as insurance salesmen and then branch out into financial planning as their experience broadens. Initially their careers are product sales driven. If they survive that stage of their career they move into giving financial advice. Anyone can call themselves a “financial advisor”.

The Certified Financial Planner (CFP) license is the benchmark for financial planning compentency in the United States. CFP licensees have met rigorous educational requirements and have taken an oath to act in their client’s best interests. This is also known as a fiduciary oath. A fiduciary is legally, ethically, and morally obligated to put the client’s interests before his own. Many product sales oriented advisors are not held to that standard.

3. Compensation

What is the advisor incentivized to do? Is he paid a commission to sell a product, a fee for giving financial advice, or a fee for managing portfolios (or a combination of the above).

Many professionals that hold themselves out as financial advisors are actually selling insurance products (life and annuities being the most popular – because they are the most lucrative for the product seller). I’m not suggesting selling insurance is a bad profession. It’s a great profession and I know some awesome agents. But there is a conflict of interest when an agent can win a trip to Maui if you put your life savings in a certain product. I met a couple whose former advisor sold them a variable annuity to place in their charitable remainder trust so the insurance salesperson could win a trip. Unfortunately, it was not the right product for their needs. That’s the downside to product-focused advice.

I’m a member of the National Association of Personal Financial Advisors (NAPFA), the nation’s leading organization dedicated to the advancement of Fee-Only comprehensive personal financial planning. It’s made up of like-minded Certified Financial Planners that are client focused rather than product focused. This removes the conflicts of interest that plague the product-driven financial industry.

4. Chemistry

Shared values are a very important aspect of chemistry. I married my bride because we have the same values (and she’s smart and beautiful). Consequently we get along very well because I know where she’s coming from and she knows where I’m coming from.

In an advisory capacity, I’m working with families that have similar values to mine. It allows me to give them the best advice possible to accomplish their goals.

Communication and rapport are also critical to the success of any relationship.

5. Custodian

Trust but verify!!!

The safest place to keep your assets are in brokerage accounts with the big custodians. I use Charles Schwab for our client’s accounts. There are tons of reputable custodians out there (Fidelity, Vanguard, TD Amertrade, etc.). I like the big third-party custodians because clients can view their accounts online and the custodians send them a monthly statement. When a trade happens, clients get a trade confirmation explaining what it is that was purchased and at what price.

I avoid limited partnerships like the black plague. I’m not a big fan of them because the limited partners have no control or say over their money or the terms in which they can get it back. They are also less stringently regulated and have less transparency. Many speculative investment managers use these vehicles for this reason. Hedge funds are commonly limited partnerships as are energy investments (0il and gas drillers are the most common). Obviously, I’m not saying that all hedge funds and all oil and gas investments are bad. Some are quite profitable. But I’m not investing my clients’ money in them.

Another reason I avoid limited partnerships is because they are effective vehicles for perpertuating fraud. Ponzi schemes are easily implemented through limited partnerships. The vast majority of limited partnerships are run by ethical general partners, but the downside to being a limited partner outweighs the benefits for my clients.

Write checks out to the custodian directly, never to the advisor or his firm.  I’ve had dozens of people write checks to me or Dogwood Capital Management only to tell them, “No, you’ve got to make the check payable to ‘Schwab'” with your account number on it.” In Madoff’s case, his investors were writing checks to his firm which was responsible for the fraudulent reporting that enabled him to do what he did.

Accounts should be registered in your name or the name of your trust (however you manage your finances). If you have your assets in a pooled account (like a limited partneship), you do not have easy access to your funds.

These five “C’s” can be very helpful in assessing whom you are entrusting your life savings with and can go a long way towards preventing an investor from experiencing his own “Madoff moment”.

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