How to Choose a Financial Advisor

01/09/2013 8:30 am EST


Mark Longo


Are you asking the right questions of your financial advisor? Learn what you need to know to choose the right one, courtesy of expert Mark Longo.

We’re here with Mark Longo, who’s going to talk to us about what each investor should look at when they talk to a financial advisor.

You know, Gregg, choosing a financial advisor is obviously one of the most important decisions from a financial perspective that any investor could really make.

You’re choosing someone who’s going to come in and do really two things: protect the assets that you have, and also hopefully help grow that pie. Unfortunately, especially in this environment we’re in right now, a lot of the financial advisors, asset managers, and planners are kind of failing on that first part, which is protecting the assets.

There’s a very simple reason why that is. A lot of these planners and asset managers in this day and age have come up through the ranks where they’ve been primarily taught to be long-only equity managers. That’s where the bulk of their skill set lies. So when they’re looking at things like risk mitigation through a portfolio, their first real, primary tool is diversification.

The traditional thought was 20 stocks or so in a portfolio was enough to diversify you when you were fully diversified. If you had a very sophisticated financial planner, he might break you down in different asset classes, maybe 60% equities and 30% or 40% bonds. If they were very sophisticated and maybe it was 60/30 and then 10% a gold ETF or something like that, and then you were supposedly really covered. You have been diversified across multiple asset classes and you really were protected against what may come.

Unfortunately, in this environment, over the past few years, we’ve seen increasing, almost disturbing levels of correlation across different asset classes. So the old days of being able to just diversify across 20 stocks, now that number is closer to 40 to be closer to true diversification. Even then, you could see adding more and more stocks; you’re kind of just chasing a fool’s errand at that point.
You’re not really protecting yourself.

Same thing with other asset classes: they’re starting to move more in lockstep. Gold, bonds, what have you, foreign investments, they’re moving at a much larger, higher degree of correlation than they ever have before. So if you’re using diversification to mitigate your portfolio risk, you’re really kind behind the game at that point.

So, what are some other things that you should be looking for in a financial advisor in this day and age to be able to help you survive and protect in this environment? Truly, you really need to look for an advisor that has a more advanced skill set and tool set.

They have knowledge, in this environment of correlation, that one of the really only true ways you can diversify your portfolio is to incorporate some sort of options or futures component, because these components can provide, first off, in the case of options, a lot very near-term, downside protection for your portfolio. If you’re in long an ETF in the index, or Apple (AAPL)—everyone loves Apple these days—you can buy a protective put against that and mitigate the near-term downside risk.

Also, from a volatility perspective, you can have a financial advisor who understands volatility itself is an asset class. There are products now you can trade that with, whether it’s using plain vanilla options to trade a volatility or a volatility product like the VIX; VIX calls, VIX call spreads, VIX calendars.

A lot of these products give you exposure to pure volatility, and the nice thing about that is that volatility, right now, is really the only asset class that really has a proven inverse to negative correlation to the underlying market. So the market's moving around, volatility is going to give you that negative correlation that you’re not getting from fixed income, that you’re not getting from gold, and these other places that were traditional safe havens for your financial advisor.

So the moral of the story: if you have a financial advisor today or if you are looking for one in the future, you should really be asking them these questions. "Do you have these skill sets? Are you knowledgeable in these areas? Can you offer me these skills, and if not, are you willing to find a sub-advisor who can do this for you and you can handle the other parts of diversification?"

If the answer is no to any of those questions, then you really owe it to yourself to look beyond, because quite frankly, it's not a cheap prospect. You’re paying these people a percentage of your assets. You should really be looking to maximize the bang for your buck you’re getting from that investment. So you want someone who brings the most skills and the most knowledge to the table, and that is someone who can implement those strategies.

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