A portfolio invests its assets to earn a profit, just like a business. In the same way that the owner of a business (sometimes represented by a board of directors) may hire executives to run it, the owner of a portfolio may engage a professional for advice. Define your role clearly. Are you going to be involved in day to day decisions? Or is your role more oversight?
Treat the hiring of an advisor as you would the hiring of an executive. Consider not only their competency but also their fit. Understand the compensation of management. Try to align the goals of management with yours. Importantly, understand the fees. Ask a lot of questions. Does the advisor get compensated by fees from you? By commission? Is there compensation based on the recommended investment? From what universe of investments does your advisor choose? Does the advisor’s firm get income from the investment funds used? Does the firm mark up any investments, such as bonds, which you are buying?
Particularly when you are hiring a manager to run your business, you should have a written business plan. This plan should specify the goals of the business and the strategy that will be used to achieve the goals. What investments are permissible? How much discretion (authority) do the managers have? What calls do the owners retain? How will success be measured? When will success or failure be measured? What kind of reports do you want and with what frequency?
Fees are often charged as a percentage of the assets under management. You should think of your fees as an expense of your business and as a share of the profits you expect to make. If you pay 1% in fees and expect to earn 6%, that’s about 17% of your gross profits. Even if you think you’ll earn 10%, a 1% fee is 10% of the profits. That’s a significant share.
In addition to the direct fees, watch for indirect expenses. If you own a mutual fund or exchange-traded fund (ETF) there are expenses. You should know how much they are. You should also know what’s typical and what’s low in the industry.
Finally, be involved. Meet with your advisor. Review your strategy and your current investments. Understand the drivers of performance and expenses. Ask about the risks you are assuming. All of this is your business.