When communicating with financial advisors, you’ll frequently hear the words “control” and “influence.” They have very specific—and very different—meanings and financial advisors aren’t always clear about why these words are so important. Smart investors should know exactly what they mean.
Advisor Control
“Control” means that you have delegated investment work and decision-making to financial advisors. The industry calls this a discretionary relationship; the advisor has discretion over your assets, meaning that the advisor can make investment decisions without your advance approval.
Advisor Influence
Influence means you have delegated investment work to financial advisors, but you retain control over the final investment decisions. The industry calls this a nondiscretionary relationship. In general, advisors charge the same asset-based fees whether they’re acting in a discretionary or nondiscretionary role.
Influence Can Be Control
ERISA, the federal law that regulates U.S. pension plans, has a different perspective on influence and control. Advisors are deemed to have control if trustees approve all the advisors’ recommendations. The reason, of course, is that it would be impractical to have all the stakeholders in a pension fund control investment decisions.
Financial Experts
Why would an investor delegate control or influence? For one thing, these are the only two types of relationships you can have with financial advisors. If you don’t delegate at least influence, then why use an advisor? Acting as your own advisor is a third route, best taken by those with a sophisticated understanding of finance.
When you use advisors, you hope to get real financial experts with specialized knowledge who deliver competitive rates of return for reasonable amounts of risk and expense. It is important to research advisors’ sales claims and not just take them at face value.
Key questions to answer:
- Does your advisor control or influence the investment of your assets?
- Are you receiving competitive rates of return?
- Are you comfortable with the amount of risk to which you’re exposed? * Do you even know the amount of risk to which you’re exposed?
- Are the expenses you’re paying reasonable?
Accountability
It is easy to assign accountability when advisors have control; you can quantitatively measure the outcome of their decisions.
It’s harder to assign accountability when advisors make recommendations, and you retain control over the final decisions. If you approve those recommendations, at least some responsibility is yours if they turn out badly.
The Empowered Investor
Most people lack the time, inclination, or knowledge to invest their own assets. That means you need a financial advisor who can do the work for you.
Or depending on how much you have to invest and what your needs are, you may turn to a cheaper but less service-oriented robo advisor.
But delegating work, control and influence to financial advisors is not without risk. The biggest danger is the possibility of selecting the wrong advisor who produces bad results for excessive amounts of risk and expense. Whichever path you choose, the critical responsibility you need to take on is to consistently measure your advisor’s contribution to your financial success.
Jack Waymire is the founder of Paladin Research & Registry, a leading provider of information services to investors who rely on financial advisors.
Originally published October 1, 2015.
