Form ADV: How to Research Financial Advisory Firms (EP.123)

0:28We all need to make smart decisions with our money. out. One of the most overlooked yet invaluable resources in this endeavor is the Form ADV Part 2, a document that peels back the layers of your investment advisor's practices and potential conflicts of interest. Venturing into this document might feel overwhelming, but with the right approach, it becomes a treasure trove of insights. And in this episode, we'll do just that. But first, I want to let you know about a free ebook you can download from today's show notes at thelongterminvestor.com. It's called How to Interview an Advisor, and it just lays out a process for interviewing advisors, along with 10 important questions and a scorecard for you to use.

1:12Now, this is obviously a great resource for anyone considering hiring an advisor, but I've heard from a number of people that already have an advisor that the ebook is an eye-opening resource. So please head on over to thelongterminvestor.com and check it out. Now, let's dive into the Form ADV Part 2. If there's a Part 2, you might be wondering, what about Part 1? And yes, there is a Part 1, but it's mostly meant to identify the firm submitting the form to the SEC and just has a fill-in-the-blank format. Part two, on the other hand, provides a more in-depth narrative about the firm written in plain English, detailing business practices, potential conflicts of interest, fees, and other essential information.

1:58In essence, the main objective of Form ADV Part 2 is to offer transparency and to ensure that clients and prospective clients have a clear understanding of the nature of the relationship they have or might have with an investment advisor. Understanding the ADV Part 2 starts with just simply understanding its structure. And when you dive into the form ADV Part 2, you're going to notice that it's split into two sections. Part 2A, charmingly known as the brochure, is the broad strokes macro view, if you will. This section provides information about the investment advisor's business practices, fees, conflicts of interest, and more.

2:38It offers a detailed overview of the firm's services so that clients and potential clients can understand what to expect from the advisor. Then there's Part 2B, the Brochure Supplement, which is dedicated to providing information about specific personnel within the firm who provide investment advice to clients. It details their professional background, qualifications, disciplinary history, and any other key details. Once you understand the structure, then you can jump into the services offered. Start by looking for details on the type of advisory services the firm provides, whether they offer comprehensive financial planning, portfolio management, or other services.

3:19Some advisors are what are known as advice only, which means that they'll provide planning but do not actually manage portfolios or assist in the implementation of financial planning strategies. Others are investment management only. Some firms will go into more depth than others, particularly if they're specialists in certain areas. Next, you'll want to understand how they charge for those services. Do they charge a flat fee, hourly rate, or a percentage of assets under management? There isn't really a right method of earning compensation, but you ought to know what you're paying for the services provided.

3:56For example, imagine paying 1 % for an advisor that is primarily investment management versus someone that is charging the same amount for investment management and comprehensive financial planning. You're also going to notice other fees in this section, such as transaction costs and custodial expenses. Be sure to dig into the additional fees to find out, does the advisor or their company earn revenue from anybody other than you, the client? Because in these such instances, that can create additional conflicts of interest that aren't readily apparent without fully understanding the individual or the company's incentives beyond serving you.

4:36After you understand compensation, take a look at the type of clients served. Is it individuals, corporations, or other type of entities? Do they have a minimum account size? Take note because I don't think you want to be an exception. I would think that you want to work with someone that has experience that is relevant to you. After that, I'd go and look at the investment strategies and analysis, where you can learn about the types of strategies a firm employs, the risks associated with those strategies, and how they go about selecting and monitoring the strategies. Every advisor's got their own unique style, and if you download the resource that I mentioned at the beginning of the show, you'll have a decent idea of things to look for, but I think having a basic understanding of the who and how investments are selected is very interesting.

5:26The next thing I tell people to look for is disciplinary information. You'll want to check if the firm or its representatives have faced any legal or disciplinary events. A clean record is generally a positive sign, but it's essential to know the details if there are any events listed because you should be just as interested in how the misstep was rectified. And then, of course, you'll want to look at conflicts of interest. I mean, really read this section carefully. It's going to disclose if the advisor earns money from sources other than the client's fees. For example, an advisor might earn a commission for recommending a particular product or utilizing a particular service.

6:04And while not inherently negative, conflicts of interest can subtly influence advice. By understanding these potential pitfalls beforehand, clients can make informed decisions about whether an advisor is the right fit. I mentioned custody earlier. Advisors with custody of client funds or securities have additional responsibilities. You'll want to ensure that they have measures in place to safeguard your investments. Using a third-party custodian is a lot like placing valuables in a bank safety deposit box. The advisor has a key for instructions, but they can't freely access the box's contents.

6:41And again, I also mentioned the brochure supplement or Part 2B. Here is where you're going to be able to review the credentials, qualifications, and any disciplinary history of the individuals who will be managing your money or giving advice. The last thing I'll note as we're walking through the Form ADV is that you ought to ask questions. After reviewing the document, prepare a list of questions or concerns to directly discuss with the advisor. Say you're wondering about how a firm pays its advisors or how the firm earns its money. This is the section to voice your questions. Lastly, in an era where misinformation is just one click away, you can always use resources like the SEC's Investment Advisor Public Disclosure or FINRA's BrokerCheck website to verify the information provided in the Form ADV and to see additional details about the advisor's history.

7:36When it comes to entrusting someone with your financial future, diligence is more than just a virtue. It's a necessity. The Form ADV Part 2 is a tool that empowers clients to make informed decisions. And by understanding its contents and relevance, you're not just choosing an advisor, but ensuring that the trajectory of your financial journey is anchored in trust, transparency, and mutual understanding. Thanks as always for listening. And until next time to long-term investing.

8:13Thanks for listening to the Long-Term Investor podcast. To access free financial resources and submit questions to be answered on the show, visit thelongterminvestor.com. Peter Lazaroff is an employee of PlanCorp and BrightPlan. All opinions expressed by Peter and any podcast guests are solely their own opinions and do not reflect the opinions of PlanCorp or BrightPlan. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of PlanCorp and BrightPlan may maintain positions in the securities discussed in this podcast.