True role of an investment advisor

Many investment advisors are eager to give you advice when investing in the stock market.

The article will identify how you could choose one that best suits your needs. This article will hopefully help investors distinguish between frivolous claims and claims with merit. Investment advisors don’t have a crystal ball and they are not guarantors of investments. But they do have duties and responsibilities. Investors, from their part, should know what those obligations are before they invest. 

Fair dealing 

An investment advisor (hereinafter referred to as advisor) has a fundamental responsibility for fair dealing. The securities industry requires an investment advisor to treat his customer in a fair and honest manner.  He shall observe high standards of commercial honor, just and equitable principles of trade. It is the standard on which investors are supposed to depend.

Duty of loyalty

An advisor makes his money through commission. Thus an inherent conflict can exist between the advisor’s interests and those of the customers. But the advisor must always place the interests of the customer first. The duty to the customer must be paramount. For instance, trading frequently can become an issue. The advisor should only recommend trades when they meet the needs of the consumer, not merely to generate commission. Excessive trading by an advisor for the sake of increasing commission is known as ‘churning’ and it is illegal.

Disclosure

 An advisor also has a duty to disclose all material information related to an investment recommendation Also, an advisor has an obligation to disclose the various risks on an investment recommendation. Advisors must be truthful in all communications with investors. Essentially, their communications should provide a sound basis for evaluating any recommended securities. Exaggerated, false or misleading statements are flatly prohibited.

Trading authorizations

 Advisors may not perform activities in a customer’s account unless the customer has approved and authorized the trade in advance by signing a Discretionary Account. Even in such situations advisors are expected to act with caution.  

Suitable recommendations

 Investment recommendations should be consistent with the customer’s financial status, investment objectives, level of understanding and risk tolerance. Under the “suitability rule” and the “know your customer” rule, an advisor must reasonably believe that the recommendation is appropriate for that particular customer based upon his specific financial situation, understanding and needs. The advisor should create an up-to-date customer profile that matches the customer with the appropriate investment. 

An advanced advisor will focus on the following when rendering recommendations to his clients.

Asset allocation

The phrase “asset allocation” means how the overall portfolio is distributed among asset classes such as stocks, bonds, and money market instruments. In Sri Lanka, investment advisors deal with equity and corporate debentures while fund managers handle other forms of asset classes. Asset allocation sounds simple – until you realize that this one decision can account for 91.5% of your investment returns over time.

To select the proper asset allocation, the advisor should look at the client’s investment time horizon and goals. As time goes by the advisor is expected to adjust asset allocation as the client’s needs and the markets change.

Return & risk analysis

The least understood part of investing is often the relationship between risk and return – and how to position a portfolio on that spectrum. An investment advisor should help clients determine their risk tolerance and assist them in selecting the stocks   that suit their needs. Understanding investment risk is the first step in beginning to manage it wisely!

Special situations

Of course, some investments are riskier than others and may therefore require additional duties of the advisor. For example, trading with money borrowed from the stock brokering firm( trading on margin) is a carefully regulated activity. 

Stay in contact with clients

The client’s situation may change. Things change and with it the risk level of the client changes. If a client just had a child the situation needs to be reassessed, the client now has more obligations and expenses and the risk level may have to be reduced. Therefore the advisor has a fiduciary duty to stay in touch with his client to ensure that investments are still suitable. If an advisor has not at least contacted his clients by phone in the last 3 or 4 months it is best to talk 
to them.

 

 

Investors place their total faith in their investment advisor. Usually their (investors) financial affairs are in good hands and there is nothing to worry about. However smart investors will be mindful when interacting with their investment advisors

Role of the stock brokering firm

Many customers follow the advice of their advisor based upon the reputation of the stock brokering firm. Both the stock brokering firm and advisor should act in good faith with customers. Customers automatically trust and rely upon the stock broker firm to operate under the high standards imposed upon the 
securities profession.

Soft skills 

Advisors also need certain soft skills and personal characteristics to succeed in this occupation. Here are the most important ones:

Active listening: He must be able to listen and understand the client’s financial goals.

Critical thinking: To figure out how to help the client meet his goals, he needs to evaluate all the 
available data.

Reading/ Comprehension: It is necessary to understand documents that describe various 
financial instruments.

Verbal communication: Must be able to clearly explain the financial services provided to 
potential clients.

Service orientation: A desire to help people plan for the future 
is important.