Many would be surprised to learn that the person managing their money may not be worth the premium paid by the investor. When picking a financial advisor there are some very important questions to ask. Many times these are the questions that financial advisors either don’t know the answer to or are embarrassed to answer.

Custom Benchmarks

one of the most important questions to ask the portfolio manager is what benchmark they are using to compare the portfolios performance to. The way the manager answers this question will tell the investor allot about the manager. Ask the manager to explain why they are using the certain benchmark. Many managers will use a broad index fund for the benchmark. They will do this because their performance looks a whole lot better when compared to a broad index. Today with new technology there is no reason portfolio managers should be using broad indexes as benchmarks. The manager is comparing apples to oranges by doing this. For a more information on this review, www.styleadvisor.com/products/styleadvisor/attribution_analysis.html

Managers that correctly represent the true performance of their portfolios will use a “custom benchmark”. A custom benchmark is created by finding the combination of indexes that best represents the performance of the portfolio. A way of doing this is to use the Russell indexes. This way the manager is able to create a custom benchmark by combining the risk return characteristics from the various indexes. In doing this the manager has created a fair benchmark for comparison. It is very unlikely that one single index would be the best representation of the manager’s portfolio. Many managers will use a single index for a benchmark either because their performance looks allot better or because they do not know how to use the software to create a custom benchmark, in either case the investor should look for another advisor that will fairly represent their portfolios performance.

Determining the managers skill level

Find out if the portfolio manager is actually skilled or is just getting lucky. Ask the portfolio manager what percentage of outperformance can be attributed to the manager’s skill or strategy. Many advisors will not know how to answer this so here are a couple of important questions.

What can the alpha be attributed to?

- Ask what the portfolio invests in. Then ask what percentage of the portfolios performance can be attributed to what it’s invested in. For example if the portfolio is invested in stocks from different sectors that make up and are included in the S&P 500 then ask the portfolio manager what percentage of the portfolios performance can be attributed to the sectors the portfolio is invested in. If 100% of the portfolios performance can be attributed to the sectors the portfolios invested in then the manager is creating absolutely no value for the investor. In other words the investor could easily invest their own money in ETF’s that represent the sectors and avoid the management fees and be better off. If 85% of the performance of the portfolio can be attributed to what it’s invested in then the portfolio manager may be responsible for 15% of the over or under performance, hopefully over! In this case the portfolio manager may be responsible for the outperformance and may be worth paying to manger investor’s money!

These questions will help the investor determine if their money manager has any skill. Questions like these will help the investor gain more knowledge in the area of money management.