Just as you’d scrutinize a potential new car’s specs or a house’s foundation, your investments deserve the same diligence. The Form ADV Part 2 offers a panoramic view into the inner workings of an advisory firm, from its business practices to the individuals pulling the strings behind the curtains.
Listen now and learn:
- Where to find this important document
- Key points to examine carefully
- How to make well-informed decisions regarding financial relationships
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Show Notes
In the expansive universe of financial advice, understanding the people and institutions we entrust with our wealth is paramount.
One of the most overlooked yet invaluable resources in this endeavor is Form ADV Part 2, a document that peels back the layers of your investment adviser’s practices and potential conflicts of interest.
The Securities and Exchange Commission (SEC) requires all investment advisers to submit the SEC Form ADV whether they are a broker-dealer or a registered investment advisor (RIA).
Deeper Reading: How To Interview An Advisor
Part 1 of Form ADV is meant to identify the firm that is submitting the form to the SEC and has a fill-in-the-blank format.
Part 2 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.
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.
RIAs are required to deliver Form ADV Part 2 to all clients and prospective clients. Additionally, the form is publicly available on the SEC’s Investment Adviser Public Disclosure (IAPD) website, which allows anyone to review the details of a registered investment advisor.
Venturing into this document might feel overwhelming, but it becomes a treasure trove of insights with the right approach. Here’s how to tackle it:
1. Understand its Structure
When you dive into Form ADV Part 2, you’ll notice it is split into two sections.
Part 2A—Charmingly known as the “Brochure”—provides information about the investment advisor’s business practices, fees, conflicts of interest, and more. It offers a detailed overview of the firm’s services, so clients and potential clients can understand what to expect from the advisor.
Then there’s Part 2B, the “Brochure Supplement,” which provides information about specific personnel within the firm who provide investment advice to clients. It details their professional background, qualifications, disciplinary history, and other key details.
2. Services Offered
Look for details on the types of advisory services the firm provides, whether they offer comprehensive financial planning, portfolio management, or other services.
Some advisors are “advice-only,” which means they 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 more in-depth than others, particularly if they are specialists in certain areas.
3. Fees and Compensation
Next, you need 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 necessarily a “right” method of earning compensation, but you ought to know what you’re paying for the services provided.
For example, imagine paying 1% for an advisor providing primarily investment management versus someone who is charging the same amount for investment management and comprehensive financial planning.
You will also notice other fees in this section such as transaction costs and custodial expenses. Be sure to dig into the additional fees to find out if the advisor or their company earns revenues from anyone other than you (the client). In 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. Types of Clients
Check who they typically serve. Is it individuals, corporations, or other types of entities? Do they have a minimum account size?
Take note because I don’t think you want to be an exception. You should want to work with someone with experience relevant to you.
5. Investment Strategies and Analysis
Next, learn about the types of strategies they employ, the risks associated with those strategies, and how they go about selecting and monitoring the strategies.
Every advisor has a unique style. 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 who and how investments are selected is very interesting.
7. Disciplinary Information
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.
8. Conflicts of Interest
Read this section carefully. It’ll disclose if the advisor earns money from sources other than client fees.
For example, an advisor might earn a commission for recommending a particular product or utilizing a particular service.
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.
9. Custody
Advisors with custody of client funds or securities have additional responsibilities. Ensure 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.
10. Brochure Supplement (Part 2B)
Review the credentials, qualifications, and any disciplinary history of the individuals who will be managing your money or giving advice.
11. Ask Questions
After reviewing, prepare a list of questions or concerns to discuss directly with the advisor. Ensure you’re comfortable with their responses.
Deeper Reading: How To Interview An Advisor
12. Where to Find Form ADV Part 2
Lastly, in an era where misinformation is just a click away, you can use resources like the SEC’s Investment Adviser Public Disclosure (IAPD) website or FINRA’s BrokerCheck to verify the information provided in Form ADV and to see additional details about the advisor’s history.
When it comes to entrusting someone with your financial future, diligence is more than just a virtue – it’s a necessity. Form ADV Part 2 is a tool that empowers clients to make informed decisions. 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.
Resources:
- EP 28: How To Interview An Advisor
- SEC Investment Adviser Public Disclosure (IAPD) website
- FINRA’s BrokerCheck website
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Long-term investing made simple. Most people enter the markets without understanding how to grow their wealth over the long term or clearly hit their financial goals. The Long Term Investor shows you how to proactively minimize taxes, hedge against rising inflation, and ride the waves of volatility with confidence.
Hosted by the advisor, Chief Investment Officer of Plancorp, and author of “Making Money Simple,” Peter Lazaroff shares practical advice on how to make smart investment decisions your future self with thank you for. A go-to source for top media outlets like CNBC, the Wall Street Journal, and CNN Money, Peter unpacks the clear, strategic, and calculated approach he uses to decisively manage over 5.5 billion in investments for clients at Plancorp.
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