Being aware of the different types of financial advisors is important, but what questions should you be asking advisors? Our top recommendations to ask an advisor are summarized here:
The title, “fiduciary” indicates your advisor has the obligation to provide suitable investment advice and act in the best interests of their clients. A non-fiduciary may put their own financial interests first by recommending investments that are not ideal, typically due to higher costs which generate commissions to the advisor.
Investment advice should not be expected for free, but you should understand how much you are being charged and why. Advisors have a variety of fee structures. One way to avoid conflicts of interest is to choose a Fee-only Fiduciary. Fee-only advisors generally charge a fee based on a percentage of assets managed, a flat annual fee, or an hourly rate. Fees based on transactional commission structures may also be used. This fee structure could allow conflicts of interest as the advisor could be motivated to sell investments or products based on the commission it generates.
You should be aware of your total all in costs to invest, as fees eat away your investment returns. Your total costs traditionally include the following fees: investment management fees and trading fees. Your advisor’s custodian may charge additional fees such as custody fees. Finally, if your advisor relies on mutual funds to structure your portfolio, you may also be charged fees by the mutual fund in the following forms: front or back end loads, mutual fund management fees, and 12b1 fees. If an advisor is not straight forward about the costs of investing, it may be wise to research advisors who are more transparent.
You want an advisor who has an independent third party custodian to hold your assets. Custodians hold physical possession of your assets and prepare statements which price your assets. A third party custodian is an important safety check to avoid fraud. Advisors should never come in physical contact with your assets.
There are many licenses and designations that financial advisors can obtain, but which one should you look for? If you’re looking for a money manager, a registered investment advisor with a CFA (Chartered Financial Analyst) credential demonstrates superior competence in investments and are held to the highest ethical standards. If you’re looking for a financial plan, CFP’s (Certified Financial Planners) are fiduciaries who have met experience and educational requirements. A variety of registered representatives also exist who specialize in selling various investments. If you are unsure of a designation you can always refer to FINRA for a complete list and definition of professional designations.
You want an advisor who proactively communicates with you regarding your portfolio. It is important to know if you will have access to your advisor, how often you’ll meet, and when they are available for phone calls or emails. We recommend you meet formally with your advisor at least once per year to review performance and ensure you are on track to meet your financial goals. The ability to have regular communication with your financial advisor is crucial as it ensures you are monitoring your advisor’s progress and communicating about how your needs may have changed.
You need to make sure your financial advisor has an investment strategy that fits your goals and current financial needs. A good financial advisor will want to learn about you, your financial situation, and financial goals in order gauge your risk tolerance and recommend a strategy. Further, your strategy and risk tolerance should be revisited at least annually or when your situation changes. Lastly, you want to understand how your advisor typically invests assets and what your portfolio would look like under their investment style.
You should seek an advisor who is able to provide investment performance which aligns with the Global Investment Performance Standards (GIPS). These standards ensure that performance is presented in a manner which can be compared across other firms and against relative benchmarks.
Advisors who follow GIPS will use an index such as the S&P 500 to benchmark their equity returns, as it is a broad overview of the U.S. equity market. This comparison shows how your investments performed relative to the overall market. It may sound great that your equity portfolio went up 8%, but what if the total market was up 16%? You would have massively underperformed the overall market.
Ask your advisor for their historical investment returns so you can compare them against relevant benchmarks and other advisory firms. If your advisor is not transparent about their performance versus a benchmark, take that as a sign to interview other advisors. Performance should be readily available for current and prospective clients. Keep in mind that past performance does not indicate future results. However, by reviewing your advisor’s historical track record, you are able to start a conversation about your their past successes and failures.