After 17 years as a CERTIFIED FINANCIAL PLANNER™ and an additional 6 years in the financial services industry before that, I have heard a lot of questions from people seeking to hire a financial planner or advisor. Find out the answers to these questions and you will be informed and able to decide on the best advisor for you.
Questions to ask an advisor
Hiring a financial advisor is a big decision. You’re handing over your hard-earned money, hoping someone else can help you earn even more and help you implement a plan that will allow you to reach your goals. That’s why you need to interview your advisor. Your question-and-answer session is only as successful as the questions you present. To make a good decision about a financial advisor and your financial road map, you need to phrase the questions appropriately to get the best answers.
1. “Are you a fiduciary all the time?”
A fiduciary is a person who has a legal and ethical responsibility to create a trusting relationship where he/she will act in good faith. Consumers are getting new protection to make sure you’re getting your money’s worth when they hire a financial advisor. That’s why you need to ask your advisor about his role as a fiduciary.
Fiduciary is a newly regulated term in the financial industry with the Department of Labor rules taking effect in 2017. This means advisors must ensure your interests are top of mind when providing advice on retirement accounts. This means commissions must be disclosed, and the expenses you’ll pay for basic retirement money management must be explained.
This disclosure is key in rollover-type situations like a retiree who rolls over a 401(k) balance to an IRA. The White House estimates that when conflicted advice is given, the retiree loses around 12% of the value of his or her retirement savings over a 30 year period.
The advice may be conflicted if the advisor makes decision-based on the larger commission he will receive rather than the product being in the retiree’s best interest. The White House estimates $17 billion a year is wasted on exorbitant fees. This law should add transparency and consumer protection, but it remains to be seen how much.
2. “What are your credentials and experience?”
It’s easy to find people, online and learn about their background. That doesn’t mean you shouldn’t ask about an advisor’s credentials and experience. Don’t assume a bio tells you everything about a person. Get to know your advisor personally and professionally.
Advisors often have a bunch of initials after their name like CFP (Certified Financial Planner), CFA (Chartered Financial Analyst), PFS (Personal Finance Specialist), or CPA (Certified Public Accountant). These are industry credentials earned after completing educational courses. Sometimes they even agree to a specific code of ethics.
Understand what the credentials mean. Every designation means something different. Ask your advisor why he chose one designation over another, and how it separates him from the competition.
Look for an advisor who is active in his or her industry. While not essential, an advisor who is involved in trade groups and organizations may have connections to other resources which may help your relationship grow in the future. The active advisor is one who is constantly learning, collaborating, and engaging with others in the industry.
Financial industry regulations
Make sure your advisor is registered with the appropriate regulatory agency. Then have a very candid conversation asking about disciplinary action. Finally, check yourself to see if the advisor is telling the truth.
The Securities and Exchange Commission has a database of disciplinary records for advisors with more than $110 million in assets. The SEC also has basic information on advisors including previous firm associations, previous employers for 10 years, criminal charges and convictions, industry exams, and professional designations. There is a wealth of information in the SEC database that gives clients a true picture of the person they are hiring.
Some advisors may not manage $110 million, so you will only find their name or firm registered with state regulators. So, don’t be alarmed if you don’t see a filing with the SEC. In Missouri, brokers and advisers register with the Secretary of State. Call 1-800-721-7996 to check on an advisor. In Kansas, the Office of the Kansas Securities Commissioner at the Kansas Insurance Department regulates the financial industry.
Financial Industry Regulatory Authority (FINRA) also offers free background information on financial brokers, advisors, and firms.
Bottom line: do your homework. Credentials are an important question to consider.
3. How will you determine my risk tolerance?
Risk means something different to you and I. You need to determine what you consider risky since it’s your money. While you ultimately hold the keys to this decision, your advisor should help you pick a risk level you can tolerate based on your financial situation and personal goals.
Gone are the days of solely using the pen and paper risk profile questionnaires. Also gone are the days of basing risk tolerance on just your age. Today’s advisor should use a three-pronged analysis to address your acceptable level of risk.
This is the amount of risk you are comfortable with and is based on your personality. Your mindset, approach to investing, and purpose should be considered. Your advisor should take the time to get to know you through either a conversation or questionnaire.
This is the amount of risk you need to take to generate the required return to meet your goals. A financial plan or analysis is used to determine the required risk to achieve one or multiple goals. The plan or analysis will consider your current resources and ability to add more resources in the future.
This is the level of risk that you can afford to take. Generally, the more time you have the more risk you can afford to take. For example, if you plan on paying for your child’s education and he starts college in 6 months, you probably don’t have much risk capacity for this goal.
Once these areas of risk are identified, a balancing of the factors can be administered to determine the appropriate amount of risk for you.
Once your appropriate risk is determined, your current portfolio should be analyzed and stress tested so you understand how it could behave in different market situations. You and your advisor should have a high level of confidence with this analysis. If necessary, the portfolio should be altered so it matches your level of acceptable risk. Acceptable levels of risk and portfolios change, so be sure to monitor both over time and make adjustments as necessary.
4. “How do you incorporate your investment strategy with financial planning?”
Financial advisors study the ups and downs of the market daily, and have a good understanding of the economic principles that drive it. That’s why you are hiring them. That being said, financial planning is not a science. There are best practices, but there is a level of personal choice involved. Ask your advisor about his investment philosophy. Ask this question twice. First, ask it at the start of your conversation. You’ll likely hear a broad answer. Then ask it again at the end of your conversation so you get an answer that more directly applies to your goals, strategy, and risk level discussed in the conversation.
Be sure your advisor provides you with an investment policy statement. This statement will outline the strategy that you both agree on.
5. Will you have discretion over my investment account?
This question gets to the heart of how your advisor will manage your money. Will he help you select funds, and then leave the money alone or will he make transactions for you without your approval? To do this, a discretionary fund may be set up. Determine the discretionary limits. Are there certain funds you want invested in, or certain funds you want to avoid? Discuss the degree of discretion before you start your investment plan.
Your advisor should prepare an IPS (Investment Policy Statement) for you. Go over this with your advisor so you understand the guidelines your advisor will follow when managing your portfolio. The IPS should address the amount of agreed upon risk as well.
6. “Could you explain all expenses to me?”
A client who asks about expenses is doing their homework. Expenses vary dramatically among financial advisors, investments, and portfolios. Understanding costs ahead of time ensures there are no surprises. It is important to understand fees, because fees take away from your return.
Here’s a breakdown of the different types of fees you can pay. Some are paid to the advisor and some are for investments.
Advisors create revenue from either fees or commissions. Although fees and commissions sound the same, they can be very different.
How advisors can get paid
You hire a fee-only advisor when fees are paid to the advisor only by the client. This type of arrangement tends to reduce or eliminate many potential conflicts of interest. In other words, if the client is the only one paying the advisor, they are not receiving other monies from investment or insurance companies. The advisor is not motivated to “sell” a “preferred product” to earn more money. Fee-only advisors have a fiduciary duty to do what is in the client’s best interest, not their own best interest. See more on this in question 4.
Some advisors earn commissions for selling products such as mutual funds and annuities. These commissions are paid to the advisor by the mutual fund or insurance company. And guess what, not all commissions are equal. Some annuity commissions are as high as 10% of the amount invested. When an advisor is put in the position of trying to decide which competing product to sell to the client, it is easy to understand that the advisor may have a conflict of interest when one product may pay him 3% and another may pay him 10%. When advisors earn a commission, they are not acting as a fiduciary, meaning they are not bound to act in the client’s best interest.
Now for the confusing arrangement. You guessed it, a fee-based advisor can earn fees AND commissions. Before you get all worked up, an advisor can’t earn a fee and a commission on the same product. However, they can charge fees on some products and earn commissions on others. Drawing from the above two paragraphs, this means that an advisor can act as fiduciary sometimes. Other times he may not act as a fiduciary. This is known in the industry as changing hats. It can difficult for the client to know and understand which “hat” the advisor is wearing at any moment.
Fees paid to investment and insurance companies
In addition to fees paid to the advisor, clients need to know that they may also pay fees to investment companies and insurance companies. All mutual funds, exchanges traded funds, and annuities have a management fee (unless fees are being waived for a temporary period). Just like UPS charges a fee for delivering packages, mutual funds and exchange-traded funds charge fees for running funds. These internal fees can be as low as 0.05% or as high as 2.0%. Either way, it is important to know what you are paying.
Get the fee structure in writing before you commit to the financial advisor. Ask if the fees fluctuate year to year, and by how much so you can plan for the future.
Like everything else in life, you get what you pay for. Don’t be scared off by high fees, and don’t be lured in by low fees. You need to find an advisor you trust. Then consider the fees you’ll pay for his or her service. Only you can determine if the price is worth it.
If your financial advisor acts uncomfortable talking about fees, that’s a red flag. They need to be transparent. If the advisor is not transparent, you need to consider if this advisor is the best choice moving forward.
7. “How will you measure the success we have working together?”
This is an important question to ask before you agree to work with an advisor, because it makes sure you are both on the same page. It creates measurable expectation levels. That way an investor is not disappointed down the road.
Success varies depending on an investor and risk level. Individual performance will vary among the advisor’s clients. That’s why you need to ask how success will be measured for your individual plan.
Establishing measurement tools at the start of your relationship, also helps you set goals together. That way you can evaluate if you are on track to meet your goals as time goes on.
8. What are your policies on cyber security?
Cyber security is a big issue, and your financial advisor needs to take steps to make sure the personal and sensitive information you share with him is kept private. However, a survey by the Financial Planning Association Research & Practice Institute found only 29-percent of advisors say they are totally ready to deal with cyber security risks even though the vast majority know it’s a problem. That’s why cyber security policies are a question you need to ask your advisor.
Hackers are breaking into computer systems for large and small companies, so extra steps need to be taken to make sure your information is safe. Your advisor should have a written policy that addresses cyber security.
Ask who has access to your information, and the steps taken to protect it. Also, what happens to all that information if you leave the firm. Does your advisor handle all cyber-security steps, or do they have a person or firm dedicated to addressing the growing and changing threats?
9. May I have a copy or your ADV Part II?
Your relationship with your advisor needs to be open and transparent. Reading and understanding the Advisor’s ADV Part II is a great way to understand how your advisor operates. Advisors are required to provide this document to clients and it can be found at the Securities and Exchange Commission.
The ADV Part II has information about many different things, including:
- Fee and Compensation
- Services Offered
- Disciplinary Information
- Review of Accounts
If you have any questions about the form, just ask the advisor for clarification.
10. What happens if our relationship does not work out?
When you choose a financial advisor, you enter into a relationship. It’s like any other relationship in life. Sometimes it works out. Other times it doesn’t. According to the Spectrem Group, 58% of investors switched advisors. With more than half of investors looking for new advice, you need to ask what happens if the relationship doesn’t work.
Communication issues, fund performance, and strategy are some of the reasons you may change advisors. When money is attached to that relationship, it can get messy just like a normal relationship between spouses. You need to ask what happens if you take your money elsewhere. While it may be a sore spot for the advisor because his source of income is gone, it’s a fact of life in the financial industry. Specifically, ask how the advisor feels when a client leaves so, there’s no disappointment later.
Also, ask how the funds and investments are transferred when you leave. Is it a fairly simple and standard procedure, or is there a waiting game?
Sometimes it is the advisor who wants out of the relationship. Advisors want to enjoy the relationship as much as the client does. If a client is a burden or has unreasonable expectations, a good advisor may exit the relationship to make room for a client he perceives may be a better fit.
Now that you know the questions you should ask your advisor, the 5 questions you should not ask your advisor.
Todd Minear, CFP©