Choosing a financial advisor can be a daunting process. After all, you’re handing your hard-earned wealth over to someone who is virtually a stranger. The process doesn’t have to involve guesswork or nervousness, however.
The right financial advisor will be completely transparent and give you a clear sense of how they can be used as a tool to create a worry-free financial future, rather than adding to your nervousness. Thankfully, this can be accomplished with the right research and asking a few tough questions.
Just like you’d inspect a car and speak with a car dealer before driving off the lot, you can get a deep sense of your advisor before making the leap. In my decade of serving as a financial advisor, I’ve seen how many individuals could have avoided mistakes with bad advisors just by asking a few questions beforehand. Just because you’re not an expert in finance does not mean you can’t come prepared.
How Will We Communicate?
Financial health is holistic and it involves knowing all the moving pieces of your financial life. And as you know, plenty can change in a year (or less) – from having babies to buying a new home – that drastically affects your finances.
Similar to a doctor, the right financial advisor will encourage an open dialogue and check-ups to see if there are any changes to your financial health. This not only catches any financial road bumps that might stand in the way of your investment goals, but it can serve as a reassurance and anticipate any changes down the horizon.
Are You A Fiduciary And Do You Have A Series 7?
Whenever you visit a doctor or a lawyer, you know there are legal safeguards in place to ensure you’re getting advice that’s in your best interests. While it would be ludicrous (and highly illegal) for your health practitioner to make recommendations so they can fatten their wallet, it’s an ordinary and perfectly permissible practice in finance.
It’s a little-known secret that most advisors (legally brokers) operate under the suitability standard, meaning their advice only has to be “suitable” for their client. That can include commissions, hidden fees, and recommending investments to fulfill a sales quota, which can eat into your returns. In fact, former President Obama's Council of Economic Advisers estimated that this type of advice costs Americans $17 billion each year.
To avoid all that, go with a fiduciary. Advisors that uphold the optional fiduciary status are required to act in their clients’ best interests, similar to a doctor. The best way to tell if they’re a fiduciary (yes, I’ve seen brokers throw around the word) is to determine if they have a Series 7, which allows you to receive commissions. Fiduciary advisors are not permitted to have a Series 7 license, and if they previously held one, they have to surrender it.
Do You Have Custody Of My Assets?
Remember the infamous Bernie Madoff fraud? One reason he was able to keep the Ponzi scheme going for so long is that his firm “held” the (actually non-existent) assets of his clients. That fraud (and other similar schemes) can be defended against by utilizing a third-party custodian, with their own depository and accounting system with safeguards to protect you.
Although the SEC “encourages” advisors to do this post-Madoff, it’s still not a requirement. By making sure your advisor uses a reliable third-party custodian, you’ll add an extra layer of security to your investments, and ensure your wealth is only being used to actually invest.
What’s Your Investment Philosophy?
Too much confidence, as I’ve said before, is a dangerous recipe for long-term investing. While investing heavily in "hot" stocks might result in a rare win, more often than not, it will leave you severely disappointed, according to Morningstar.
This isn't only limited to individual investors, however. Research shows that even a majority professional financial managers are likely to become overly optimistic in the belief that they can beat the market after they see high returns. If you want to avoid the pitfalls of market timing, you can avoid this by finding a manager who sticks to a rational, long-term investment plan with your goals in mind. The best way to ensure a rational plan (and it's something you'll want from your advisor regardless) is an Investment Policy Statement.
As an essential investment roadmap, an Investment Policy Statement outlines your goals, needs and investment strategy that will be adopted. This won't only outline a facts-based investment plan, but it will help you articulate your goals and stick to them. Just like you wouldn't drive to California without a roadmap, you'll want a clear guide for reaching your financial destinations.
How Will I Know That I’m Making Progress Toward My Goals?
Ultimately, anything your financial advisor tells you about performance is just lip service if they can’t clearly explain your performance. It always shocks me when I speak to a potential client who has almost no idea what their returns are monthly, or if they’re even on track for the big-picture goals (like retirement).
The right financial advisor will paint a clear picture of not only where you’re at now with your investments, but where you’re headed in the future. And if they use jargon or complex charts, don’t be afraid to ask for clarification. None of us are born knowing finance, after all. The right advisor will break down any terms you’re unfamiliar with and give you a clear sense of all the moving parts in your portfolio.
