Believe it or not, anyone can call themselves a financial advisor, regardless of education, knowledge, or experience. Sounds crazy, right?
Sadly, most financial advisors are not required by law to always work in the best interests of their clients. This legal obligation to put a client’s best interests first is known as a fiduciary duty.
Why aren’t financial professionals required to be a fiduciary for their clients at all times? Well, it’s complicated, involves years of history, and boatloads of lobbying dollars. However, because of this, it’s up to you to do your homework before hiring a financial advisor.
Choosing a financial advisor is one of the biggest financial decisions you’ll make. Here are 7 questions to ask before hiring a financial advisor that you may not typically find in the financial press.
1. Are you a fiduciary at all times when dealing with clients? If so, will you put that in writing?
Most advisors will have to answer “No” to this question. These days, an advisor can be “dually registered”; which means they can be registered as both a fiduciary advisor and as a broker/dealer representative.
Dually registered advisors are allowed to take off their fiduciary hat at certain times to sell you products or investments that pay them commissions. When they’re wearing their “broker” hat, they may also be incentivized to sell you investments that generate higher profits for their firm.
Why wonder which “hat” your advisor is wearing when you can work with one who is a fiduciary at all times?
2. Can you show me how much (in dollars, not percentages) it would cost to work with you? Would you put it in writing?
If the advisor can’t or won’t give you a detailed accounting of all fees and expenses that are charged to your account, that’s a red flag. Unfortunately, many brokerage firms have made an art of hiding fees from clients over the years.
When working with a fiduciary, fee-only financial advisor, there are three typical fees you can expect to pay:
- Advisory Fees. These fees can be an hourly charge, a one-time project fee, a retainer (in some states), or a percentage of your investments. This is the only fee compensation for fiduciary advisors – hence the term “fee-only” advisor.
- Expense Ratios. These are the fees charged by mutual funds or ETFs that compensate the fund company and its management team.
- Transaction Fees. These fees are charged by your custodian (such as TD Ameritrade, Schwab, or Fidelity) when any investment is bought or sold in your account. While some transaction fees can go as high as $50 per trade, high-quality “no transaction fee” investments have proliferated in recent years.
Since fee-only advisors aren’t compensated through 12b-1 fees, commissions, or account fees, they’re free to choose the optimal investments at the lowest costs. Fees and commissions (or the lack thereof) need to be an important issue when hiring a financial advisor.
Quality professionals deserve to be compensated for their hard work, knowledge, and wisdom. Advisors with integrity welcome this type of transparency and shouldn’t hesitate to list their fees in writing.
3. How deep is your financial planning experience?
When it comes to financial planning, an advisor’s depth of experience is just as important – perhaps more so – than the number of years they’ve been in the business. A comprehensive financial plan should always go beyond investments to examine strategies and tactics such as:
- Minimizing taxes with strategic Roth IRA conversions,
- Taking advantage of retirement to lower capital gains taxes,
- Determining a sequence of withdrawals from different account types,
- Paying off your mortgage,
- Social Security timing, and
- Lowering Medicare insurance premiums.
Ideally, any advisor you consider has years of experience creating these types of detailed financial plans for clients. Be sure to ask for a list of services that the advisor offers. Quite often, tax planning is not a service offered by many financial advisors.
It’s also a good sign if the advisor has the CERTIFIED FINANCIAL PLANNER™ or CFP® certification. To become a CFP@ Professional, an advisor must have years of experience, a four-year college degree, pass a grueling exam, and take continuing education classes every year.
4. Who is your custodian?
A competent financial advisor will use a third-party custodian for client accounts. A custodian is simply the place where your accounts are housed. TD Ameritrade, Schwab, and Fidelity are the three major account custodians that work with independent, fee-only financial advisors. A third-party custodian provides clients safety and convenience with online access, monthly statements, FDIC and SIPC insurance, and local branches throughout the country.
Remember Bernie Madoff? One of the reasons he was able to defraud investors was that he was not using a separate custodian. There was no objective oversight from a neutral third-party reporting to clients.
Every honest financial advisor knows that using a third-party custodian is in the best interests of their clients. This is an important question they should be happy to answer.
5. Do you specialize in a particular type of client?
Some financial advisors may specialize in helping people in specific professions such as optometrists. Some advisors might choose to focus on helping employees of a specific company, such as Home Depot. Others can specialize in certain age groups, such as millennials. I’ve even heard of an advisor who only works with professional bass fishermen.
The takeaway is that you wouldn’t go to a podiatrist if you needed new glasses.
It’s important that your financial advisor has the experience and expertise to help with your specific needs. While almost all advisors start as generalists, you’ll be better served by someone who has worked with many others in similar situations as yours. They’ll have a better understanding of what you need and why.
6. Can you beat the market?
The answer you’re looking for here is, “No”. While it’s important for an advisor to be confident in his or her investment strategy, that confidence should be based in reality. History shows that beating the market is not realistic over long periods of time. In addition, consistently timing the market is difficult. If an advisor’s returns sound too good to be true, there’s reason to be suspicious.
Instead, focus on the advisor’s investment process. Will they review your 401(k) or other workplace retirement plans? Do they use asset location for tax efficiency? Can they implement tax-loss harvesting into their trading process? How often do they rebalance portfolios?
Whether it’s indexing, tactical asset allocation, active management, or technical analysis, it’s important that an advisor has an investment philosophy – and a process that stands behind it. While I have an opinion on which is superior, there’s a place and process for everyone.
7. How are your personal investments managed?
Ideally, the advisor you’re interviewing invests his or her own money exactly like his or her clients. If they’re not willing to eat their own cooking, why would it be good enough for you?
Hiring a Financial Advisor: Closing Thoughts
With all the jargon, alphabet soup designations, and different types of firms, it’s no wonder that hiring a financial advisor can be a stressful process. However, when you find the right one, it can mean the difference between stress and peace of mind in retirement. Any worthwhile financial professional will welcome tough questions with patience and understanding.
If you’d like more questions to ask a potential financial advisor, I recommend these resources:
NAPFA’s Consumer Resources Page.
XYPN’s 5 Questions You Must Ask Before Working with a Financial Advisor
If you’re looking for an advisor and think Prana Wealth may be a good fit, then click here to set up a quick, complimentary introduction call. We do still have the capacity to take on new clients.
As a fee-only financial advisor in Atlanta, we can (and do) work virtually with clients all across the U.S. and we’re here to help you when you’re ready.