Many people don’t mind talking about how they make their money or how their career has evolved. Nevertheless, try asking what they are doing with their money and how they plan to grow it, and you will often get a bunch of conflicting ideas instead of a well-planned coherent strategy. Sometimes, you may not hear anything at all. If you, like so many other people, have difficulty even thinking about how to manage your money, choosing the right financial advisor will be one of the most important decisions you will ever make; the advice you receive will directly impact your results and your financial future.
Where to start?
Before you begin your search, however, it’s also important to understand the risks you face. Although everyone has a horror story about a financial advisor who ran off with their friend’s retirement savings to the Caymans, the greater risk is employing someone who doesn’t understand or cater to your specific needs.
For this reason, you need to be clear about how much capital you wish to invest, your risk tolerance, and what your long-term goals are. For instance, a person in their 20s or early 30s will have a much different investment outlook than someone who is closing in on retirement. Furthermore, the questions you ask yourself will help you figure out what services are most important. For example, are you only interested in increasing your savings, or do you need assistance reducing your debt load?
Types of Financial Advisors
Prior to your search, it is helpful to be familiar with the different types of advisers within the industry.
Generally, they fall into three categories.
- Commission-based: these advisors sell various financial products such as annuities, mutual funds, and bonds. The downside is that there’s a conflict of interest if they can make money off products they may advise you to purchase.
- Fee-based: these advisors offer advice for a fee but may also sell financial products; so be aware that they may also represent a conflict of interest
- Fee-only: these advisors charge a flat fee, or an hourly rate, or even a percentage of the assets under management. Often these types of advisors work on an overall plan which also considers things like taxes and retirement goals.
Rise of the Robo-Advisor
Another type of advisor which has become increasingly popular, especially among millennials, is the robo-advisor. A robo-advisor is basically a digital financial advisor that uses computer software to calculate the best way to allocate your assets. Advantages are lower costs and often a much lower initial investment than a traditional adviser. Robo-advisers usually charge .25-.50% of assets under management while traditional advisors average around 1%. On the other hand, one of the disadvantages is that a robo-advisor can’t offer the type of personalized assistance needed for issues like debt consolidation or damage control when things start to go south in the market.
Fees and Commissions
One of the most important criteria for your search is knowing what an advisor charges. As I mentioned before, they work on different models. However, it is critical to your long-term financial health to manage those fees. For instance, if your portfolio is up 4% for the year but your advisor charges 1%, then your return is only 3%.
In addition, it also makes a significant difference whether your advisor charges on all assets under management or just the assets he actively manages. For example, if your advisor charges .75% on everything, then he may wind up being more expensive then someone who charges 1% on the half of your assets that he truly manages.
Furthermore, some advisors like to put their clients in certain funds that also charge commissions. In other words, you could be paying a commission to someone else at the same time your advisor is taking his fee. The main takeaway here is that an advisor should be as transparent as possible with his fee structure and commissions because these costs can really erode your return over the long run.
Now that you are aware of the different types of advisors and what your needs are, there are a few basic questions you need to ask.
What are their qualifications?
• Are they a Certified Financial Planner (CFP)? Being a CFP, a common industry designation, indicates that the advisor has met certain requirements set by the CFP Board of Standards.
• Are they a Registered Investment Advisor (RIA)? This designation means that they have passed the Series 65 Exam and are registered with the Securities and Exchange Commission. An RIA is important if your focus is on buying and selling securities.
When researching someone’s background, it is always beneficial to see what type of industry credentials they possess.
Who are some of their clients?
Referrals are a great way to get a feel for an advisor is to speak with some of his clients. By contacting people who have worked with him for at least a couple of years, you can get a good idea of how he deals with people. The important thing is to ask pointed questions and note their responses. Remember, financial advisors are not a one-size-fits-all commodity.
Are you comfortable with them?
In the end, this may be the most important question you answer. Your relationship with an advisor is an intimate one since they will be privy to all your financial dealings. Even the most thorough online dating service can’t tell you how comfortable you’ll be when you finally meet that person. For this reason, don’t be afraid to keep asking questions until you are confident this person is right for you. Trust is paramount since they will play a big part in your financial future.
The Risks Are All Yours
Be aware that the risks are all yours in this relationship. Imagine getting skydiving tips from someone who stays inside the plane. If your chute fails to open, they can adjust their advice for the next person. In other words, the advisor has nothing to lose, but you are risking everything. Since bad advice can cripple your long-term investment goals, you need to be very clear about your expectations. For this reason, it is critical to find a financial advisor who meets your individual needs. As Fred Schwed cautioned in the title of his book over half a century ago, don’t ask where the yachts of the bankers and brokers are, ask "Where are the customers’ yachts?"