One of the five investor mistakes Peter Mallouk identifies in his book 5 Mistakes Every Investor Makes and How to Avoid Them is working with the wrong advisor. He outlines seven questions he thinks investors should ask potential advisors. I’ve taken the liberty of providing the answers you might want to hear. I also added one question that I think you should consider asking as well.
My goal is to provide you, the investor, with a few suggestions to consider should you find yourself needing a new advisor. Some answers, in my opinion, should be non-negotiable, while others may vary based on personal style, preference and individual goals. (For more, see: 7 Financial Advisor Red Flags.)
Okay, so let’s get to the questions. The reason I like the idea of providing you with questions that should be asked of a prospective financial advisor is they are not confrontational. If an advisor thinks these questions are confrontational, he/she might be the wrong advisor for an investor. These questions are like asking the salesperson at a car dealership what the warranty is on a new car. An advisor helping you invest all or a portion of your assets should be equally happy and willing to answer these questions too.
1. Where Will My Money Be Held?
Part of how the advisor answers this question should be non-negotiable, specifically the part about how the assets should be held with a third party. The advisor should not be able to change ownership of assets under any circumstance. This is how investors get scammed. My preference is that an investor use a third party that is cost effective and gives the investor the ability verify assets independently.
2. Are You a Broker?
A broker gets paid to sell a suitable product. They do not have a fiduciary responsibility. I see some instances where clients have a portion of their assets in an investment they are very familiar with. For the most part they direct the advisor to buy X or sell Y, and in this instance, paying a commission only when an investor buys or sells makes sense. However, for a diversified portfolio with a long-term objective, my preference would be to use a Registered Investment Advisor (RIA).
3. Are You a Dually Registered Advisor?
Dually registered means the advisor works for both a registered investment advisor and a broker/dealer. An RIA is a firm engaged in the investment advisory business and is registered either with the Securities and Exchange Commission (SEC) or state securities authorities. Investment Advisor Representatives or IARs of RIAs have a fiduciary duty to their clients, which means they have a fundamental obligation to provide suitable investment advice and always act in their clients’ best interests. A broker or registered representative is an individual that charges a fee or commission for executing buy and sell orders submitted by an investor. My suggestion here is to be aware of the differences. If your advisor is dually registered, just ask him/her to explain when a recommendation is being made, is it for a commission or based on ongoing advice?
4. Do You or Any Affiliates You Work With Have Proprietary Investments?
Proprietary funds can usually be found at just about every company that has a large sales force who can sell mutual funds. This includes banks, credit unions, brokerage firms, insurance companies and wealth management companies. In-house mutual funds were developed by companies to be sold by their own distribution networks and are now part of an overall move into wealth management. This should be one of those non-negotiable points.
5. How Are You Compensated?
Of all the questions, this one should be the easiest one for an advisor to answer and is the least confrontational. A common misdirect in the financial service world is to quote the fee in percentages. Do not allow this. Make the advisor go slow here and make sure you completely understand how fees are charged, how much and how the advisor is compensated from those fees. If you get the “you get what you pay for” speech, I personally would not use this advisor.
6. What Are Your Credentials?
This question is designed to confirm and identify advisor competence. There are a couple comprehensive tools that allow you to quickly and easily see an advisor’s background and experience. One is BrokerCheck and the other is Investment Adviser Public Disclosure. A few of the more common designations are Certified Financial Planner, Chartered Financial Consultant (ChFC), Personal Financial Specialist (PFS), Chartered Financial Analyst (CFA) and Chartered Investment Counselor (CIC). (For more, see: The Alphabet Soup of Financial Certifications.)
7. What Is Your Planning and Investment Management Approach?
Though this question is number seven, it is very important in my opinion and you should not have to ask it. I hope it is obvious that these questions will not be the first thing you pull out and ask a prospective advisor. You might not even get to them in the first meeting. The first part of any professional relationship is synergy. And while you’re seeing if there is synergy and getting to know the advisor, the planning and investment management approach should have come up and been covered. In my opinion, the advisor should help the investor invest a specific account into investments that are aligned with his/her time horizon, risk tolerance, and goals for that specific bucket of money, in a way that is understandable and transparent.
I mentioned earlier that I have an additional question, one that is a little more confrontational than the previous seven but worth asking. As someone who has been investing, working with financial advisors and managing advisors for over two decades, I feel this reveals a lot about who is going to be managing your money. There are four parts of the investment process we have some control over. They are: costs, taxes, quality of the investments and risk/volatility. I think this question reveals whether the advisor actually thinks he or she is delivering on all four.
8. Can I See the Invoice of You Charging Yourself to Invest With You?
An advisor will sell and tell their clients how and where to invest their money. But sometimes when you ask them where they invest, you might find one of two answers you do not want to hear. Perhaps they do not have any money, which means they are investing based on academics and not experience. Or they might say they do something else with their investments, not what they are recommending to you. In either case, I think this is at least a yellow caution light – if not a red flag – when it comes to doing business with an advisor.
Choosing a financial advisor is very personal and can be quite stressful. Most people hire an advisor only a few times in their lifetime, so it is not something we are experienced at doing. There is a lot more to it – synergy, communication style, comfort, trust, etc. These questions do not help with all of these points, but may help ease your mind and might just keep you from making a common mistake investors make; working with the wrong advisor.