Let’s assume you want to invest your assets in a mutual fund. How would you go about selecting the best fund?
You would visit a website like Morningstar that provides independent fund ratings plus other data that will help you make informed, objective decisions. Examples of data include performance records, expense ratios, and risk metrics.
Chances are you will select the fund with the best track record. Morningstar says 82 percent of investors select five-star-rated funds. This makes sense because Morningstar knows more about researching mutual funds than you do, not to mention, you save a considerable amount of time.
However, what happens if you decide to use the services of a financial advisor? Who will research the advisor for you, and how much will it cost you?
It is your sole responsibility and you will find that selecting a financial advisor is a complicated, risky process. Risky because there can be catastrophic consequences if you select the wrong advisor— just ask Bernie Madoff’s clients.
Why so complicated?
Most financial advisors are salesmen who use high-pressure sales tactics to convince you to buy what they are selling. If that isn’t a big enough problem, financial advisors also have minimal disclosure requirements for their credentials, ethics, business practices, and services.
Sure, you can view the advisors’ compliance records at FINRA.org, but you need a lot more information to select the best financial advisor.
It is your responsibility to obtain this additional information from financial advisors. High-quality advisors are more forthcoming. Lower-quality advisors withhold information that would cause you to reject them.
Select the best financial advisor
Is there a simple solution for selecting the best financial advisor? The answer is yes, there are definitely ways to find excellent financial advisors.
But if you prefer to be part of the choosing of a financial advisor, you have to ask the right questions and know good answers (ones that benefit you) from bad ones (ones that will damage you).
You also need a process for gathering the information so you can make an objective decision that is not excessively influenced by the sales skills of the financial advisors.
The Request for Proposal (RFP)
Institutions (pension plans, endowments, foundations) use RFPs when they select financial advisors.
They use the RFPs to gather the same information from multiple advisors. Anyone who refuses to provide the information is automatically rejected.
There are three primary RFP benefits:
- Advisors answer the same questions
- It is easy to compare their responses
- The institutions have documented responses
You may or may not want to use the RFP process. At a minimum, you should ask the right questions and require written responses.
Top 10 questions for financial advisors
I am sharing the top 10 questions you should be asking financial advisors so you can be organized when you’re interviewing possible candidates.
Who do you work for?
Let’s say the advisor works for a Registered Investment Advisor that is owned by a broker/dealer that is owned by a bank or insurance company. You want to know this information to minimize any potential conflicts of interest if the advisor tries to sell you bank or insurance products. This is called cross-selling which is rarely in your best interests.
Are you a Registered Investment Advisor (firm) or an Investment Advisor Representative (professional)?
These are the “only” registrations that permit firms and professionals to provide financial advice and ongoing services for fees. Anyone who does not hold these registrations is a salesman who is limited to selling financial products for a commission. Make sure you select an RIA or an IAR.
Are you a financial fiduciary?
Real advisors (RIAs, IARs) are financial fiduciaries. They are held to the highest ethical standard in the financial services industry. Fiduciaries must always put your financial interests first. Stockbrokers are not fiduciaries. There are held to a lower ethical standard. Make sure the advisor is a financial fiduciary.
Do you have any disclosures on your compliance records?
Financial advisors can have multiple complaints on their compliance record and still hold active licenses that permit them to sell financial services and products. Avoid advisors with multiple complaints that required them to make financial restitution to clients.
What are your years of financial service experience?
It takes years of experience to be a financial expert. Make sure the years are applicable. For example, you need a financial planner. The advisor should have years of planning experience. Years of selling mutual funds for a commission is not financial planning.
Do you hold any active certifications or designations?
One of the best ways to acquire specialized financial knowledge is a certification or designation. Unfortunately, there are more than 250 of them. Some are high quality (CFP®, CFA®, CIMA®, CPA®). Others have been purchased so advisors look more knowledgeable than they really are. My company, The Paladin Registry, provides an independent overview of the quality of these designations and certifications. The service is free and there are no registration requirements.
What services do you provide?
Stockbrokers sell products (mutual funds, stocks, annuities). Financial advisors (RIAs, IARs) provide investment advice and services. There are five types of wealth management services (planning, investment, risk management, tax, legal) that are provided by various types of professionals.
How are you compensated for your advice and services?
Financial advisors are compensated with three types of fees (hourly, fixed, asset-based). The asset-based fee is a percentage of your assets (1 percent of $500,000 is a $5,000 annual fee). Hourly and fixed is usually charged for their planning, tax, or legal services. You should compensate financial professionals with fees just like you compensate other professionals you depend on for specialized knowledge, advice, and services (CPAs, attorneys).
How do you communicate with your clients?
There is verbal communication that can be face to face, telephone, and Skype. There is non-verbal communication in the form of email and reports.
The most important report documents your performance on a monthly or quarterly basis. Other reports document holdings, transactions, and receipt of income.
What firm has physical possession of my assets?
Financial advisors should not come in contact with your assets—except the fee they charge for their services. You will need the services of a custodian. Make sure the custodian is a major brand name firm you have heard of: Charles Schwab, Fidelity, TD Ameritrade are three of the bigger ones.
Choosing a financial advisor is at least as important as choosing a babysitter, yet many people give it less thought. And just as you wouldn’t leave your precious children with just anyone, you should leave your financial future in the hands of someone you don’t know. By asking the most strategic questions, you can be more confident that your assets are in good hands.
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