The decision of whether to retain a financial advisor can have major long-term consequences. Here are some questions to ask yourself before hiring a financial advisor.
1. What do you want to achieve?
It’s important to understand what you hope to achieve by retaining a financial advisor.
- Do you need help managing your investments?
- Planning for retirement?
- Dealing with an inheritance or other financial windfall?
- Help with budgeting and paying off debt?
- Other financial planning issues?
There are thousands of financial advisors available to you. Defining your goals is the first step towards creating a short list.
2. Do you prefer In-person or virtual financial advising?
COVID-19 has revolutionized the way financial advisors do business and presented consumers with cost savings opportunities.
If it’s not important for you to meet in person with your financial advisor, your options increase exponentially.
Financial advisors are running a business. Their fees are impacted by their overhead. An advisor based in a major metropolitan area like New York City or Los Angeles will have higher costs than one in a less populated city like Columbus, Ohio.
With appropriate due diligence, you may find a well-qualified financial advisor in a smaller city who charges significantly lower fees than a big-city advisor. This difference in fees can be meaningful over the long term.
Another option for those who don’t require in-person services is robo-advisors. They offer low-fee advice. Some robo-advisors will also give you access to certified financial planners with the CFP® designation.
Major fund families, like Vanguard, Fidelity, and Schwab, offer robo-advisors. You can find a list of robo-advisors with details about their offerings here.
3. Do my financial needs require niche services?
Many financial advisors limit their services to specific niches.
These niches include occupations (physicians, dentists, surgeons, teachers, etc.), employees at designated companies (often technology companies), academics, designated investments (often retirement plans), investors going through transitions (widows and widowers, divorcees), special needs, sales of businesses, and sexual preferences.
Moreover, a registered investment advisor will not only help you build and manage your investment portfolio but also put your interests first as their client.
If you fit into one of the niche categories offered by a financial advisor, you may find it beneficial to consider their services. They have specialized knowledge enhanced by dealing with many others in a similar situation. As a result, they may be a better fit for your needs.
What to look for in a financial advisor
Once you have completed this preliminary work, it’s time to focus on differentiating among the financial advisors you want to consider. Ideate questions to ask your financial advisor to have complete knowledge of their background and experiences.
If you watch or read the financial media, you may believe that trying to pick stock “winners,” timing the market, or finding the next “hot” mutual fund manager are important factors that determine your investment returns. Many financial advisors claim the ability to engage in these activities successfully.
However, you rarely hear stock market “experts” discuss the merit of asset allocation, diversification, and rebalancing. Yet, the U.S. Securities and Exchange Commission believes these factors are critically important for investors.
- Asset allocation is the division of your portfolio among different asset classes, like stocks, bonds, and cash.
- Diversification is “the practice of spreading money among different investments to reduce risk.”
- Rebalancing involves keeping your portfolio to your original asset allocation to maintain your level of risk.
Before retaining a financial advisor, ask them what role asset allocation, diversification, and rebalancing play in their investment recommendations. Any response other than “they are incredibly important” should be a red flag.
The importance of being a fiduciary
All registered investment advisors are legally required to be fiduciaries to their clients.
Being a “fiduciary” means the advisor must act in the best interest of the client at all times. The fiduciary obligation requires the advisor to avoid conflicts of interest, disclose any conflicts that can’t be avoided, and provide full and fair disclosure of all material facts to clients and prospects.
Brokers are held to a lower standard of care called a “suitability” standard. While their recommendations are “suitable” for the client, they may not be in their best interest.
Before retaining an investment advisor, you should determine the scope of their legal obligations to you.
Investment advisors have different investment philosophies. Before retaining an advisor, you need to understand whether they limit their recommendations to low-fee index funds (where the fund manager tracks a risk-adjusted benchmark), actively managed funds (where the fund manager attempts to “beat” the returns of a risk-adjusted benchmark), or both types of mutual funds.
Vanguard, which offers both index and actively managed funds, summarizes the differences between the index and actively managed funds here.
There’s considerable evidence that a majority of index funds, which often have lower management fees than actively managed funds, outperform actively managed funds, particularly over the long term and after accounting for fees and taxes.
Warren Buffett, perhaps the greatest investor of this generation, advocates for index fund investing: “When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.”
Careful consideration of these questions and things to look for should prevent you from making mistakes when retaining a financial advisor. Set up a call →.