In the investment world, a good financial advisor is just as important as your investment. A financial advisor is responsible for making sure you put your money where you will reap the best returns, advises whether to choose growth over value and vice versa, or both. They help you do the hard work of examining all the fundamental and technical analyses of companies, look out for indicators of a plummet or surge, and advise accordingly. They advise on taxes and draw up financial plans for your money. A financial advisor should be an investor’s close ally in navigating the often intimidating financial world.
There are millions of financial advisors out there, and choosing the right one for your investment plans can be a daunting task. Your financial advisor is a gateway to all the financial possibilities available to you.
You need to ask them questions to see if they are the perfect fit for your investment and financial plans- someone you can trust with your finances. Here are the five critical questions we feel will need to be addressed before letting someone advise you on what is arguably the most valuable possession on earth: money.
1. Are you a fiduciary?
If you have been in the financial world for a while, you have encountered this term already. However, if you are a novice, the fiduciary standard was created by the Securities and Exchange Commission (SEC) that makes it a requirement by law for financial advisors to put the needs of their clients above their own. This standard was designed to make sure financial advisors give their clients’ needs top priority using the principles of loyalty, duty, and care.
The fiduciary standard requires financial advisors to make known any conflicts of interest in their work to the client as these could limit an advisor’s ability to act in the client’s best interest. Although this standard is in place, there is no clear method for upholding and adhering to it.
Not all financial advisors are fiduciaries, and while many might market themselves as such, they could be found to adhere to a lesser standard of care called the suitability standard. Under the suitability standard, financial advisors, brokers, and dealers make investment recommendations that are suitable for the client but not necessarily exclusively in your best interest. Just because a recommendation is suitable for you in the moment does not mean it meets all your other investment goals.
To understand the difference between the fiduciary and the suitability standard, take the example of a doctor that only prescribes drugs for which he receives a commission from the pharmaceutical company; the drugs could make you feel better and yet not necessarily be good for your health in the long run. A variation of this scenario could be if a different drug might yield better results at an even cheaper price but is not recommended because the doctor doesn’t receive a kickback. Here, the doctor is not working in your best interest. This is why you need to ask a potential financial advisor if they are a fiduciary if they will sign a fiduciary oath, how they uphold the fiduciary standard in their business, and if they apply that standard in every part of their business, and if they are a registered representative. These answers will help you understand if the advisor is what they say they are.
2. What is your fee structure?
Financial advisors must be paid for the valuable advice they give. They charge fees, compensation, and commission for the advisory services, which must be discussed and negotiated beforehand.
Here is how a financial advisor can be compensated for their work
This fee structure is pre-arranged between the advisor and the client for different parts of the business. For example, a financial advisor can set the fee for picking your investment portfolio at $5,000.
Here, the financial advisor will charge you hourly for the work they do for you over a specific period.
Assets under management (AUM)
This is one of the most common investment fees. AUM fee is paid to the firm or individual that manages your investment assets annually, and it is levied as a percentage of the assets managed.
Financial advisors can receive commissions on common financial products like mutual funds, insurance, stocks, annuities, etc. It is important to know if your financial advisor is receiving a commission on the products they recommend so you know there is no conflict of interest in their recommendations.
A financial advisor could choose one fee structure or have multiple structures. Make sure you ask the potential advisor to illustrate clearly what their fee structures will be for their services.
3. What is your investment philosophy?
Ask your potential financial advisor about their investment philosophy. This should be a clear, evidence-based strategy and principles that can be clearly communicated. An investment philosophy includes strategies and principles like diversification, long-term investment, keeping investment costs and taxes low, not being swayed into investment by media headlines, maintaining financial discipline, and not trying to time a stock market, among others.
4. How will we work together?
It is essential to get a clear understanding of how often you and your advisor will be engaging with each other; it should be frequent and consistent to avoid any surprises.
The advisor will then reveal their communication style, systems, process, and overall business operations to you. It would help if you asked whether your interactions will cover important things like budgeting, retirement planning, tax planning, whether they will put their financial services in writing, how often they will reach out to you, where and when, and setting up your financial plan. This section spells out your entire relationship with the financial advisor, what you should expect from them and what they expect from you, and for how long.
5. What are your credentials?
You do not want to entrust your financial future to an unqualified person, so you must ask for their credentials to know how professional and proficient they are. Just like any other industry, financial advisors have certifications and memberships, some of which may include: Certified Financial Planner (CFP), National Association of Personal Financial Advisors (NAPFA), and Certified Public Accountant (CPA), among others.
With these questions, you are looking to ascertain if the potential financial advisor will work in your best interest, falls into your budget, has a sound investment philosophy, how you will work together and if their credentials meet industry standards. All these hints will help you make a good decision when selecting a financial advisor with whom to partner.