This is a true story that happened last week.
I spoke at a local high school. More than 50 teachers showed up to learn about personal finance and investing basics. It was awesome!
After finishing, a teacher walked up to pick my brain. She used to have a financial advisor, but he left his company. She wanted to find a trusted advisor again. But she had a problem.
“I wouldn’t know where to start. I don’t know what questions I should ask. I’m not sure how to tell the difference between a good advisor and a bad one, between high fees and low fees. How do I know I’m not being scammed?”
She felt paralyzed by uncertainty.
It was an important reminder for me. Most people don’t know where to start! They are unaware of their blind spots (by definition!).
The Best Interest‘s mission is to help people like that.
So below are my 16 important thoughts, questions, and reminders that you should bring to a prospective financial advisor.
1) They should ask questions to you.
First things first: the financial advisor should be asking questions of you just as much as you’re asking questions of them.
Questions about your goals, your timeline, your risk tolerance, your income, etc.
You don’t need to drive the conversation. And you don’t need to commit to anything!
A good advisor will ask you lots of questions and listen to your personal circumstances.
2) “Are you a fiduciary?”
A fiduciary has an ethical and legal obligation to work in the best interests of their clients.
They have to be honest, clear, forthright, and helpful.
It’s…peculiar…that some advisors are not fiduciaries. In other words, they don’t have an obligation to work in your best interests.
You want a fiduciary by your side. Be wary of settling for less.
3) “How do you get paid? And how much do you get paid?”
A very important question. Everyone gets paid somehow. Some common answers might be:
- I sell insurance products or annuties and collect a commission up front
- I sell “loaded” mutual funds and collect a commission up front
- I trade stocks on your behalf and collect a commission on every trade.
- I invest on your behalf and collect a percentage fee of the assets under management (AUM, fee-only)
- You pay me a retainer, whether you use me or not
- I charge by the hour, straight up.
Which is best? Which is worst? We’ll discuss in #4.
An important point, in my opinion, is that the advisor should be clear, straight, and concise about their answer. Obfuscation is a red flag!
4) “What are your conflicts of interest?”
Everyone has conflicts of interest. If they say otherwise, proceed with caution.
The key is understanding the incentives behind their conflicts and the severity of the conflicts. Here are six common examples.
4A) I sell products and collect commissions.
They’re incentivized to sell products to you whether you need them or not.
Their compensation occurs at the time of sale. They’re incentivized to be helpful before you purchase, not after. This is bad for your long-term benefit.
4B) I trade stocks on your behalf and collect a commission on every trade.
They’re incentivized to trade. A lot. Note: these fees come out of your profits, so it’s bad for you.
The more they do, the better for them. But the worse for you.
4C) I invest on your behalf and collect a percentage fee.
They’re incentivized to bring more of your money under their management (which is usually good for you but could be bad).
They’re also incentivized to make your money grow over the long run. This is usually good (more money is good!). This can also be bad (taking more risk to seek extra reward).
They collect the same fee whether they do 100 hours of work or 2 hours. So make sure you’re getting your money’s worth! Jump ahead to #12 to see some of the slate of services you should demand.
But this advisor is incentivized to keep you happy for the long term. You win together.
4D) I’m a fiduciary.
Not much of a financial conflict here. In fact, this advisor voluntarily made their career more complicated. Fiduciary status is a hoop to jump through.
Why do it, then? To stand out from the crowd.
This is a positive for clients and prospective clients. Seek a fiduciary!
4E) You pay a retainer, whether you use me or not.
This advisor is incentivized to do as little work as possible and to do it as quickly as possible.
They collect the same fee whether they do 100 hours of work or 2 hours. Make sure you’re getting your money’s worth!
Typically, this advisor is not investing on your behalf. You have to maintain and monitor your investments.
But this advisor is incentivized to keep you happy for the long term. You win together.
4F) I charge by the hour, straight up.
This advisor is incentivized to take their time with your work. Sometimes too much time. If a 5-hour job can be stretched to fill an 8-hour day, that’s good for the advisor.
As a client, try to obtain time estimates up front.
Typically, this advisor is not investing on your behalf. You have to maintain and monitor your investments.
But this advisor is incentivized to keep you happy for the long term. You win together.
Everyone has conflicts…
Every advisor has conflicts of interest. Their revenue is your loss. Therefore, it’s important to understand how they get paid.
In general, the AUM fee-only model, the retainer model, and the hourly model are most beneficial for clients. The advisors are incentivized to do good work over the long run on your behalf. You win together.
Commission-based models are not ideal, since their incentives are not aligned with the typically long timelines of their clients.
5) “Do you only advise on investments? Do you also provide financial planning, tax planning, trust and estates, retirement planning, etc?”
You want an advisor—or team of advisors—who have the expertise to provide multiple services.
Investment advising is insufficient, especially if you view yourself as a financial rookie. You need all the help you can get. See #12 for more info on this.
6) “Do you pay referral fees to others? Or collect referral fees yourself?”
Red flags here. If you are referred to an advisor, an accountant, an attorney, etc., you want those referrals because that person is the best fit for you.
Not because there’s a $500 referral fee changing hands. Don’t be a pawn in their referral game.
7) “What’s your investment philosophy?”
Answers here will vary. As a potential client, you should understand:
- How risky is this advisor? How conservative?
- What kind of timelines are involved?
- How “active” is the advisor in making trades?
- What assets (stocks, bonds, etc.) will your money be invested in?
- Are their choices customizable to your needs?
8) “What credentials do you and your team have?”
CFP (Certified Financial Planner) and CFA (Chartered Financial Analyst) are the cream-of-the-crop for financial planning and investment analysis, respectively.
Seek out those credentials. Most other credentials are glorified marketing, rather than markers of true effort and understanding.
9) “How is your advisory business structured?”
In a perfect world, your advisor and all her coworkers would be “rowing in the same direction” on your behalf. At some firms, that’s exactly the case.
At other firms, the advisors are “siloed.” They don’t work together.
Even worse, other firms have competitive incentives. One advisor’s loss is another advisor’s win. Clients don’t win in that situation.
As a client, you’d prefer everyone at your firm to be working together for your benefit.
10) “Who manages your money?”
An advisor should manage their money in the same manner they recommend to their clients. Period.
11) “What kind of long-term returns should I expect?”
This answer depends on the assets involved. But a traditional diversified portfolio (e.g. 70% stocks, 30% bonds) returns an average of 10% per year over the long run.
But inflation eats about 3% of that spending power.
Taxes (depending on your account type) might eat another 1-2%.
And healthy conservatism (will the future mimic the past?) might eat another 1-2%.
In summary, the real return, net of fees and taxes, will end up around 4% per year.
12) “What’s your value proposition? In other words, why is your cost worth it?”
If your advisor only invests your money, that’s a bad value proposition. (This is similar to #5 in this list.)
Why?
Because the average advisor provides average returns. That’s just math. And you can seek out average returns on your own. Why pay for average returns?
A worthwhile advisor, however, provides significant value through:
- Financial planning
- Retirement planning
- Goals-based investing
- Investment withdrawal strategies
- Systematic rebalancing
- Tax-efficient investing and withdrawals
- Asset allocation
- Asset location
- Behavioral coaching
- Stress reduction
- Financial education
- Tax-loss harvesting
- Unique/private investing opportunities
…all of which is stuff that you might not know how to do on your own. Some advisors provide a few of these services. Some provide all these services. The important goal is that your advisor provides value in return for the fees you pay. Investment management isn’t enough.
13) “What’s your succession plan?”
What happens if the advisor gets hit by a bus? Is there a succession plan in place?
What happens if the advisor retires? Or moves to another firm? What happens to your relationship with the?
14) “What communication cadence should I expect?”
How often will you meet? How often will the advisor send an email, a newsletter, a podcast, etc. to stay in touch?
Can you, as a client, request more or less communication than typical?
15) “How many clients do you have?”
Differents strokes for different folks. I’ve heard that a “normal” fully loaded individual advisor should have between 100 and 200 client relationships.
Should you be spooked by 250? 300? 400? I’m not sure.
I do, however, know some advisors with 1000+ client relationships. Just do the math. There’s no way those advisors are monitoring, communicating, etc. with all of their clients regularly. That’s an issue.
16) “Can I speak with a few client(s) to hear their opinions of you?”
It’s good to hear from real clients about their experience with the advisor. Of course, you must realize the advisor will only connect you with happy clients who give glowing reviews. But still, you should ask those clients some of the same questions listed above. Do their answers match/mirror what the advisor told you?
Any Questions?
If you get satisfactory answers to those 16 questions, that’s a great start. Your advisor passes “the smell test.” After that point, ask questions like:
- Do I trust this person?
- Are their costs competitive?
- Do I enjoy being around them?
And make a choice that feels right to you!
If you’re a financial expert, what other questions would you add to my list?
Thank you for reading! If you enjoyed this article, join 8000+ subscribers who read my 2-minute weekly email, where I send you links to the smartest financial content I find online every week.
-Jesse
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I would also add on that you should interview several advisors, and not just go with the one that your Uncle or friend recommended. Believe me, I know, because I went with the one my Uncle recommended. I also believe that fee based is best. I worked with a fiduciary AUM advisor, and frankly it was way more costly than if I had payed someone by the hour. Great post!
Great add, thanks AR!