10 Questions to Ask When Hiring a Financial Advisor

Not all financial advisors are created equal.  In fact, there is huge variability in how advisors are compensated and the standards to which they are held. “Conflicted advice is costing America’s working families about $17 billion per year in IRAs alone,” according to a report from the President’s Council of Economic Advisers. 

Now, for a history lesson.

Financial Services Industry - Past

Historically, when the financial services industry emerged, there were traditional “stockbrokers” who recommended investments to their clients.  The broker (registered with a broker dealer firm) received a commission, and the client earned or lost money on the investment.  Pretty straightforward, right?  Essentially, most stockbrokers were salespeople. The more investment products they sold, the more money they had in their pocket. 

Financial Services Industry - Present

Clients eventually wanted their broker’s advice on other issues indirectly related to investments, such as retirement planning, debt reduction and tax strategies.  A new wave of financial advisory companies emerged to meet this demand: Registered Investment Advisory firms, or RIAs. 

A financial advisor will generally fall in one of three camps:

·      Commission-based broker

·      Fee-only RIA

·      A hybrid, meaning the advisor can work under the brokerage or RIA

Let’s talk about the fiduciary standard and what it means for you, especially when seeking financial advisor.  A professional following the fiduciary standard always acts in your best interest.  The suitability standard held by many traditional brokers is more lenient.

An Illustration of the Fiduciary Standard

Suppose you walk into a store to buy a suit.  You see one that catches your eye and proceed to the fitting room.  As you glance at yourself in the mirror, you notice that the color makes you look a little pale and heavier.  But you’re shopping alone and know that fitting room mirrors can be deceiving.  You step outside and ask the fitting room clerk for a second opinion, “How does this suit look on me?” 

If the fitting room clerk is operating under a suitability standard, she may say something like, “It looks nice.  I think you should buy it.” 

If instead the fitting room clerk is held to a higher fiduciary standard, she can recommend only a suit that looks fantastic on you (it’s in your best interest).  The fiduciary clerk may respond, “Hmmm.  I like this suit on you but think this other one may look even better.”  You try on the new suit and love it.  The color is perfect, and it fits wonderfully.

The fitting room clerk doesn’t receive a commission.  Under either standard, she doesn’t have a financial incentive to recommend one suit over another.  Yet if held to the fiduciary standard, her recommendation must be in your best interest.

Let’s take the same example one step further.  Suppose you are still shopping for a suit but go into a store where the associates are paid on commission.  You look at two suits – one priced at $250 and the other at $350.  Both suits look good on you, but this commission-based sales associate will get a larger check if she recommends the more expensive suit.  When you ask her opinion, she suggests the $350 suit.

Financial Advisor Compensation

Fortunately, a new Code of Ethics and Standards of Conduct were recently put into place.  This industry standard means all Certified Financial PlannerTM (CFP®) professionals are required to act as fiduciaries in their clients’ best interest at all times.  If advisors don’t follow the standards, they could lose their licenses.  This change is a great win for consumers. 

Bottom line: If you want to work with a financial advisor, look for a Certified Financial PlannerTM.  Even better, find one who is “fee-only” and doesn’t work on commission.  The National Association of Personal Financial Advisors (“NAPFA”) is the leading association of fee-only professionals whose only source of compensation comes directly from you, the client.  In other words, advice and compensation are totally independent of product recommendations.  XY Planning Network is another great resource if you’re earlier in your financial journey and are seeking a fee-only CFP® professional.

Fee-based advisors sound a lot like fee-only advisors but actually operate differently.  Hybrid advisors can accept fees for their guidance and investment oversight but also can receive commissions on specific investment products such as annuities, life insurance policies, or loaded mutual funds.  This could create a conflict of interest for the fee-based advisor.  If he has the choice between selling an annuity and earning a more substantial commission than one on a passive exchange-traded fund, he may suggest the annuity. 

Trust is critical, and this Financial Planning article proves it.  Only 36% of US adults tend to trust investment and wealth management professionals.  People can benefit when advisors break away from conflicted fee-based environments.

10 Questions to Ask a Financial Advisor

Now that you have some background on the types of advisors and their professional standards, let’s turn to 10 questions you should ask when hiring a financial advisor.   The exact list of questions is subjective.  Obviously, you may not have time to ask all of these questions during an initial consultation.  Instead, try to gather as much data as you can in advance by reviewing a firm’s website and the LinkedIn profiles of its advisor(s).

1. Are you held to a fiduciary standard at all times?

2. How are you compensated?

3. Who is your ideal client? Do you have other clients like me?

4. How long have you been practicing? Please tell me more about your experience and qualifications.

5. Have you ever been publicly disciplined for unethical actions?

6. What is your financial planning and investment process?

7. Can you explain the concept of active versus passive investing to me?

8. Do you own the same investment products you’ll recommend to me?

9. How do you invest in yourself?

10. Why did you choose this work?

Don’t be discouraged if the first few advisors you interview aren’t a good fit.  Finding an advisor who is attuned to your needs takes time.  It’s like dating.  You may have to go on a couple of bad first dates before you find the love of your life.

Dig deeper if you’ve asked at least a couple of questions and are satisfied with the advisor’s initial answers.  Questions at this stage should focus on communication.  How often will you be meeting with the advisor?  In-person or virtually?  How quickly will that advisor respond to emails or phone calls?  Are you going to work initially with this advisor, only to be “handed off” to a less experienced firm associate as time goes on?

Finding the Financial Advisor Right Fit

Again, it comes down to fit.  If you are a Type A personality who wants a returned phone call within an hour of leaving the message, you may not work well with an advisor who returns calls within two business days.  If you live an hour away from the advisor’s office and really value in-person meetings, find out if that advisor is willing to come to you or meet at a central location.  Technology enthusiasts who prefer to hop on a virtual video conference will find it easy to work with an advisor that is hundreds or thousands of miles away.  Know yourself and the expectations you have for the working relationship.

If married, also ensure that your spouse likes the advisor.  Spouses should be equal participants in the financial planning process, and an advisor should have that same mantra.  Proceed with caution if the advisor is aware you are happily married and is perfectly fine working with only one of you.  He or she should be looking at your joint financial goals.  Call me old-school, but I’m of the opinion that “two shall become one” when they celebrate the sacrament of matrimony. 

In fact, I had a prospective client contact me by phone on a Friday afternoon.  He and I had a great conversation, and he wanted to start working with me.  I was really excited and thought this advisory relationship would be wonderful, but I said, “Wait.  I know you’re married and haven’t spoken to your wife yet.  She doesn’t know anything about me.  Please let’s schedule a time to talk with her, too, so I can ensure this will be a good working relationship for both of you.”  He agreed, and she was part of the lengthier introductory meeting. 

Take the Next Right Step

WorthyNest® prides itself on being a fee-only, fiduciary wealth management firm that guides parents through important financial decisions using a values-based approach.  Schedule a free, introductory meeting if you are interested in exploring an ongoing relationship with a trustworthy advisor.