Investment guru Bill Bernstein once quipped that by the time you know enough to select a high-quality financial advisor, you could probably manage your assets on your own.
Sadly, that's not all that far from the truth. The financial-advice industry features a bewildering array of titles, designations, and compensation schemes.
It's no wonder so many investors shortcut the process, opting for recommendations from friends and family members with limited financial backgrounds. Nor should it come as a surprise that lesser advisors who happen to be strong salespeople can rake in clients, while skilled but less slick financial professionals toil in obscurity.
People skills are important when it comes to getting financial help; financial matters are highly personal, so you need to have a basic comfort level with any individual you’re entrusting to help you out. But you also need to conduct due diligence before signing on with an advisor. The process can be broken down into two, rather manageable, steps. The first involves taking stock of your needs in the realm of advice consumption: What are you really looking for? The second step, which I’ll focus on today, is to take what you just learned about your own needs and goals to identify an advisor who can help you meet them.
5 Key Questions to Ask a Financial Advisor
- Are you primarily a financial planner or an investment advisor?
- Are you a fiduciary?
- How do you charge for your services?
- What designations/credentials do you have?
- What’s your backup plan?
1) Are you primarily a financial planner or an investment advisor?
This is one of the first forks in the road that investors will encounter when surveying the universe of financial advisors: There are wealth managers/investment advisors, and there are financial planners.
The former type of advisor has a narrower purview—investments—than do financial planners, who consider all major aspects of a financial plan, not just investments: insurance, estate planning, and household budgeting, to name a few. However, it’s worth noting that the best investment advisors think holistically about their clients’ plans, while many financial planners possess top-notch investing acumen. So, there’s not necessarily a bright line.
If you’re seeking a financial planner: Ask prospective planners about their areas of special expertise, and the demographic groups they typically serve. If you’ve identified specific areas you need to work on—for example, figuring out how your small-business ownership impacts the rest of your personal financial plan—ask the planner if she’s had experience with situations like yours. Also look for someone who has earned the certified financial planner or chartered financial consultant designation, discussed below.
If you're seeking an investment advisor: Ask about investment strategy: Does it jibe with your own philosophy? Does the advisor use basic portfolio building blocks like low-cost mutual funds, or dabble in more arcane investments like futures and options? Is the strategy readily understandable? (If not, ask every question you can think of until it is. If the advisor gets exasperated, you're not a match.) The gold-standard designation for this type of advisor is the chartered financial analyst.
Softer, but no less important, does the advisor approach their job with a healthy dose of humility? You can get at that by asking about what they expect a balanced portfolio to return over the next decade. Any advisor who’s promising portfolio returns higher than the mid-single digits over the next decade isn’t being realistic and/or may be taking excessive risks.
2) Are you a fiduciary?
Here’s another key question to ask prospective advisors. Being a fiduciary simply means that the advisor must put their client’s interests ahead of their own when consulting on portfolios and plans. It seems obvious that anyone proffering financial advice should adhere to such a standard, but as things stand today there is no uniform standard.
The good news is that many financial advisors already adhere to a fiduciary standard. Investment advisors who are registered investment advisors—or work for firms organized as registered investment advisors—are already fiduciaries. Certified financial planners are required to act as fiduciaries when offering financial advice. (The CFP board expanded fiduciary requirements for all certified financial planners in all financial-advice contexts in October 2019.) Your job is to ask the question outright: Are you a fiduciary, and will you be one in every context in which you’ll serve me?
That’s not to suggest that financial professionals who aren’t fiduciaries are automatically unethical hacks, by the way; many non-fiduciaries uphold high ethical standards and treat clients with every bit as much care as their fiduciary counterparts. But investors who work with a fiduciary have a higher level of legal protection than if they work with an advisor who’s held to the lower “suitability standard.” The latter type of advisors need to be able to defend their recommendations as being appropriate/suitable for you, versus fiduciaries, who are legally obligated to recommend the “best” products for you given your situation.
3) How do you charge for your services?
Advisor compensation can get messy. One of the first questions to ask is whether the advisor is fee-only, fee-based, or commission-based. Fee-only means that the advisor is compensated by charging fees for various services and is never compensated with commissions. Commission-based advisors obviously accept commissions for recommending products. Fee-based advisors may charge primarily fees for services they provide, but may also accept commissions. (People frequently confuse “fee-only” and “fee-based”; there is a difference.)
As with the fiduciary discussion above, advisors who accept commissions shouldn't automatically be marked with a skull and crossbones. But receiving commissions for products can introduce conflicts of interest, incentivizing advisors to recommend products that aren't necessarily in clients' best interests. The fee-only model is cleaner. And while the commission model is often touted as a way for investors with smaller portfolios to gain investment advice, that's a straw-man argument, in my opinion.
If you’ve decided to go with a fee-only advisor, you still need to ask about the specific business model, as well as a dollar estimate of what you’ll pay for the advisor’s services in a given year. (Ask for an estimate that includes underlying investment fees, too.) Fee-only advisors can charge by the hour, per project or a percent of assets under management (AUM).
There is also another model, which is picking up traction in the marketplace, known as a ‘retainer’. You pay a flat monthly or annual fee for advice, much as you would for a gym membership or cable TV. Such fees are on top of any investment-specific expenses. This model can make sense for investors who need ongoing advice on various aspects of their financial plans but don't yet have portfolios that are sufficiently large to qualify for advice under the AUM model.
4) What designations/credentials do you have?
In addition to getting clear on how you’re compensating the advisor, it’s also worth asking about the designations the person has earned. Don’t be blinded by a long list of letters after the advisor’s name; some designations, such as the following, carry more heft and have heavier requirements than others. (Note: There are other several other worthy designations for advisors, such as chartered life underwriter, or CLU, but they’re not as broadly applicable as the following.)
If you're seeking a financial planner, look for the following:
Certified Financial Planner: A certified financial planner is a financial planning expert accredited by the Certified Financial Planner Board of Standards. To use the CFP designation, planners must complete an educational program, pass a comprehensive exam, and log extensive financial planning-related work experience.
Chartered Financial Consultant: Much like the better-known CFP, this is a broad financial planning designation. Chartered financial consultants must complete an educational program and a series of exams, while also logging related work experience.
If you're seeking investment advice, first and foremost, look for the following:
Chartered Financial Analyst: Individuals with this designation qualify as financial experts accredited by the CFA Institute. To use the CFA designation, advisors must log substantial work experience involving investment decision-making and take courses on subjects such as economics; financial reporting and analysis; ethical standards; equity and fixed-income investments; and portfolio management. They also must pass a series of rigorous exams requiring substantial study time.
5) What’s your backup plan?
Even if your advisor is young, it’s still worth asking about backup planning. Who would step in and help if the advisor could not do so for a period of time, due to death, illness, or even a long vacation? Especially if you’re hiring an advisor on an AUM or retainer basis—but even if you’re not—there should be individuals in place to serve as backups if your primary advisor isn’t available.
