How to Choose a Financial Advisor
18 Questions to Ask Prospective Advisors — and Three Points to Ponder Before You Do
Point to Ponder #1: Do you really need to meet prospective advisors in person? In the old days — meaning before the Internet — all business was local. People always went to the bank and to the offices of their lawyers, accountants, and financial advisors.
Them’s the old days. And them days is going away fast.
Today, millions of people work with the financial industry without ever meeting face-to-face the people who serve them. Internet banks are fast replacing brick-and-mortar branches, and your friendly neighborhood tax preparer may well be shipping your papers (via the Internet) to India, where a very inexpensive recent college graduate fills in the blanks on your 1040.
And so it’s no surprise that millions of people now get their financial advice solely via the telephone or Internet. Think about it: Have you ever visited your mutual fund company? (We’ve even experienced this in our firm. Although we have dozens of offices around the country, we have thousands of clients whom we’ve never actually met face-to-face, because we don’t happen to have an office where they live. In fact, I still vividly recall the first time an out-of-town caller inquired about hiring us. Although we were a little nervous about it at first, we’ve found that distance is not a problem at all, and we’re able to get to know our clients and provide them with effective advice and service just as easily over the telephone and through email as we can face-to-face.)
Think about it: Do you really need to hire a local advisor? If you insist on that, you’ll be limiting your search to the local talent pool, possibly denying yourself great advisors who don’t happen to live in your neighborhood.
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How important is it, really? Think about how often you meet with your current advisor — I bet it’s no more than once a year, and it may even be less. Instead, you’re probably talking often via phone or email. Does it really matter what city the advisor is calling from?
If it does, what will you do if you decide to relocate? If you move to another state, will you fire your advisor because he’s no longer local? That would make little sense — which explains why my firm now has clients in all 50 states: Many relocated for a new job or moved in retirement so they could be closer to their grandchildren. But we’re able to serve them equally well regardless of their (or our) zip code.
So, think carefully before you decide that you must only select from a list of local advisors.
Point to Ponder #2: Do you understand what he’s saying?
Sadly, some advisors try to impress (or intimidate) clients by talking too fast or using technical jargon ordinary consumers can’t comprehend. No matter what anyone tells you, the field of personal finance is not all that complicated. If you don’t understand it, don’t do it.
Best test: Try to tell others what the advisor said. If you can’t, don’t proceed with that advisor.
Point to Ponder #3: Don’t bother asking for references. And beware advisors who offer them.
When you were looking for a job, your resume probably said, “References available upon request.” Did you ever submit to the Human Resources Department the name of that guy who hates you?
Every advisor has at least one client who hates him. Think you’ll ever get that name as a reference? That explains why asking for references is a waste of time. All you’ll be doing is contacting the advisor’s fan club — hardly the basis for making a sound hiring decision.
And never hire any advisor who mentions the names of other clients. Not only is it a violation of client privacy (will he pass your name around to others one day, too?), testimonials are generally prohibited by the SEC. That’s because there’s no guarantee you’ll have the same experience as other clients.
It’s a great idea to ask for references when hiring a plumber or dentist. Both are in control of their work, and one of them is going to spend unmonitored time in your home. But advisors work in a field where the results of their recommendations are beyond their control — and that makes client references of questionable value.
If you think failing to ask for a reference constitutes a glaring omission, relax. Soon, you’ll see how to glean the information you want in a more effective way. With these three points in mind, here are the 18 questions to ask when interviewing prospective advisors:
Interview Question #1: Are you licensed as a stockbroker, insurance agent, or investment advisor?
Asking this question serves two very useful purposes: First, and most importantly, it cuts through all the marketing hype and bamboozlement. No matter what title a practitioner gives himself or what designations he’s obtained, asking how he’s licensed will tell you how he earns a living — and what kind of product recommendations you are likely to get from him.
No matter what he might claim to the contrary, a practitioner who’s solely licensed as a broker or insurance agent makes a living selling investment or insurance products. His need to earn a living will inevitably affect his recommendations.
The second benefit of asking this question is that you’ll be making it clear to the candidate that you’re knowledgeable — dramatically reducing the risk that he might try to bamboozle you.
Interview Question #2: How are you compensated?
As you’ve seen, many practitioners hold multiple licenses. Therefore, you need to get a clear understanding of exactly how he or she earns a living. In addition to learning whether you’ll pay fees, commissions, or both, ask if the practitioner earns any compensation from third parties. Many do. As I told you in Chapter 26, sometimes money managers, insurance companies, wrap account sponsors, mutual fund companies, and others pay brokers and agents extra commissions for hawking their products. In some cases, brokers and agents who sell lots of a certain product are rewarded with trips to exotic locations, expensive jewelry or watches, fancy dinners, or trips to sporting events and concerts.
In other cases, practitioners receive free computers or software to help them operate their practices. Although this is more benign than tickets to the Super Bowl, it’s still an incentive for practitioners to recommend something that’s in their best interests instead of the best interests of their clients or customers.
Such payments are called “soft dollar” or “third-party” compensation, and your advisor should disclose it.
Interview Question #3: What costs will I incur in addition to your compensation?
As we’ve seen, there can be a huge difference between what your advisor charges you and how much you actually pay. If you open an IRA account, for example, will you have to pay a set-up fee? Will you pay a termination fee when you close the account or transfer money to a different account? Some brokerage firms and insurance companies charge annual maintenance fees or other charges.
You won’t know in advance what these costs are unless you ask. So make sure you receive complete disclosure about the total costs you will pay to implement the recommendations that your advisor will give you. And make sure you receive this disclosure in writing, before you agree to retain the advisor’s services or invest any money.
Interview Question #4: What are your services?
Before you walk into a doctor’s office, you already know where it hurts. Likewise, you know what you need from your advisor. Does he provide those services? The typical services needed include financial planning (including college and retirement planning), insurance analysis, tax advice and preparation, investment management, and estate planning. But many advisors only handle one or two of these areas, leaving the rest to other practitioners you have to hire.
Make sure your advisor’s expertise and services match your needs, and if you need additional services, ask if the advisor will assist you in coordinating all those services or whether you must do so on your own. A related question pertains to documentation. Will the advisor handle all record-keeping chores for you and provide you with all the information you’ll need for tax preparation? How often will you receive statements and can you check the status of your accounts at any time online?
If the advisor issues performance reports, make sure they conform to the Global Investment Performance Standards, which dictate how firms calculate and report investment results.
Interview Question #5: What is your investment methodology?
Ask if the advisor has a fundamental philosophy that guides his investment approach, and if so, ask him to describe it fully. Many don’t have a formal approach to investment management; instead they merely sell a variety of investment or insurance products without any established methodology or approach.
If there is a formal approach in place, find out what that is and how the advisor came to develop it. Did he create it alone, or is there a formal Investment Committee operating under specific policies and protocols? Find out how long the current approach has been in place — which leads to the next Interview Question.
Interview Question #6: Describe what your practice was like before, during, and after the 2008 credit crisis.
Learn what kinds of advice and investments he was typically recommending in 2005–2007 and whether he is still giving that type of advice today. Ask how many clients he had in 2007, and how many of them are still with him today — if he’s experienced significant turnover in clients, you’ve just obtained information that’s far more valuable than you’d ever get from calling a reference or two.
If many of his clients left him, it could be because the investments he had recommended didn’t perform well, or he hadn’t clearly explained the risks of those investments, or he hadn’t remained in close contact with those clients during the market meltdown and proved unsuccessful in meeting their needs. Any of this must make you wonder if you will be happy with him over time.
Interview Question #7: Do all the advisors in your firm manage investments the same way as you?
The nation’s big brokerage firms, banks, and insurance companies employ hundreds of thousands of brokers and insurance agents — and each is free to sell whatever products he or she wants. Within a single firm, for example, one advisor might be telling a client to sell a stock that another advisor in the firm is telling clients to buy. One could be trading options while others pitch muni bonds or annuities. In short, there is no consistency regarding the advice and recommendations offered by salespeople who work at big firms.
It is often the same at smaller advisory firms. When dealing with organizations that operate this way — where each advisor has full discretion to handle each client however he wants, with no regard for how others in the firm handle their clients — you must choose your advisor very, very carefully. After all, you can go to the best hospital in the world, but if your surgeon is a klutz, you’ll die anyway.
That’s why you want to know if your advisor works collaboratively with the other advisors in the firm. If he does, you have a higher degree of confidence that the advice you’re receiving is the product of many people — and two (or fifty) heads are better than one. You also get the benefit of knowing that there’s more than one person you can turn to for information or help when needed (see the next Interview Question below).
Conversely, if your advisor is a solo practitioner or works independently at a larger firm, you have to hope that you’re selecting the best advisor in the firm.
Unless you interview them all, you can’t be sure — and since every advisor in the firm has clients, it’s obvious that someone has made the wrong choice. Knowing that your advisor works with his colleagues rather than acting on his own regardless of what they think can help you get better advice.
After all, no matter how good, experienced, or smart an advisor is, you really don’t want your life’s future financial security to be dependent on the actions or advice of just one person.
Interview Question #8: If something happens to you, what happens to me?
I’m not talking here about your advisor getting hit by a bus or running screaming from the office never to return (although I’ll get to those scenarios in a moment). No, I’m just wondering what happens if you need help while your advisor is out sick or on vacation.
Sure, cell phones and email help a lot in ensuring that your advisor is never far away. But what if he’s on an airplane or hiking down some canyon out of cell range?
Ask the candidate how he handles occasions when he’s out of the office. This can be a real problem if your advisor is a solo practitioner who works part-time (as many insurance agents do) or without any assistants (common for many brokers and agents).
It’s common for advisors in larger firms to buddy up, covering for each other when one is away. Find out if the advisor you’re interviewing has such an arrangement, but don’t stop there. It’s one thing to know that someone else will answer the phone or respond to an email, they need to be able to do more than merely say, “Harvey will be back on Thursday.”
You want to verify that Harvey’s buddy is able to actually help you. That means he has the ability — and authority — to handle transactions (especially liquidations, because if you need cash quick, you want to know that you can get it, even if Harvey is away). And if you need advice — say you have to make a financial decision and there’s a deadline that can’t wait — is that buddy familiar with your financial situation, or is he just some broker or insurance agent in the office who was forced into taking other’s phone calls? Ideally, you want to know that if your advisor is away, there are others in the firm who are very familiar with the investments and insurance you own, and who can talk with you knowledgeably and offer advice just like your advisor could.
I’m talking here about depth of talent, and it’s of tremendous importance when hiring an advisor. Don’t let your financial future be dependent on the advice — or sheer availability — of just one person.
Of course, the above describes the inconvenience of having an advisor away on vacation or out sick. But what happens to you and your account if your advisor quits, retires, or dies?
I’m talking about a succession plan. Does your advisor have one? Most don’t, despite the fact that one of those events is eventually going to occur. So ask the candidate how long he plans to continue in this field and what will happen to your account if he sells his practice, quits the firm, or leaves due to death or disability. Are there others in the firm who can take over with minimal disruption to you? Sure, you’ll have to get to know the successor, but you’d have to do that anyway if your advisor’s departure forced you to find another advisor. And if you are forced to start over, you may find yourself having to transfer accounts, sell assets, and buy new ones, resulting in fees or taxes.
Talented advisors realize they have an obligation to ensure that their clients will be cared for after they are gone and they have succession plans in place to assure continuity of services.
Make sure your advisor has a plan in place. And learn its details. Don’t merely let a prospective advisor say, “Yes, I have a plan.” Make him describe it, so you can decide if it’s well thought out and realistic. What is the name of the person who he expects will take over? What will be the transition process? Make sure you are comfortable with these answers. And if you’re not, make sure you’re comfortable with the idea of having to find a new advisor if this one dies, quits, or retires.
Interview Question #9: Do you personally own the same investment and insurance products you’ll be recommending to me?
I’ve learned over the years that a great many brokers, agents, and advisors never personally invest in the products they tell their clients to buy. It’s reasonable to assume there might be some differences in what your advisor buys for his own account compared to what he recommends for you — his personal situation might be quite different from yours, after all — but if he’s telling you to invest your life’s savings in annuities and he doesn’t own any of them himself, or if he’s recommending a third-party manager but he hasn’t placed his own money with that manager, well, you just have to ask yourself a question: If he doesn’t buy what he’s selling to you, are you sure you want to buy it? Put another way, would you dine at a restaurant whose chef refused to eat there?
Interview Question #10: What kind of people do you usually work with?
Do not tell the candidates about yourself right away. Instead, ask them to describe their typical clients. If they describe you, it could be a good match. If they describe someone quite different, you could be out of place. As part of this question, ask how much money their typical clients invest. If you have $50,000 to invest, you don’t want an advisor who works primarily with millionaires, or you’ll probably be ignored. Likewise, if you have $1 million and the advisor works mostly with assets of fifty grand, the advisor may not have the expertise you require.
Ideally, you want an advisor who has extensive experience working with people just like you. Never be a surgeon’s first patient. And never let a podiatrist operate on your spleen.
Interview Question #11: How long have you been in this business?
Don’t assume that age translates to experience. A great many stockbrokers, insurance agents, and investment advisors are career-changers, and their gray hair belies the fact that they’ve been in the field only a year or two.
Interview Question #12: What is your ratio of support staff to professional staff?
If the advisor works alone or has only limited access to support staff, then you’re paying for your advisor to lick envelopes. You want an advisor who operates in a professional environment, not a solo practitioner who must do everything himself.
An effective office operation will have no less than one support staff member for every professional.
Interview Question #13: Do you conduct background checks of your staff?
It’s obvious that your advisor will be in possession of your date of birth, Social Security Number, and detailed information about your bank accounts, investments, and insurance policies. (That’s why I’ve shown you how to check your advisor’s regulatory history.)
But your advisor’s staff will also have access to this information as well. Are they trustworthy? Your advisor should never hire anyone without checking their criminal record and credit report. After all, people with checkered pasts or who are under financial pressure are more likely to engage in improper behavior than those who enjoy more stable lives. Ask your advisor if he conducts background checks of all job applicants — and be concerned if he does not.
Also make sure that your advisor periodically re-checks his staff ’s background. After all, many people’s lives drastically changed during the latter part of the ’00s. Millions were laid off, suffered massive investment losses, or lost their homes to foreclosure. Did any of this happen to the advisor’s staff (or their spouses)? If so, an employee might be experiencing severe financial difficulty, and temptation could place your money or identity at risk.
You should not trust your financial future to an advisor or firm who does not take basic steps to protect you.
Interview Question #14: What is the advisor’s reputation, both in the field and in the local community?
Those who have roots and solid reputations to protect tend to be more careful than someone with neither.
Interview Question #15: Do you have a clean regulatory record?
Don’t be afraid to ask this question and, if you like, follow it up by contacting the regulatory authorities. Every legitimate practitioner holds at least one FINRA or insurance license, so it’s easy to find out if there have been any complaints. To check with the SEC directly, go to www.adviserinfo.sec.gov and click on “Investment Advisor Search.” To check with FINRA, go to www.finra.org/brokercheck.
Interview Question #16: Do I have to sign a contract?
Most Registered Investment Advisors require clients to sign contracts; brokers and insurance agents never do. What does the contract require you to do? What limits does it place on you? What abilities does it grant the advisor?
For example, some advisors don’t allow clients to terminate the relationship or make withdrawals without 90 days’ notice. Others allow the advisor to make all investment decisions without your prior consent. Some require you to pay in advance. Read the contract carefully, and make sure you’re comfortable with everything it says.
And our final two questions …
Interview Question #17: Why did you choose this work?
Aside from giving an occasional stupid answer (“I needed a job”), advisors who are asked this question tend to give a response that falls into one of two categories: They either talk about their fascination with investments, economics, financial planning, and other numbers-oriented topics, or they talk about their fascination with people and how the dynamics of family relationships, emotions, attitudes, and desires interact with effective financial decision-making.
You have to decide if you prefer to work with an advisor who is more interested in the markets, or more interested in how you will interact with the markets.
Interview Question #18: Why should I choose you?
This is a fair question, and the answer will reflect the advisor’s experience and depth of character. The answer should be a reflection of the advisor’s skills and abilities, with an emphasis on how he can help you. Beware any candidate who treats this question as an opportunity to disparage others. True professionals do not need to diminish the competition in order to make themselves shine.
When you’re done with the interview, you should be able to ask one final question — of yourself: Do you like this person? Don’t hire someone you dislike.