How to Choose a Financial Adviser
18 Questions to Ask Prospective Advisers — and Three Points to Ponder Before You Do
From The Truth about Money, Part XIII - How to Choose a Financial Adviser.
Point to Ponder #1: Do you really need to meet prospective advisers 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 advisers.
Them’s the old days. And them days is going away fast.
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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.
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.
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