1. Are You a Fiduciary?
Most people have the common misconception that all financial advisors must always act in the best interest of their clients. Unfortunately, this is not the case at all. In fact, only a small percentage of advisors actually practice strictly as fiduciaries. Why is this so important? By law, a fiduciary must always act in the client's (your) best interest.
The easiest way to determine this is to ask the advisor how they get paid. As a fiduciary, I'm paid a flat fee as a percentage of the assets I manage or based on the financial plan that I complete. I don't receive commission-based on the investments I recommend.
Beware that some advisors practice as “hybrid” registered investment advisors (RIA). This means that at times they will act as a fiduciary and others they can practice under a lesser standard (suitability). While this is a convenient registration as it allows them to sell insurance and other commission based products to their clients and/or charge a flat fee, it also can blur the lines of whose interest (yours or theirs) takes priority and when.
If your advisor is a “hybrid” RIA and they recommend investments that charge a commission you have the right to ask them how much they receive in commission based on you investing in the product. To take it a step further, ask them why this product is better than others along with a table that includes a break down of the analysis they performed with similar products.
2. What is Your Area of Expertise?
The world of financial advising is unnecessarily complicated. The professional recommending auto insurance can call themselves a financial planner while a hedge fund manager may call themselves the same thing. Unfortunately there is no law ruling against this. However, what's the difference?
One is an expert in property and casualty protection and the nuances of protecting your assets using different insurance companies and policy riders. The other is a wiz at implementing strategies and purchasing securities to mitigate investment risk. Two distinct specialties, but both may use the same title.
When hiring a professional to help you accomplish your financial goals understand what their area of focus is. This is especially helpful to understand their capabilities and limits. It will also help you better understand if you should keep all of your assets with this one person or company.
When I worked as an insurance advisor I would frequently try to upsell clients to open an IRA or investment account with me. In doing so I could then help them diversify their investments between insurance and securities while making money from the mutual funds or ETFs they invested in. In some cases this made sense, but for more complicated cases I found myself out of my league.
Be up front with your advisor to find out what focus they can assist you with. While it may be convenient for you to keep all of your assets with one professional, it may not be your most cost efficient choice or quickest path to achieving your goals.
3. How Does Your Advice Fit in My Financial Plan?
Every person needs a financial plan. It doesn't matter if your goals are to pay off student loan debt, buy a home or to make your portfolio last your lifetime.
The easiest way to accomplish your goals is to measure your activity and track your progress. Why do you think professional boxers weigh themselves every day? They want to know each day if they are overweight so they can take specific actions to meet their target. Your financial goals should be approached using the same technique: precise measurements.
During your first meetings an advisor may stress how their product or strategy can help you take the fast lane to your financial goals, but the easiest way to clearly see if this is true is by reviewing their advice within a financial plan.
Doing so will allow you to see how their advice affects other areas of your life such as income, taxes, legacy, etc. More importantly, it will give you a benchmark to review with any other financial professional who may be assisting you and to revisit at your next meeting with that advisor recommending their solution.
4. Where will my money be held?
Remember that Bernie Madoff guy? He was the one who was able to keep a ponzi scheme (paying old investors off with new investors money) going for at least two decades while stealing several billion dollars. How was he able to do so for so long?
The most significant reason is because his firm served as the investment advisor and custodian. This means that he not only chose the securities his clients invested in, but he also kept possession of the money within his firm.
The easiest way to protect yourself from ever becoming victim of a ponzi scheme is to make sure your advisor places your funds with a third party custodian. Most RIAs will use one of the major custodians such as Charles Schwab, Vanguard, TD Ameritrade or Fidelity.
Placing your money in these firms puts a firewall between your advisor and your account. That means they will be able to make adjustments to what type of securities you invest in and the amount in each, but will not be able to withdraw funds without your permission. Even better, the custodian will provide a statement, typically monthly that allows you to keep track of the activity and balance (if you decide to open it).
Another quick way to protect your money is to NEVER write a check to the advisor themselves. This is a big red flag that should always be avoided.
There are several other areas to focus on when selecting your advisor, but these are the core concerns anyone should be familiar with. Remember, it's your money and your future. The biggest complaint I hear from clients when we begin working together is that they are reluctant to make changes that are in their best interest because they have been burned in the past by other advisors. Don't let your dreams fall victim to an unscrupulous advisor, be knowledgeable and protect yourself.