Advisor Background and Qualifications
How long have you been in the industry? What’s your background?
The more relevant industry experience the better; relevance involves actually advising clients. A newly-minted financial advisor might have spent several years doing various jobs within the industry that don’t necessarily contribute to them becoming expert advisors. The threshold for calling yourself a financial advisor is not that high, so you may be engaging with one that does not possess the desirable level of experience.
Additionally, be wary of job-hopping or firm-hopping (you can view this on the SEC’s Investment Adviser Public Disclosure website).
What designations do you have?
An industry designation deep dive is beyond the scope of this article, but at a high-level, there are certain steps an advisor can take that indicate that they have done the bare minimum. By the same token, possession of pertinent designations indicates a deeper level of commitment to their profession.
At a minimum, depending on the type of work that an advisor will be engaging in, relevant U.S. governing bodies require that a financial advisor obtain certain licenses including the Series 6, Series 7, Series 63, or Series 65. Possession of these licenses is not an indicator of an advisor who has gone above and beyond to expand their knowledge.
However, financial advisors are not required to obtain designations including Certified Financial Planner (CFP), Chartered Financial Consultant (ChFC), and Chartered Financial Analyst (CFA). Therefore, these can be indicative of dedication to the profession.
What return expectations do you have for the U.S. equities (stock) market over the next decade? How about for a 60/40 (stocks/bonds) blended portfolio?
A financial advisor that has excessively high market return expectations will likely advise you to save too little to meet your financial goals, whereas an advisor with market return expectations that are too low may advise you to rein in your spending too aggressively. The former is more harmful than the latter.
When evaluating an advisor’s response to this question the objective is not to look for precision, but instead you want to get a sense of how they think. Be wary of an answer that is wildly different than expectations respected institutions have released. A quick internet search for “market return expectations” can provide you with reference points to gauge what well-known institutions expect. Wildly different can mean a couple percentage points, as over longer stretches compounding can lead to stark differences in results.
Have you had any clients fall short of any of their financial goals while working with you? If so, why?
The financial advisor may not have an example of this, but if they do the answer could be telling. For example, let’s say the advisor provides an example and places sole blame on the client, or worse, on financial market volatility as the culprit. This is not a good sign as the advisor is shirking their responsibility, especially in the latter instance.
What types of clients do you typically work with?
You want to find a financial advisor that has experience working with clients that are in a similar situation to yours. Advisors sometimes tailor their practices to specific niches, such as dentists, doctors, corporate professionals, millennials, professional athletes, and many others. The more experience an advisor has navigating the nuances of your specific situation, the better they’ll be able to serve you.
Advisor Incentives and Compensation
Are you a fiduciary? If so, are you or your firm dually-registered?
A fiduciary standard legally binds financial advisors to place your interests ahead of their own. A less stringent standard applies to financial advisors that are not fiduciaries, which increases the opportunity for conflicts of interest between you and them.
Dual-registration means that an advisor or firm acts in one capacity as a fiduciary but also assumes a role that does not maintain that standard. Logically, you may think that the fiduciary role in this scenario supersedes any lesser registration, and you’re correct in that line of thinking. However, practice convolutes this theory, and this academic study shows wearing two hats can negatively impact you as the client. For more insight into these different financial advisor roles, please reference our Investment Professionals Infographic.
How are you compensated?
There are many different financial advisor compensation structures. These include: fees based on a percentage of the assets the advisor manages (generally referred to as fee-only), commissions of the securities they sell to you, a combination of these two (typically referred to as fee-based), or a different model altogether. The term “fee-based” is misleading as it tries to piggy-back off of the positive connotations associated with fee-only.
There is no one-size fits-all model that is right for everyone, so consider the level of guidance you need for your particular situation. The less support you need from your advisor, then the more a commission-based model may make sense as it can be more cost-effective than a fee-only model. However, the incentives in play can work against you when an advisor receives commissions. A fiduciary standard often does not apply and they earn more as you buy and sell more securities. Higher trading levels don’t typically equate to better investment outcomes for you as the client.
You can see how different advisory firm potential fee levels compare by accessing our advisory firm grades here.
Are you able to allocate client assets to any investments you feel are best, or are you limited by products (investments) your firm offers? If there are limitations, what are they and why do they exist?
This question gets at a granular aspect of the industry, but it is important. Some financial advisors work for large firms that inhibit what they can offer you as a client. For example, a financial advisor could work for a firm that prohibits the offering of Vanguard mutual funds, a well-known low-cost offering. You may wonder why they would do this? Generally, it comes down to mutual fund companies, such as Vanguard, refusing to pay to be on the firm’s platform or product shelf. It’s hard to imagine a financial advisor can act in your best interest if they don’t have access to certain investments.
What’s your investment approach?
At a high-level, investment approaches fall into active or passive categories. Adherence to an active investment strategy entails more buying and selling of securities as investment managers attempt to beat the market (typically an index, such as the S&P 500). Passive investment approaches are generally less involved. They often hold exchange-traded funds that track indices the active managers are attempting to beat.
There are also other angles to consider when prodding an advisor about their investment approach. For example, you may prefer to stick to an Environmental, Social, and Governance(ESG)-focused investment strategy that considers not only financial outcomes, but broader impacts as well.
If active, how do they seek to outperform passive options?
The feat of outperforming passive investment options is an extremely challenging task. There are firms that dedicate many millions of dollars to focus solely on this, and still cannot guarantee results. If a financial advisor takes an active approach, push them to explain how they seek to beat other market participants. If they claim that they are picking individual stocks themselves, be extremely skeptical. Firms with far greater resources that focus strictly on this effort have a hard time doing it, so how will this advisor do it on top of the other non-investing responsibilities they have on their plate?
What’s your philosophy on performance benchmarks?
Some advisors choose to use performance benchmarks, while others are against it. Both sides of the argument have merit. On one hand, benchmarks hold the advisor accountable for their investment selection, particularly if they take an active investment approach. On the flip side, you as the client could focus on the wrong things due to this, such as short-term performance results.
Do you handle managing the investments or do you outsource this?
If a financial advisor outsources investment management, then likely the fee they charge will be in addition to a third-party investment management fee. If they do outsource, ask what the all-in fee will be. Also, if they are outsourcing investment management and charge you an annual fee, see what else they’re providing on an ongoing basis to justify their annual fee.
What asset allocation buckets do you use?
You’ll want to get a sense of the different markets your advisor will utilize. You don’t want to be missing market segments that could benefit your portfolio. For example, if they simply invest in U.S. stocks and bonds, you’re missing international allocations that could help your portfolio.
Do you stress test client portfolios? If so, how?
While the typical financial advisor may not do this themselves, and that’s not an indication that they are falling short of what they should deliver, this is still something that the advisor should give thought to. If they are investing in mutual funds on your behalf, often those funds will run stress tests to determine how their portfolios will perform under different market environments, and the advisor should be cognizant of this. So, while they may not test how your overall portfolio may behave under different market conditions, they should understand how its component parts will.
What value do you provide for your fee?
This gets to the heart of what the financial advisor is providing to you and makes them justify their fees.
What services are offered?
You want to understand if the financial advisor can provide everything you need now and down the road. The financial advisor may offer investment management (setting up and watching over the investments in your portfolio) but not offer financial planning (creating the broader roadmap for your financial life, which investment management is a piece of). However, be cautious of broad terms such as this because industry pros can define things differently. It’s best to ask them to explain what they mean if it is unclear.
Do you partner with any other firms to provide services you don’t offer?
For services outside the scope of the financial advisor’s expertise, they might have arrangements with firms to make these services available to their clients. For example, a financial advisory firm might recommend an accounting firm to handle tax needs. If the advisory firm you’re working with does this, be sure to understand any compensation arrangements that are in place. The firm they’re referring you to might be paying the advisor for the referral. This may be just fine, but it’s still important to understand any point where conflicts of interest may arise.
Potential Red Flags
Have you had any clients leave? If so, why?
A financial advisor could have caused a dispute with a client or fell short of expectations they set for that client at the start of their relationship. Compare the financial advisor’s response to other advisors you’re meeting with; this question could be illuminating. Nearly all advisors have had a client depart, and the transparency of their response can be telling.
Have you had to make any disclosures to the SEC? If so, what for?
Disclosures are declarations of any past criminal, regulatory, or disciplinary actions against the financial advisor. This can be checked on the SEC’s website, so you can see if a financial advisor is being truthful in their response. If they have had to make disclosures, their explanations of those disclosures provide additional information about that advisor. Misunderstandings and mistakes happen, but a lack of proper explanation is cause for concern. Our PennyPilot Grade (Accessible Here) scores the disclosures reported of over 5,000 advisory firms.
Firm Setup and Operations
Do you have a team of financial advisors I’ll work with, or will I only work with you?
You want to gain an understanding of what resources are available to you as a client, and who you may or may not be in contact with should your regular advisor be unavailable. You might get along well with the advisor you initially meet with, but not as well with other advisors or support staff that you will interact with. If your financial advisor works within a team, try to meet multiple team members that you could potentially be working with down the line.
You can also gain insight into whether or not your advisor has someone to bounce ideas off of and share their workload with. Given the abundance of information financial advisors must stay knowledgeable about and the array of responsibilities they maintain, dividing the workload can benefit you as a client.
Do you have a succession plan in place?
When your financial advisor decides it’s time to retire, or if something more sudden occurs that renders them unable to continue in their role as an advisor, you want to know whose hands your assets will be in. An advisor failing to implement a proper succession plan could cause you to struggle with moving assets and translating the financial plan you and your original advisor put in place.
Where will my money be held?
Provided they meet certain criteria, the Securities and Exchange Commission’s (SEC) “custody rule” requires financial advisors to hold client assets at a qualified custodian. A custodian oversees assets on behalf of clients, will provide quarterly statements directly to clients, and enables clients to independently verify the status of their assets irrespective of what their advisor’s claims regarding the assets are. The SEC’s requirement benefits investors helping reduce the likelihood of fraud, like the Bernie Madoff Ponzi scheme.
While the custody rule aids in mitigating the risk of theft or fraud, investors should conduct their own diligence. Inquiring about where your money will be held is an important part of this diligence. You should understand whether or not the advisor uses a custodian that is independent or affiliated with the advisor. Independent is better. Some of the most widely-used custodians include Schwab, Fidelity, TD Ameritrade (recently acquired by Schwab), and Pershing Advisor Solutions.
What software do you use when planning or investing for clients?
Your financial advisor has a plethora of software options available to them when operating their business. They can leverage cutting edge tools that will benefit you, or they could be stuck in the dark ages. You can ask what they use to research investments, produce performance reports, or create financial plans. Their answers can be telling and don’t require you to be an expert in Fintech (Financial Technology) solutions. For example, if they respond that they don’t use performance reporting, planning, or research software, then they likely cannot serve you as well as a financial advisor who does take advantage of available software. Sure, it saves the financial advisor money, but at a cost to you as their client.
How do you stay up to speed on topics that will impact client financial plans or portfolios?
Change is constantly present as financial advisors work for their clients. Financial markets are often in flux, rules and regulations shift, and many other things can occur that could impact you and your loved ones’ financial prospects. It is an advisor’s job to stay on top of these changes and manage them in a way that is beneficial to your interests. A financial advisor that gathers information from a wide range of resources and invests in their own continuing education has an advantage over those that take a less intellectually curious approach.
Do you have asset minimums and what is the asset level of your typical client?
You don’t want to waste your time evaluating an advisor that won’t accept you as a client. An advisor also may generally work with clients who possess greater assets than you, which could leave you lower on their priority list. On the flip side, an advisor may generally work with clients that possess less assets than you, which may render them out of their depth when it comes to managing your assets.
How do you measure client success?
Your financial advisor should prioritize helping you accomplish your financial goals. However, improper measurement of whether or not you’re on track to meet these goals can be detrimental.
For example, as a client, you may want to focus on performance. This can be misleading, particularly over short time frames. Let’s say you jointly decide with your advisor that portfolio return is the metric that you will use to determine success. This could cause your advisor to take too much risk with your portfolio to produce outsized returns. This may look great in the short run but could lead to unforeseen land mines when markets hit a rocky stretch.
Will you provide advice on assets not held with you? If so, do you charge for this?
In addition to your accounts that a financial advisor maintains discretion over, an advisor might also provide advice on assets that are not directly under their control, such as a 401(k) account you have with your employer. Some advisors might provide this guidance at no additional cost, some might charge for this, and others might refuse to handle this altogether. Ideally, an advisor is looking at your financial situation holistically and guiding all decisions that impact your end goals.
What communication parameters do you set for your clients?
A financial advisor may only speak with clients once a year and set criteria for communication outside of that, such as in the event of a major life change. The advisor setting proper communication frequency expectations is a good thing, even if it occurs less frequently than you originally thought necessary. This can help clients avoid rash decision-making in the face of a volatile market, that can deter them from the plan originally established. Whatever the communication frequency is, make sure it works for both you and your advisor and that it is clear from the start.
What communication mediums do you use?
Your financial advisor can communicate through a variety of different mediums including video calls, in-person meetings, or document sharing via a client web portal. At these different touchpoints the information provided can vary as well. Some advisors provide and review quarterly or annual portfolio reports and billing statements with you, others may not. If the advisor does, the level of granularity provided can differ between advisors. See if the advisor can share a sample report with you so you can identify if it has all the data you would like to see. Make sure they deliver reports in a secure manner, not as an email attachment with your account numbers exposed, for example.
Will you help with financial decisions such as a home or car purchase?
Seeking a financial advisor’s help for significant purchases such as these can go a long way in helping you meet your financial goals. Does the financial advisor you’re engaging assist with this, and do they charge extra for this type of advice? Or, do they include it as part of their ongoing fee? All quality advisors that view your financial situation holistically should aid in these decisions.