How to Choose a Financial Advisor

Finding an advisor you can trust and feel comfortable with can be daunting – even downright scary. Reading news articles about the financial industry would make anyone wary about trusting even the largest, most reputable financial institutions. Excessive fees, fraud, and conflicts of interest seem far too common.

No one wants to be the victim of the next Bernie Madoff. Knowing that the advisor isn’t going to book a one-way ticket to the Cayman Islands is a threshold criteria for anyone to whom you’re entrusting your financial affairs.

So how do you know if you can trust someone? The best way to go about figuring out if you should trust an advisor is to ask a lot of questions and verify the answers. The questions outlined in this article are a good starting point. If the advisor seems reticent to provide you with information or evades questions, it should raise a red flag.

A trustworthy, competent financial advisor can provide extraordinary value– both for your finances and your peace of mind. The key is to find an advisor who is right for you and your financial needs.

What Are You Looking For?

One of the first things to consider when hiring a financial advisor is what it is you’re looking for. What in particular do you want the advisor to help you with? The two main services provided to financial advisors are investment management and financial planning. An advisor who focuses on investment management is primarily concerned with picking stocks, bonds, and funds for your portfolio. An advisor who focuses on financial planning is concerned with your particular financial situation, helping you to reach your personal goals through saving, budgeting, tax planning, and other financial decisions, such whether to refinance loans and whether to rent or buy a home. While these two functions are distinct, they also overlap. Financial planning affects how much
you can invest, while investing decisions help you reach your future financial goals.

While many advisors will counsel you in both areas, many will have a primary focus on one or the other. Think carefully about the type of service you expect. Ask the advisor what specific services they provide and what services are included in their fee.

What Are the Advisor’s Credentials?

Surprisingly, there are no rules governing who can call themselves a financial advisor. You don’t need to have a college degree, or even a high school degree, to be a financial advisor. That’s why it’s important to know your advisor’s qualifications before entrusting them with giving you financial advice.

In addition to the advisor’s educational background, you should also inquire as to any relevant certifications he or she has. There is an alphabet soup of letters financial advisors put after their names, many of which don’t mean that much. The most reputable certifications are the CERTIFIED FINANCIAL PLANNER TM (CFP®), the Chartered Financial Analyst (CFA), and the Certified Public Accountant (CPA). Each of these certifications requires hundreds of hours of preparation and days of rigorous testing. If you encounter other certifications, be sure to research what level of expertise, if any, is required to obtain it.

Be sure to verify the advisor’s credentials. Most certifying organizations maintain an online database of their members, which may include any complaints or disciplinary actions against them. You can confirm academic degrees by calling the educational institution.

Has the Advisor Been Subject to Disciplinary Action?

One of the most important things to do before hiring any financial advisor is to make sure they haven’t been subject to disciplinary action. You can check the advisor’s official record at www.brokercheck.finra.org or by contacting your state’s regulatory authority. The advisor’s record should contain the advisor’s employment record in the industry and disciplinary actions against the advisor. If you have trouble finding the record, ask the
advisor how to get it.

If the advisor claims to be a Registered Investment Advisor (more on this in the next section), you should ask for the advisor’s Form ADV, which can be found at http://www.advisorinfo.sec.gov/ or by contacting the state authority that regulates advisors. Form ADV consists of two parts. Part 1 contains information about the advisor’s business and whether they’ve had problems with regulators or clients. Part 2 outlines the advisor’s services, fees, and strategies.

What Legal Obligations is the Advisor Bound By?

While you might expect that every advisor has an obligation to give you financial advice that is in your best interest, many advisors are subject only to a standard of “suitability” – that is, the investments they recommend need only be suitable for your situation; they don’t need to be the best choice.

To illustrate, suppose there are two mutual funds, Fund A and Fund B, that have a similar mix of stocks and bonds. The primary difference between the two funds is that Fund A charges higher fees than Fund B. All else being equal, you would make more money investing in Fund B due to its lower fees, but Fund A would still be a “suitable” investment for your situation. You would expect that your advisor would advise you to invest in Fund B. However, if Fund A pays your advisor a commission every time he or she invests a client’s money in that fund and Fund B doesn’t, the advisor may decide to
recommend Fund A. Recommending Fund A would be permissible for advisors who are subject to the suitability standard.

Other advisors are bound by a fiduciary standard, which is higher than the suitability standard. These advisors are called Registered Investment Advisors, or RIAs, and they are required to act in your best interest. An advisor who has a fiduciary duty to you is not permitted to recommend an investment that charges higher fees just because the advisor would receive commissions from the investment product.

While it is important to know whether your advisor is bound by a suitability standard or a fiduciary standard, the inquiry should not end there. There are advisors subject to the suitability standard who may nonetheless act in your best interest and advisors who are subject to the fiduciary standard who violate that duty. Nothing substitutes for having a thorough knowledge of the types of investments that you are investing in, the fees that are incurred for those investments, and whether the advisor is being paid for placing you in a particular investment.

What is the Advisor’s Investment Strategy?

You want to make sure the advisor has a sound investment philosophy that is compatible with your tolerance for risk. An advisor’s investment strategy is the criteria the advisor uses to select assets in which to invest. For example, Warren Buffett bases his investing decisions on a value-investing philosophy, which holds that you should invest in stocks that are trading at a discount to the company’s underlying value and sell stocks that are trading at a premium to the company’s value. Other investment philosophies suggest that you should buy stocks based on a stock’s movement in the markets (technical analysis) or stocks that pay high dividends (dividend investing).

Your advisor should incorporate this philosophy into a comprehensive strategy that balances risk with returns, based on your time horizon. Be wary of advisors who try to “time the market” or promise high returns. It may be an indication that they are being too risky with your money.

You should ask the advisor for a written investment policy statement. If they won’t provide you with one, that may be a red flag. You can even ask the advisor if they use the same strategy they recommend for you for their own personal investments.

Also ask to see if the advisor is limited with respect to the investments that he or she can offer to you. Some advisors are captive to certain investment companies and are constrained to investment products sold by that company. Be wary of advisors who are limited in this capacity, as they may not able to offer you the best investments out there.

How Does the Advisor Get Paid?

Once you’re convinced your prospective advisor isn’t the next Bernie Maddoff, the next thing you need to know is how the advisor gets paid. Fees charged by financial advisors are surprisingly opaque and have been the subject of a decades-long battle between financial institutions and consumer advocates. How an advisor is paid is important because it can affect what advice he or she gives you.

Many advisors get paid on a commission basis – meaning that the advisor gets paid a commission every time one of their clients purchases certain investment products. For example, the advisor may get paid when his or her clients invest in a certain mutual fund. These advisors may not directly charge you anything for their services. Or they may charge a fee while also receiving a commission on investment products you purchase through them. It is important to know if your advisor receives commissions because it can create a conflict of interest between what is best for you and what is best for the
advisor.

On the other hand, “fee-only” advisors get paid solely by their clients; they receive no benefit from recommending any particular type of investment. Fee-only advisors typically charge clients based on a percent of the amount of assets they are entrusted with
managing; the percent generally decreases as the amount under management increases. Less frequently, fee-only advisors will charge by the hour or on a flat fee basis.

Some advisors may charge based on a combination of these approaches. For example, they may prepare a financial plan for a flat fee but get paid a commission for investments.

The benefit of having a fee-only advisor is that you can be sure that they have no conflict of interest with respect to the investments they recommend. However, this model may not be for everyone. Advisors who charge a percent of assets under management will often work only with clients who have a certain minimum amount of investable assets. This minimum amount can range from $200,000 to $5 million. If the amount of money you have to invest is below $200,000, then an advisor who charges hourly or on a flat-fee basis might be a good choice. Advisors who work on a commission basis can also be a good choice; just be aware of the fees that are charged on the investments they recommend. Any fees in excess of 2% are probably excessive.

Where Will Your Money Be Held?

While basic, one of the most important things to know is where your money will be held. The institution where the money is held is referred to as the custodian. All advisors must maintain

If the advisor works for a large financial institution (for example, Charles Schwab), that institution generally maintains client accounts and imposes a number of fraud-detection safeguards. Independent advisors or small investment firms generally maintain client accounts at outside financial institutions, referred to as custodians, which impose safeguards to protect your money. If an individual advisor or a financial firm tells you that they maintain client accounts themselves, you should probably take your money elsewhere.

The institution serving as the custodian of your account should appear at the top of your account statements. The account should always be in your name. If the account statement indicates that the account is held under the advisor’s name, you should ask why and consider alerting the authorities. Never

Do You Feel Comfortable with the Advisor?

Regardless of an advisor’s credentials, if you don’t feel comfortable with the advisor, then he or she is probably not a good fit for you. You need to work with someone you feel you can be honest with and talk to about sensitive family matters. Financial advisors need to know things about your family that can be difficult to talk about – not just money, but personal issues like health issues and relationships – and discord – among various family members.

Is Working with an Advisor Worth All of the Trouble?

After all of this, you might conclude that working with a financial advisor is more trouble than it’s worth. However, having a high-quality, trustworthy advisor can be invaluable. First, a good advisor can help you implement tax and financial strategies that save you money in the long run. They can also help ensure that you have in place appropriate insurance policies and necessary legal documents. Finally, an advisor can play a critical role in creating a solid financial plan and helping you make wise long-term investing decisions during times when most investors act out of fear or greed. In sum, having a great advisor can provide you with priceless peace of mind that you and your family will be taken care of down the road and in the event of unexpected circumstances.

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About the Author

Shannon McNulty

Shannon McNulty is the founder of Savvy-Parents.com and a lawyer in New York City who provides legal planning for parents with young children. Shannon received her J.D. from Georgetown University Law Center and her LL.M. in Taxation from NYU School of Law. She has also earned her CERTIFIED FINANCIAL PLANNER(TM) designation. You can learn more about Shannon and her firm at www.cityparentslaw.com.

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