Top 5 Financial Advisor Interview Questions You Need to Ask Before You Hand Over a Check
You’ve finally received your huge tax refund. This year you want to start saving outside your 401(k) for retirement and for other big things like a new car, the big anniversary trip, and to help your kids out for college. You need a financial advisor because you don’t really have time to research all this stuff. You’ve asked around and did some googling and you found three names you think are reputable, but how do you know for sure? It’s your hard-earned money, how can you trust an advisor to give you straight answers in your best interest?
First, check out these 5 ground rules to help you avoid the worst financial advisor in your town. Then, of the advisors that make your short list, pick three advisors to interview and ask these 5 questions:
Are You a Fiduciary?
A fiduci- what? A fiduciary is an individual obligated to act in the best interest of another party. Some everyday examples are the relationships between an appointed guardian and a minor child, or an attorney and a client. Relating to financial advice and investments, only registered investment advisors must meet the five fiduciary responsibilities – put clients’ interests first, act with the utmost good faith, provide full and fair disclosure of all material facts, do not mislead clients, and expose all conflicts of interest.
Some advisors out there are held to a lower standard called the “suitability standard”. Simply put, the suitability standard allows an advisor to suggest investments that are “suitable” based on what the advisor knows about the client’s financial situation. Excessive cost doesn’t matter. Conflict of interest doesn’t matter. Full and fair disclosure doesn’t matter. As long as the investment sold is “suitable”, it’s fair game.
I know what you’re thinking. You’re wondering why every financial advisor isn’t held to the fiduciary standard. You’re not alone. A 2016 survey by Financial Engines found that 93 percent of Americans believe that all financial advisors should be held to the fiduciary standard and should be obligated to do what is in the client’s best interest. And at Pacesetter, we agree. That’s why we are a registered investment advisor; so that you know you’re getting the best possible advice that we can give.
Now, not every advisor that is held to the lower standard is going to be a crook. But you have to honestly ask yourself - do you want to hire someone to manage your money when they legally do not have to do what’s best for you? Of course not! Ask if they are a fiduciary.
How Are You Paid?
The second question you’ll want to ask is, “How are you paid?” That seems like an obvious question, but surprisingly, some investors believe they aren’t paying their advisor anything because they are not physically writing a check. Listen – nobody works for free! Are they doing this just out of the kindness of their heart?
All advisors are paid by their clients in one of three ways: 1. Commissions 2. Fees and Commissions 3. Fees Only
Advisors that are paid via commissions may provide financial advice, but they make their money when you buy investments or investment products through them. The more the advisor buys and sells on your behalf, the more they make. The investor pays the commissions through a reduced amount of capital to invest and/or a fee to make a trade. Typically, advisors that are paid via commissions are broker-dealers or insurance agents and are only held to the suitability standard. Take caution because the advisor can legally suggest investments or investment products that have higher commission payouts as long as the investments are considered suitable, not necessarily the best option for the investor.
Fee-based advisors are paid an ongoing management fee, but may also be paid via commissions for selling or trading. This is a huge conflict of interest. They are wearing two hats and are charging you for both. You may also become confused as to when you’re talking to your fee-based advisor giving you advice and when you are you talking to your commission-based advisor selling you a product. It’s easy to second guess financial advice when you don’t know how much your advisor will profit if you accept the advice. Fee-based advisors may be held to the suitability standard, the fiduciary standard, or both at different times. Best be careful.
Finally, there is the fee-only financial advisor. Clients pay a fee for advice and services. The fee is a percentage of the money that’s being managed, and so it’s often called an Assets Under Management or AUM fee. Some advisors may charge a flat retainer fee on a monthly or quarterly basis instead of an AUM fee. These advisors are usually registered investment advisors that are held to the fiduciary standard. They will always provide you with advice that they believe is in your best interest and there is no direct financial benefit to the advisor when they suggest one investment versus another because they do not receive commissions. Full disclosure: Pacesetter Financial Group is a registered investment advisor and we operate on the AUM fee model simply because we want to do what is best for the client. We want to treat clients how we would want to be treated.
What About Other Costs?
As mentioned earlier, you may have to pay trading costs to buy and sell. These fees will vary by broker/custodian and by investment. Some brokers/custodians offer investments with zero trading fees, some broker’s/custodian’s trading fees can be thousands based on the size of the trade. Your advisor should be able to provide you with a trading fee schedule or be able to tell you what trading fees their current clients typically end up paying.
If your advisor recommends using mutual funds or Exchange Traded Funds, those funds will have management fees and operating costs associated with managing the fund, as well. The fee is expressed as a percentage. Expense ratios on the low side are around 0.2% to 0.5%, but some funds can be excessive at 4% or higher.
Mutual funds may also have front end, annual, or back end commissions also called “loads”. There are many very good mutual funds out there that do not charge commissions. Paying a commission on a mutual fund does not provide you any benefit, so avoid any advisors that suggest that a commissioned-based mutual fund is somehow better.
Some advisors also charge small administrative fees for things like inactivity, paper statements, or an annual fee per account. Although small, they make a dent in your long-term investment growth. You are probably already paying your advisor enough, so you don’t need to be nickeled and dimed. And honestly, you shouldn’t be charged piece-by-piece for things that are necessary for you to be their client. If the advisor you interview knows these fees are charged by the investment broker or custodian, but can’t list them or doesn’t know what your total annual administrative fees will be – run the other way.
For perspective, trading fees at Pacesetter are typically $10 or less, we recommend mutual funds that have expense ratios that are within the low range mentioned above, and there are no additional administrative fees above our AUM fee.
What Are Your Qualifications?
Do they have any designations such as Certified Financial Planner®, Certified Public Accountant, or Chartered Financial Consultant? Advisors who have these designations must meet rigorous coursework and testing requirements. They must also meet ongoing continuing education requirements in order to keep up-to-speed on current trends, regulations, and best practices.
How long have they been an advisor? What support staff do they have? You don’t want someone with little to no experience offering you advice about your complex financial issues. You need someone who has the experience to offer you comprehensive advice the first time, or has access and resources to find the best solution to your financial issues. Sometime you may want a younger advisor who can be your one advisor all the way through retirement; however, they should have open access to supportive veteran advisors so you can benefit from both consistency and experience.
At Pacesetter, I’m the odd duck and the newbie. Because I’m currently working toward the experience qualification of the Certified Financial Planner® designation, I don’t hold an advanced designation just yet. However, I’m happy to be surrounded by a team of veteran advisors - two CPA’s and one CFP®. I can confer with them when I need counsel on a more complex financial issue.
What is Your Investment Philosophy?
Finally, you want to know your prospective advisor’s investment philosophy. If you’ve made it this far, I can hear you groaning, “Not investment philosophy! I’m not the advisor. I just want to give my money to someone who knows what they are doing.” Don’t worry, I’m gonna make this simple. You can boil investing down to 2 basic strategies: strategic investment picking or strategic investment holding.
Investment picking often goes by the name “active investing”. Advisors and mutual fund managers rely on their skill and knowledge to pick “winners” - stocks or bonds that are undervalued and are expected to appreciate faster than the larger market. The goal is to “beat the market”. Strategic investment pickers believe they can find the deals that the wider investment community hasn’t been able to uncover. That’s what you want right? You want an advisor that can pick a winner and give you the best return you can get. Unfortunately, it’s not that simple. With active investing there is more buying and selling. Because there is more buying and selling there are more trading costs, higher mutual fund expenses, and more taxes from any capital gains when selling investments. Also, picking winners isn’t as easy as it sounds. You probably fill up your car once or twice every week. You’ve got a reasonable level of knowledge as to what gas prices should and shouldn’t be. For the next month, try to fill up on the one day each week with the lowest gas price and let me know how you do. It’s just as difficult for financial advisors to pick the handful of stocks that will out-perform the market each day, month, or year.
The other basic philosophy, often called “passive investing”, is strategic investment holding. In order to benefit from total-market growth over time, you strategically buy stocks or bonds that represent the total stock and bond markets, holding those investments long-term. You’re not trying to outguess anyone or find “winners”. You’re not trying to figure out when to buy and when to sell. You’re just benefiting from the consistent long-term growth of the total market. There are fewer trades, because you don’t need to buy “the hottest new stock” each month. There are fewer mutual fund expenses, due to strategically low buying and selling. Often times, mutual funds with this philosophy will spit out fewer capital gains, so there are fewer taxes come April 15th. If you haven’t figured it out already, at Pacesetter we land on the side of strategic investment holding. In our experience and opinion, the expenses and risks involved with strategic investment picking do not offer a substantial enough (if any) reward. Also, there is Nobel prize-winning academic research that points toward strategic investment holding as the more efficient way to invest. Not to mention there’s less worry. Because you’ve positioned yourself to receive the return of the larger market, you don’t have to worry that you’ve made a “bad investment” on a “hot stock”, or a “too good to pass up” bet. You don’t have to worry that you’ve waited too long to sell, or that you’re buying too early. Every day is a good day to be in the market, because every day is a day that will add up to the total annual market return you will get in a year. At Pacesetter, we have a fiduciary duty to do what’s best for our clients, and we believe that the evidence supports a long-term strategic investment holding strategy.
Find an Advisor That’s Right for You
You want the best for your money, so go out there and find an advisor that you can trust. Use the five interview questions to find the top trustworthy advisors. Pick the one you like the best and invest for life. Grow your savings. You can become financially confident and you can have a better investment experience.
- Tim Bacus, EA