8 Questions to Ask a Financial Advisor
Finding a financial advisor is a lot like shopping for clothes online. There are plenty of websites to order from, but you may not know the exact fit until after you make the purchase.
While finding the perfect pair of jeans at a bargain price is an important endeavor, I’d argue that it’s even more important finding an advisor that aligns with your unique needs and preferences.
It’s important to know exactly what you’re getting when it comes to working with a trusted professional to help you with your finances.
Consider asking these questions when you start your search for your own financial advisor.
1. Are you a fiduciary?
A fiduciary advisor, simply put, must always act in his/her clients’ best interest. This means always putting clients’ needs before the needs of themselves and their businesses. Furthermore, fiduciaries must seek to eliminate conflicts of interest and disclose them to clients if conflicts exist.
Makes a lot of sense, right? So, isn’t every financial advisor acting in their clients’ best interest? Not necessarily.
Only 2% of financial advisors are fiduciaries
Only 2% of financial planning firms in the US are true, fee-only fiduciaries and legally required to always act in the best interest of their clients, according to the Wall Street Journal.
As an example, consider a married couple thinking about buying a vacation home, and they can fund it with a loan or with part of their retirement savings managed by an advisor who charges a percentage of their portfolio.
A non-fiduciary advisor would be incentivized to dissuade these clients from pulling money out of their account in order to make this purchase because the advisor would get paid less as a result (less money in the account = less money the advisor can bill on).
A fiduciary advisor, on the other hand, would acknowledge this conflict and advise his/her clients on the decision that is in their best interest even if that means recommending withdrawing money from the account he/she manages.
A direct way to determine if an advisor is a fiduciary is to simply ask if he/she signs a fiduciary oath with every client he/she works with. Additionally, advisors that have the CFP® designation are required to act as fiduciaries when working with clients on financial planning.
The benefit of knowing whether your advisor is a fiduciary or not is to help you understand how they make recommendations with your financial plan and investment strategy.
Learn more about what it means to be a fiduciary.
2. How are you paid?
This is a fun one. Advisors may all look similar on the surface, but how they are compensated can vary widely depending on how they run their practice. This often aligns with whether your advisor is independent or affiliated with a bank, insurance company, broker/dealer, or other product provider.
There are three main ways in which advisors are compensated, and it’s worth asking which bucket they fall into:
Commission-Only
Commission-only advisors are compensated for products that they sell their clients. If a client opens an account with a commission-only advisor, they will likely pay a commission (or sales charge) on investments, annuities, insurance, etc.
The downside to this method is that there is no real incentive for the advisor to continually manage your investments, or worse, they are incentivized to encourage you to make decisions that may result in another commission that might benefit them more than you.
These folks are considered “brokers” rather than “advisors.”
Fee-Based
The vast majority of financial advisors in the U.S. are fee-based. This means that, while they can charge you a fee for advice (or a percentage of your asset base), they can also sell products for a commission.
These advisors often charge on a percentage of your assets in an investment account and may recommend insurance or annuity products on the side for a commission, as well.
Like commission-based advisors, they can also earn referral fees or kickbacks by recommending certain products or other professionals to you.
Fee-Only
Fee-only advisors are the gold standard when it comes to delivering financial planning and investment advice aligned with the best interest of the client.
These advisors are only compensated by their clients. In other words, they do not earn any commissions on products, nor do they receive compensation to refer clients to any investment or other professional. Simply put, the only money they make is earned directly from clients for advice.
You can see how this setup reduces conflicts of interest. In a lot of ways, these advisors are on the same side of the table as their clients and offer advice that best serves their long-term needs.
These advisors will either charge a percentage of your assets invested or a flat fee for advice or a combination of both. In most cases, these folks are independent and unaffiliated with product providers.
This means that they can often provide you access to a huge variety of investment options and they are not tied or otherwise incentivized to offer you specific products that might not be the best fit for you or your situation.
3. Do you have account minimums?
Most fee-based and fee-only advisors impose account minimums on new clients, meaning, if you want to work with these advisors, you have to have a large enough account size.
These minimums vary widely and can exceed $1,000,000 in assets, though a typical account minimum is around $500,000.
The truth is, there is a lot of work involved with bringing on new clients, and many advisors want to ensure that the work is worth their time. It can be insightful to ask an advisor if he/she imposes an account minimum and why they’ve come to that decision.
We at Cove Financial Planning believe that your account size doesn’t define the help that you are entitled to. We think everyone, regardless of net worth, income, and investment experience deserves high-quality, objective advice.
We’d even argue that investors that do not have “substantial wealth” can actually get the most value from a comprehensive financial plan and investment strategy.
4. What credentials do you maintain?
There are hundreds of credentials in the investment world with varying education, examination, and ethical requirements. In all honesty, a lot of them don’t mean much and can be earned by taking a quick test online and paying an annual designation fee.
It’s worth learning about an advisor’s credentials and the requirements for earning and maintaining them. Consider asking what the credential means, what the exam was like, and if there is a continuing education requirement wherein the advisor must seek out learning opportunities to maintain the credentials.
If you are seeking a financial planner, consider the CERTIFIED FINANCIAL PLANNER™ (CFP®) as good as it gets. As a CFP® Professional, I am of course biased, but keep in mind the requirements necessary to earn and maintain the designation:
An undergraduate degree
3+ years of client-related financial planning experience
Completed comprehensive financial planning education including:
General Principles of Financial Planning
Insurance Planning
Investment Planning
Income Tax Planning
Retirement Planning
Estate Planning
Behavioral Finance and Interpersonal Communication
Professional Conduct and Fiduciary Responsibility
Pass rigorous 6-hour exam (historical pass rate of 55-60%)
Complete continuing education requirements of 30 hours biannually
Adhere to strict ethical standard outlined in CFP® Board’s Standards of Professional Conduct
Visit the CFP® Board Website to learn more about what makes CFP® Professionals different
Additionally, advisors who have the Certified Public Accountant (CPA) designation have gone through rigorous exams to be knowledgeable in several areas of tax planning.
Likewise, those with the Chartered Financial Analyst (CFA) designation have taken an enormously deep dive into investment analysis. Both are credible designations along with the CFP®.
Related to credentials, it may be insightful to ask your advisor about his/her past work experience. Consider inquiring about how long they’ve been in the business, and how their past experiences have shaped the way they work with clients today.
5. What is your investment philosophy?
This question more or less gets at how the advisor views the markets and implements investment portfolios. An advisor’s response can tell you about the potential cost and makeup of recommended portfolios.
Specifically, ask about whether or not they believe in “active” vs. “passive” investing. There’s no wrong answer, but you want to ensure their philosophy aligns with your own. The following is a summary of both investing styles:
Active Investing
Active investing typically involves a portfolio manager whom performs detailed analysis and security selection within a fund in attempts to beat a benchmark such as the S&P 500 index.
Active investments are often packaged up into mutual funds, which is simply a basket of securities managed by a portfolio manager. Advisors who adhere to an active investing philosophy will likely seek out mutual funds for client portfolios.
According to Morningstar, the average equal-weighted cost of an actively managed U.S. equity mutual fund is 1.10%.
That’s all fine and good if investors are getting value for the relatively high cost of these investments. In early 2019, however, CNBC reported that 85% of large cap mutual funds underperformed their benchmark, the S&P 500 index, after the last 10 years, and a whopping 92% lagged their benchmark after the last 15 years.
Talk about neither having your cake nor eating it too. Investors are quickly realizing that they can get exposure to broad asset classes in a diversified portfolio at just a fraction of the cost through passive investing.
Passive Investing
If history tells us that active investors (and mutual funds) typically cannot beat their benchmark index, then why not just purchase the index (at an ultra-low cost)? This is exactly what passive investing entails.
Instead of an investor paying around 1% for a mutual fund with a portfolio manager making buying and selling decisions, a passive investor simply buys the index that the portfolio manager is trying to beat.
These investments are typically referred to as Exchange-Traded Funds (ETFs), and are offered by some of the largest investment companies out there such as Vanguard and BlackRock (iShares), for example.
According to the National Association of Plan Advisors, in 2018, the average equity ETF had an expense ratio of 0.20% and the average bond ETF was at 0.18%, just a fraction of the price of an average mutual fund.
These ETFs will often own many of the same underlying stocks, bonds, etc., but there will be far less turnover. In other words, the ETF does a lot less buying and selling than an active mutual fund which results in a lower overall cost and a lower tax bill, on average.
Advisors who adhere to a passive investment strategy will build diversified portfolios at a much lower cost using ETFs rather than mutual funds.
6. What are your services?
When seeking out a financial advisor, you’ll want to consider if you want or need comprehensive financial planning services or if you simply need help with investment management.
Ask your advisor about the services he/she offers and if there is any extra cost for one over the other. If they offer financial planning services, make sure you understand what the analysis and recommendations include. If you are asking a CFP® Professional, he/she will generally provide advice on the topic areas listed in part 4.
Furthermore, consider asking about sample financial plans or Investment Policy Statements (IPS). If your advisor offers to show you a sample plan, you will have a very clear idea as to what your own plan might look like, or at least the topic areas covered.
You could also ask to view a tutorial of their financial planning software for similar insight into their planning approach. Similarly, seeing an example Investment Policy Statement will shed light on how your advisor approaches risk profiling, asset allocation, diversification, and overall investment strategy.
Both are helpful in determining a good fit and ensuring you’ll be getting your money’s worth.
7. Do you operate alone or on a team?
This question is worth asking if your advisor is independent and unaffiliated with a bank, broker-dealer, or insurance company, as the latter advisors will almost always work on a team.
There are pros and cons of independent advisors operating in a team.
The benefit of an advisor on a team is that there may be some specialization happening among team members. A paraplanner on the team, for example, may be very efficient at gathering data for your financial plan and a client service administrator may be an expert with paperwork, which can help with efficiencies.
The downside is you will likely be dealing with several people on your advisory team, and you can only hope they are operating at a level in which they are all on the same page about your plan, investments, and overall experience.
There are also pros and cons of your advisor operating solo.
One benefit is that you can rest assured that you will have a very consistent experience always working with the person (your advisor) who understands every facet of your situation and has been involved in every stage including onboarding, data gathering, plan building, implementation, review meetings, etc.
Additionally, when you call your advisor, you will get him/her on the line directly and won’t have to play phone tag with an assistant or other team member. Importantly, you know that you’ll be speaking with someone who truly understands your situation and can provide direct and immediate advice.
The downside of working with a solo advisor, however, is the risk of him or her getting hit by a bus. Jokes aside, it’s more likely your advisor will retire at some point, and it’s your right to understand how your relationship will be managed if he/she is no longer in the picture.
Consider asking a solo advisor about his/her business continuity or contingency plan if unexpected disaster strikes.
8. What can I expect in working with you?
Before you purchase a new car, it makes sense to take it out for a test drive, experience what it’s like to own it, and understand what services/repairs might be included through the dealership.
Likewise, before agreeing to work with a financial advisor, it’s important that you understand and are 100% comfortable with how you will work with that person and what to expect throughout the engagement.
Ask your advisor if he/she has a sample client roadmap and/or summary of topics covered through financial planning. A roadmap can provide insight into what you can expect with frequency of meetings and areas of conversation throughout the year which, ideally, will be tailored based on your needs and preferences.
From an investment management standpoint, be sure to ask about how you can view your portfolio holdings, performance, and analysis online. It’s not fair to wait until your next quarterly statement comes in the mail to learn how your portfolio is performing and what changes are being made.
At the end of the day, it’s important that you are comfortable and confident with your advisor. Personal finance is a sensitive and important topic, and you deserve to find someone who naturally aligns with your unique needs and preferences.
Asking these questions can help you find the right partner in helping with what’s most important - achieving your goals!
Are you ready to talk with a fiduciary, fee-only advisor? Reach out to me at Ben@coveplanning.com or schedule a free consultation call.
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Ben Smith is a fee-only financial advisor and CERTIFIED FINANCIAL PLANNER™ (CFP®) Professional with offices in Milwaukee, WI, Evanston, IL and Minneapolis, MN, serving clients virtually across the country. Cove Financial Planning provides comprehensive financial planning and investment management services to individuals and families, regardless of location, with a focus on Socially Responsible Investing (SRI).
Ben acts as a fiduciary for his clients. He does not sell financial products or take commissions. Simply put, he sits on your side of the table and always works in your best interest. Learn more how we can help you Do Well While Doing Good!
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Ben Smith, and all rights are reserved. Read the full Disclaimer.