While the trend towards individual investors managing their own portfolios continues to expand thanks to low-cost methods such as exchange-traded funds (ETFs),”robo-advisors”, and discount online trading, there is still value in using a financial advisor.
A 2014 study commissioned by mutual fund manager Vanguard, the 9-million-pound gorilla of low-cost investing, determined that investors who used a financial advisor typically outperformed their DIY peers by about 3% over a seven-year period.
Is this a gigantic margin? No. But it’s significant enough to notice and discuss.
While my discussion of the merits of using an advisor is blatantly biased (I’ve been in the trenches as an financial advisor for over 20 years), I would venture a guess that I am qualified to talk about relevant questions to ask during an initial meeting. I could list a thousand. However, for time’s sake, let’s stick with five solid ones.
1. How long have you been in the business?
This isn’t an age discrimination question. It’s a market cycle question. I don’t doubt that there are plenty of twenty- and thirty-something advisors who can effectively explain and execute proper asset allocation, retirement income analysis, and any other technical function that requires technological interaction. But chances are they’ve never seen a nasty bear market.
The Tech Bubble burst, 9-11’s ensuing bear market, and the Financial Crisis of 2007-2008 were times that tried men’s souls. I was there. I know. Besides technical knowledge, an advisor, like the captain of a ship or an airline pilot, must instill confidence and calm during a storm or turbulence. A little snow on the roof (or chrome on the dome) is a sign of stripes earned. A financial advisor with 10 years or more of service is probably a safe bet. They’ve obviously “made it” in the business and have been around the track a few times.
Now, if you’re interviewing a young advisor who is on a team led by a senior advisor, that’s a little different. You’ll probably want to meet the senior FA as well.
2. What’s your investment philosophy?
Any financial advisor worth their salt has one. If you’re recommending investments, you’d better have some overarching philosophy. They should be able to clearly articulate how they are going to manage your money if given the opportunity. It should start with a broad or macro statement and then funnel down from there. It should also be easy to understand and relatively jargon-free. Many advisors will make that mistake and throw out terms like “alpha”, “beta”, “risk adjusted”, or “efficient horizon”. Even the smartest clients won’t understand unless they work in the business themselves.
3. How do you get paid?
With the emergence of the Department of Labor’s fiduciary rule concerning the responsibility advisors have in managing their clients’ retirement funds, the asset-based fee versus transactional commission debate has only increased. Today, many advisors have gravitated towards asset-based fees. However, transactional fees continue to compress and often times are in line with some asset-based management fees. If an investor is exploring an actively managed, equity-focused strategy, a fee-based program makes sense. If you’re looking at a laddered bond portfolio where bonds are held to maturity, fees make absolutely no sense whatsoever.
4. How do you manage portfolios in a down market?
Again, the answer to this question will reflect an advisor’s experience in challenging market conditions. Yes, investors should operate with a long-term mindset. But risk always must be managed. The best way for an advisor to manage money in a down market is to have sell discipline before things get ugly. Has a stock reached its price target? Are valuations looking stretched? There’s nothing worse than having impressive gains cut down by a market correction while an unsure advisor parrots the “stay the course” company line. Sometimes you have to take evasive action.
5. How is your personal money invested?
I am a firm believer in eating our own cooking. If an advisor touts a certain managed portfolio, is he invested in it? Or is he or she sitting in cash while clients are 100% invested? Warren Buffett and many, many more world-class money managers roll this way. Financial advisors should, too.
Today, thanks to the internet and the Financial Industry Regulatory Authority (FINRA), investors can get a snapshot of their advisor or prospective advisor’s work history through BrokerCheck, which is accessible through www.finra.org. BrokerCheck provides a summary of an advisor’s employment history, licenses, as well as disclosures regarding disciplinary and regulatory actions. Typically, most disclosures deal with customer complaints.
Do you bring it up in the meeting? Good question. If an advisor has been in the business 25 years or more and has one ding on his record, chances are he’s a pretty good egg. 10 years in the business with 4 or 5 dings? Bring it up. They can tell the truth or not get a new client.
While the financial advice industry receives frequent vilification due to a few bad actors, the majority of people in our industry are honest, highly skilled professionals. Rigorous, upfront honesty should be the foundation of any successful relationship. The financial advisor/client relationship is no exception and, like any relationship, the burden of honesty falls on both parties.
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