Today we present the first of a two-part series dedicated to improving your financial advising experience. An improved understanding of the options available to you during the advising process will help you better determine your personal finance and wealth management program, as well as tailor the advising to your goals and aspirations.
In managing your own investments, there is a lot to know and you need to practice consistent, ongoing vigilance while avoiding emotional decisions. If you take your investing seriously, you may wish to hire an advisor to take on this responsibility. You will still manage your investments, but by managing and choosing a financial advisor; not by managing your assets on a daily basis. This way you can gain the expertise of a qualified professional and you will have someone that is watching over your financial house consistently.
Once you have decided to engage a professional to help you manage your assets, you need to have a framework to help you make the decision about who to hire. You have a wide variety of choices, and it is important to understand some of the subtle distinctions that could have a big impact on your investment portfolio, your long-term wealth and your relationship with your advisor.
In order to assess the advisors that you are considering hiring, here are the top 5 questions that you should ask! We present the top-3 questions today and will continue with the second and final part on Friday, January 26th.
1. Are you a Registered Investment Advisor or a Registered Representative of a Broker-Dealer?
Retail Brokers
A retail broker acts as an agent for her firm. This is important, because even though you are a customer and the broker may be trying very hard to provide you great service, a broker’s legal responsibility is to the firm. When you open a brokerage account, the broker is not held to the standards of the Investment Advisers Act of 1940. Therefore, it is not required that the broker disclose any conflicts of interest with your account.
You should be aware that a broker is typically limited to selling investment products approved for use by the firm. The broker will further be incentivized to sell certain products and will therefore be compensated more for selling those products than other products. And, a broker is incentivized (through better compensation) for producing more trades.
Independent, Fee-Only Advisors
In contrast, an independent fee-only advisor is legally required to act as a fiduciary to their client. This means that they must put their client’s best interests first as well as disclose any conflicts of interest.
Generally, independent fee-only advisors will calculate their fee based as a percentage of the amount of money that they manage or advise for you. The compensation should be described in a straightforward and visible fashion. Also, an independent, fee-only advisor does not receive compensation from any of the investments that are recommended to you. Nor does she receive compensation from executing trades between investments. These potential conflicts of interest have been eliminated.
An advisor will also help you with broader financial decisions, such as helping you to decide when to retire, answering estate planning questions and helping you plan for children’s or grandchildren’s college educations.
If these issues cause you some concern (and they should!), you will want to verify whether you are dealing with a broker or an independent investment advisor. As easy as that sounds, it is not always as easy in practice! A broker may call himself any number of names from financial advisor to financial consultant to a title containing the word independent. The best way to clearly identify a broker is to ask if they are a “Registered Representative”. If so, they are a broker and are not truly an independent advisor.
If someone is an independent advisor, they are a “Registered Investment Advisor”. You should receive a document from them called an ADV, which outlines all the practices of the firm as well as information on the individual that you are meeting with. The current regulation requires that an investment advisor provide you Part 2A and Part 2B of Form ADV. Don’t just set it aside! This document tells you all about the firm and the people.
With these distinctions in mind, you will want to exercise far more caution when considering a Broker-Dealer. You may choose to work with only an independent fee-only advisor to insure that your best interests are always central. This brings us to the next question.
2. Will you act as a fiduciary, by putting your client’s interests first?
A Registered Investment Advisor, is by law, required to act as a fiduciary on your behalf. This means that the advisor will use his best efforts to act in good faith and in the best interest of the client. The advisor does not receive any compensation that is dependent on any client’s purchase or sale of a financial product. The advisor also does not receive any compensation for executing transactions within the client account.
3. Will you provide a written agreement outlining services and the fees?
You will definitely want to have a written agreement that outlines what services the advisor will (and will not) provide, as well as what the fees are. An agreement should also state how the relationship can be terminated. There may be other disclosures included here as well.
You will also want to clarify whether there is a minimum fee. This will ensure that there are no surprises.
Check back in with us Friday, January 27th, for the final two questions you should be asking your financial advisor today, including the important considerations of compensation, asset custody and more. In the meantime, what are some important questions you’ve wanted to ask your advisor?
