Ask These 4 Questions First If You Are Considering a Financial Advisor

by Jessica Sommerfield · 2 comments

Navigating investments, retirement, taxes, or estate planning on your own can be overwhelming, which is why many people choose to hire a financial advisor. An experienced financial advisor can be an ally in maximizing your current assets and reaching future goals.

But before you entrust your personal finances to one, it’s important to do your homework. If you’re in the process of considering a financial advisor, start by asking the following questions.

1. Do You Even Need a Financial Advisor?

Seeking out expert input on your financial situation is wise, especially with so many Americans under-prepared for retirement and loaded with student loans or consumer debt. But, just like any service, financial advice from a professional comes at a cost.

Before you hire someone, consider whether you’d do just as well drawing from the wealth of do-it-yourself tutorial websites and software tools available. Self-education is a sure way to engage more fully with your finances, and you’re the one most motivated to look out for your best interest.

If you’re not up for number crunching (even with automatic calculators), have a financially-complex situation, are hitting an important life milestone, or just know you lack the discipline to manage your finances responsibly, hiring a financial advisor is better than failing to take care of this important area. If this is you, the next questions can help you choose the right one.

financial advisor2. What’s the Pay Structure, and Can They Guarantee Fiduciary Loyalty?

Many people have a “guy” for investment decisions, but many wouldn’t even know how much their “guy” is costing them versus profiting them. There are two basic pay structures: fee-based and commission-based.

Fee-based advisors charge you up-front to create a financial plan or provide other services, while commission-based advisors make money when they sell you products affiliated with their employers or partnering companies (maybe an annuity or insurance plan). Essentially, they’re a salesman. Between the two, many experts recommend choosing an advisor who is strictly fee-based for more confidence that their recommendations are based on what’s best for your situation — not their own wallet.

Fiduciary loyalty means an advisor is bound to managing your entrusted assets in a way that always places your best interest first. Ask a prospective advisor if they can guarantee this. If they can’t, it’s a bad sign.

3. Do They Prefer Passive or Active Management?

With investments, advisor fees can also be affected by the type of management they prefer to recommend. Passive management follows a major stock or bond index and charges as low as 0.05% of your investment in fees, while active management involves hand-picking stocks based on performance. With this style, fees are higher (more hands on, more money — makes sense, right?). In the short-term, active management might yield greater returns, but keep in mind that, with higher fees and higher taxes, the net profit is lower than it looks.

David’s Note: We recommend index funds for pretty much everybody because in the long run, passive investing is very tough to beat, especially when you consider that the time people spend picking stocks can be better spent making money. There’s always push back because in the short term, plenty of people outperform the markets, but we will keep trying to convince the masses because low cost index investing works.

4. Is the Company a Robo-Advisor or Real Advisor?

Robo-advisors are online companies and services like Betterment that use advanced algorithms and risk profiles to provide financial advice. In recent years, they’ve become popular because they’re cheaper and more do-it-yourself. Some also consider them more error-proof than a personal advisor.

Robo-advisors have their place: if you’re a newbie investor with small assets, they’re a good place to start. At the same time, machine-generated algorithms lack the ability to take your full financial situation into account, help you set goals for the future, or provide personal reassurance in the face of a market downturn. If you need a customized financial game plan, a real-person advisor is the way to go.

There are certainly more questions to ask when considering a financial ally. What questions would you add to this list?

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  • Arminius says:

    I have a good amount of money in a few different bank accounts in Newport , R.I. and North Palm Beach , Fl . Over the years the various banks said I should sit down with one of their ” investment advisors ” and he/she would show me how to get a higher return on my money . The first time I sat down with the ” investment advisor ” , he recommended an annuity . The problem is that they take quite a large percentage of your “investment ” right off the top . So I declined . A year or two later another bank suggested I once again sit down with their ” investment advisor” , who again recommended an annuity . Then about 2 or 3 years ago another bank here in Florida again suggested ..” investment advisor ”
    He asked me a lot of questions and during the next hour I mentioned to him that the other banks advise was that I purchase an annuity and I though considering my age , it was a RIP OFF . After about another 15 or 20 minutes , what did he recommend …………an annuity . How do you spell …. C O N A R T I S T ? Never again .

  • Ajay Pruthi says:

    Hi Jessica

    Great Article. One more thing to add regarding active or passive management

    Are they churning your portfolio too much? This is one thing where advisors earn a lot of commission.

    I have seen few people who had invested at the right time but still did not earn much because of portfolio churning, though markets being all time high at this point of time.

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