Broker Check

What You Must Know About Your Financial Advisor

January 05, 2016
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When hiring a financial advisor, it’s important to do your due diligence. Investors usually don’t know what questions to ask because the industry is so complex and highly regulated, so I’ve listed them here for you. 

For questions 2-6 below, you can get independent verification of your advisor’s public record by checking the FINRA (Financial Industry Regulatory Authority) website. Just click and type in the advisor’s name.

It might take some extra time to find a competent financial advisor who has the “right stuff”, but it’s time well spent. It’s essentially a process of elimination. Here are the questions to ask, any one of which is significant enough to eliminate the advisor from contention:

  1. Are you a fiduciary?

A fiduciary is a financial advisor held to a higher standard than the typical salesperson who is commonly an employee of a bank or brokerage firm. Fiduciaries are financial advisors required by law to act in your best interest. If your advisor is not a fiduciary, then he is not required to act in your best interest, and should be eliminated from your list.

  1. Do you have a clean regulatory history? Do you have any client complaints?

Read carefully the nature of the complaints called “Disclosures” on the FINRA website at filed against your advisor. No complaints is obviously best. If complaints are listed, read them. Do they sound serious or frivolous? Ultimately, you’ll have to decide whether you are comfortable working with an advisor with complaints.

  1. In the past 10 or 15 years, how many times have you (the advisor) switched broker-dealers?

They say a rolling stone gathers no moss, but frequent broker-dealer changes can be trouble. Frequent switching can signal instability and hidden problems. Two or more broker-dealer switches in the past 10 years is reason enough to eliminate this advisor.

  1. Who is your securities broker-dealer? How many financial advisors nationwide are associated with your broker-dealer?

By the way, a securities “broker-dealer” is a firm the advisor chooses to oversee the compliance and back-office functions of his securities business. Sometimes the advisor’s securities broker-dealer will take physical custody of your assets. (More on that later). If the advisor’s securities broker-dealer has fewer than 500 fiduciaries nationwide, then I’d eliminate the advisor. Broker-dealer size is an important indicator of strength and stability. Also, it would be wise to look up the broker-dealer on Google and review its financial statements even if it has over 500 advisors.

  1. How many years have you been an advisor?

I wouldn’t take a chance with any advisor who has less than 10 years’ experience. You want to find a seasoned financial professional who has survived the test of time and is still in business. Otherwise, eliminate them.

  1. Do you hold a valid Series 7 license in my state?

Your advisor must absolutely hold a valid Series 7 license. Otherwise, he will not be licensed enough to offer you a full-spectrum of tactical and strategic investment solutions. No Series 7, eliminate the advisor.

  1. Do you have a Series 7 securities license and a valid Insurance license in my state? Are you dual-licensed? Do you work with an Insurance Marketing Organization?

Your Series 7 securities advisor should hold a valid insurance license in your state; otherwise, he will not be able to offer a full-spectrum of insurance solutions to meet your long-range goals and then be able to integrate them smartly with your investments. Insurance solutions can include life insurance, annuities, disability, long-term care and many other related products. If your advisor doesn’t hold both a Series 7 and an insurance license, then you should find one who does.

Just as a Series 7 licensed financial advisor joins a broker-dealer organization to support his securities business, he can join an Insurance Marketing Organizations (IMO) to support his insurance business. IMOs are important to you because they help advisors sort out which insurance products will best fit your needs. The best IMOs help advisors compare and rank insurance solutions from among dozens or even hundreds of options nationwide, and then produce illustrations the advisor can use to explain which policy is best for your needs. Eliminate the advisor who does not have a valid insurance license and is not supported by an IMO.

  1. How are you compensated? How are your fees calculated?

Advisors should be 100% transparent when it comes to explaining fees and how they collect them. After hearing the advisor’s initial explanation, probe a little deeper: 1) Do you post your fees on your website? 2) Do you have a minimum fee? 3) Does your fee include comprehensive financial planning? 4) Do you have any financial incentives to recommend certain products?

Find out if your advisor recommends certain products because a third party investment company helps pay marketing expenses which may not be in your best interest.

Generally speaking, a reasonable management fee is about 1.25%. Fees can run slightly higher if the advisor pays account and transaction costs and ongoing financial planning support. Naturally, fees should go lower as more assets are added to the account.  

  1. What firm will take physical custody of my assets?

I wouldn’t allow an advisor (or his firm) to take custody of my assets. (Remember Bernie Madoff?) Separation of assets is the best way to go. For example, if Advisor A works with ABC Wealth Management, make sure this company holds your assets away by a custodian you know and trust such as Fidelity Investments or Charles Schwab. Ask if your custodian will be printing and sending your monthly and year-end statements. If not, that’s a huge red flag. Eliminate the advisor whose firm takes physical custody of your assets.

  1. Who actually places the trades in my portfolio? Or, do you farm out my assets to third party manager(s)?

If the advisor farms out your assets to third party manager(s) and/or mutual fund companies, then you are likely paying hefty fees—because you are paying both the advisor and the third party manager(s)—essentially paying twice. This can cost you as much as 4 or 5% per year. Even worse, fees from mutual fund companies are typically hidden from view so you may be fooled into thinking you’re paying less, but you’re not. If the advisor wants to farm out your investments, I’d eliminate him from the list.

  1. If you (the advisor) are responsible for making the investment decisions, what types of investments are you going to recommend?

The answer you want to hear is low-cost investments such as index funds, Exchange Traded Funds (ETFs) and/or individual stocks and bonds. Again, if the advisor says traditional Mutual Funds or third party managers, he’s farming out your assets. You don’t want to be paying twice. Eliminate this advisor.

  1. What is your investment discipline? Can you explain it? What methodology do you use to make buy and sell decisions? Have your portfolios performed well?

Carefully observe how the advisor answers this question. Does the advisor have a cohesive, objective discipline? Does he have take-home materials that can be studied? His methodology must be clear and highly compelling. How has the portfolio performed over the past 5, 10 and 15 years? How did the portfolio perform when the market crashed? Can you handle a downturn of that magnitude? Then, ask this question…

  1. Do you typically stay invested in the market through its ups and downs, or do you have a specific buy-sell strategy which dictates when you get in and out of the markets?

In other words, does the advisor have a real buy-sell strategy or is he winging it? To answer this question the advisor should be able to show periods of time when he was in and out of the market. Look at the specific dates and how he performed. Did he make the right calls more often than not? If that cannot be determined, then you don’t have the necessary data to make an informed decision, so eliminate this advisor.

  1. Do you have a clear and concise financial planning process?

The advisor should be able to break down the planning process into fun and easy steps. Go to the advisor’s website and look at his financial planning section. Do you see a well thought out, step-by-step process? Has he made financial planning a priority? Does the advisor offer planning courses in which you can participate? If not, eliminate this advisor.

  1. Do I like the advisor? Is he/she someone I can work with?

If your advisor hasn’t been eliminated yet, then you may have found your needle in a haystack. This advisor has all the opportunity to become a very valuable resource to you and your family. However, the final questions are ones you must ask yourself. “Is this someone I can work with? Is this somebody I can trust? If your gut says “yes”, then I’d go for it.

For more information, contact Charles F Farrell at 888.657.3847 or leave a message in our question box.

Charles Farrell is President and CEO of Newport Capital Advisors with branch offices in Orange County, California: 1) Near Fashion Island at 23 Corporate Plaza Drive, Suite 150, 92660 and 2) Near the Irvine Spectrum Center at 9870 Research Drive, Irvine, 92618. The opinions expressed are those of the author and should not be construed as a recommendation of any specific security, strategy, or investment plan. Past performance does not guarantee future results. All investments involve the risk of potential investment losses and no strategy can assure a profit.