Many people are intimidated when they meet with a financial advisor for the first time because they're embarrassed about their lack of financial knowledge.
This is ironic because a lack of knowledge is the main reason they're seeking an advisor. Instead of feeling intimidated, you should adopt the same critical posture as when interviewing a contractor or a mechanic, even though you're not an expert in those fields either.
You're the consumer and you should act like one by asking probing questions to see whether an advisor is truly interested in and capable of working in your best interests. When shopping around for an advisor, put candidates to the test by asking five key questions:
1. How are you paid, and what are all the costs that would be involved in working with you? The answer to the first part of this question will shed light on the advisor's potential for conflicts of interest. Consumers need advisors who succeed by making money for their clients, not primarily for themselves. This is the rationale for the fee-for-service compensation arrangement that most advisors use.
If advisors recommend that you buy certain financial products that they then offer to provide, you need to determine whether the recommendations stem from an objective assessment of your needs or from a possible conflict of interest rooted in the sales commissions they'll receive. Not all advisors who sell products do so with a conflict of interest; their clients may actually need the recommended products for their portfolios.
Yet, if an advisor wants to sell you products, you should evaluate his or her motivation by asking additional questions, beginning with, "What are you getting out of this?"
Beyond the advisor's own compensation, find out all the other costs that might be involved from other parties — fees and transaction costs charged by mutual fund companies, brokerages and any other entity that may be involved. Costs are one of the few investing factors you can control by saying no if they're too high. To boost your net investment returns, advisors should be just as interested in helping you contain these costs. Ask advisors to write down all direct and indirect costs that would be involved in a relationship, from all entities involved. This list should include the advisor's own fees and commissions (if any).
Also ask for disclosure of any compensation received in any form – cash, services, training or office equipment – in return for arranging your investments with these companies. While you're at it, find out whether the advisor has an outside custodian for assets or handles this internally. Outside custodians can introduce checks and balances. If Bernie Madoff had had an outside custodian, his massive, chronic Ponzi scheme might have been discovered sooner.
If an advisor won't supply all of this information in writing, move on.
2. What are your qualifications?
Look for credentials that reflect knowledge of the field and, more importantly, that indicate continuous learning. These include any of various designations or certifications, such as certified financial planner.
Not all of the certifications and designations (abbreviations for them are the alphabet soup you see after their names) are professionally significant. Some are primarily for marketing purposes. Yet many of them require holders to engage in continuing education to broaden and deepen their knowledge base and expand their skill set. Holding the more credible of these titles generally reflects a goal of constant improvement and a general openness to new ideas about the best ways to serve clients.
You're looking for indications that your advisor is aware that the world is changing and that there may be better ways to do things, and is always endeavoring to improve.
Academic degrees are also positives, but they don't matter as much as advisory experience. A degree in business or economics is helpful, but not essential. If your advisor studied history but has logged 20 years as an advisor and is involved in professional learning opportunities, then you shouldn't hold his lack of a pertinent academic degree against him. Look for substantial experience serving clients.
3. How many clients do you have like me in terms of asset totals, life situations and goals? Advisors tend to classify clients in separate groups of people with common traits. You want to be in the group that comprises most of an advisor's clients. You don't want to be a one-off, because you don't want to be paying an advisor to learn on the job how to best serve someone like you. You want them to know this when you walk in the door so you can get the best service from the get-go.
4. Where do you want to take your firm down the road?
Is the firm planning to vastly expand from a boutique operation to a mega-firm with many more clients, making you less important? Or is the plan to scale down, become more boutique and jack up minimum investment requirements so high that the firm may not want you any longer? The point is to ensure that your long-term interests aren't inconsistent with or subordinated to those of the advisor.
You want an advisor with a well-articulated investment philosophy who can structure a solid, long-term investment strategy for you — one that will give you confidence in good times and bad.
This is an important area to explore, because how the advisor runs the business provides clues as to how they would run your personal finances. If advisors can't plan long-term for themselves, how can they do it for you?
5. What is your process for bringing new clients on board?
If there is none, this is a problem. If an advisor's answers fail to show a thorough process for getting to know you and learning about your assets, goals and risk tolerance, then the advisor likely won't render you good service. A desirable onboarding process might involve an extensive interview, a written questionnaire or both. Either way, there should be a lot of specific questions and a lot of listening involved, and taking notes or recording. Then the advisor should take this information and develop a specific financial plan based on your situation and present it to you with a rationale demonstrating why it's the best plan for you and your family.
If an advisor is quick to make investment recommendations, this is usually a red flag. Does your doctor write prescriptions without examinations or tests?
Good advisors should be willing to do this orientation work up front to serve you better — and they should have a well-conceived, standardized process for doing so.
Charles P. Boinske is president of Independence Advisors LLC , and has been a financial advisor serving individual investors for 25 years. A Chartered Financial Analyst, Boinske has been a featured speaker at national industry conferences and is a member of the New York Society of Security Analysts.