Many folks hesitate to seek help from a financial advisor, for one simple reason: they don’t know what they don’t know. And they have a sneaking suspicion that what they don’t know might hurt them.
Even if you’re currently working with an advisor, you may harbor some nagging doubts. After all, the reason many folks come to an advisor in the first place is that they’re unsure of how best to deal with money. The advisor clearly has the upper hand.
The following three questions should help you level the playing field. They’re simple and straightforward. Every client should ask them of their financial advisor.
Question 1: How are you compensated?
It might feel tacky or unseemly to ask such a pointed question of a respected professional, but ask it anyway. And don’t stop asking until you have a complete answer.
Financial advisors get paid in one of two ways: commissions or fees. Commissions come from providers of financial products, such as mutual fund or annuity companies. Commission-paying products are known as “load” products; they almost always carry higher internal expenses than no-load products.
Fees, on the other hand, come from the client. Generally, they’re more transparent and straightforward than commissions. The most common method of fee payment is a direct deduction from your investment account(s). Under this system, the advisor is expected to seek out lower-cost investment products for the portfolio.
Some advisors call themselves “fee-based.” That almost always means that the advisor receives both fees and commissions. A “fee-only” advisor does not accept commissions of any kind.
There are competing interests in any advisor/client relationship. Strictly speaking, the client’s interest is to pay as little as possible for the best service. But an unethical advisor might be more interested in their own compensation than their client’s well-being. Indeed, more than a few former “advisors” have spent time in prison for fraud and other crimes.
Fees imply that the advisor’s loyalty belongs to the client, whereas commissions imply loyalty to the product. But fee-only advisors aren’t conflict-free. Since they’re usually paid a percentage of the assets they manage, a fee-only advisor could be tempted to try and gather up all of the client’s money whether it’s appropriate or not.
Question 2: How much will you personally make from your relationship with me?
Knowing how the advisor gets paid is a start. Now you need to know how much. Do not shy away from this question; it’s a vital piece of intelligence that you deserve to know.
The advisor may not have a precise answer the first time you talk with them. But—and forgive my indelicacy here—by the time you’ve discussed the full scope of your project and the advisor has some semblance of a plan for you, you can be sure that they know the number. At this point, “I don’t know” is not an acceptable reply. Maybe they just don’t want you to know.
Most fee-only advisors will be able to answer this question off the top of their head: it’s probably a straightforward percentage of the portfolio they manage. (According to Investopedia.com, the national average rate is about 1% of the account per year.)
BONUS QUESTION: Do you receive free travel?
The question may seem odd, but the answer will tell you a lot.
Early in my career, various mutual fund and annuity companies flew me and other advisors to New York City (where we enjoyed a gourmet dinner and tickets to the Yankees), New Orleans (fancy hotel, food and drinks in the French Quarter), and Washington, DC (luxury box seats for the Washington Football Team).
If you think those companies expected something from me in return, you’re right. I felt the pressure, and it made me feel dirty inside. I stopped accepting such offers, and eventually they stopped coming. I felt a lot better about myself and my priorities.
These kinds of junkets have gradually died out over the years as investment product providers have evolved, but many brokerage firms still provide luxury vacations as a reward for reaching sales goals. Who pays, you ask? Sometimes those same product providers sponsor the trips; it just passes through the firm first. You deserve to know about it.
You may squirm while asking these three questions, but any ethical advisor should welcome them. If they hesitate, obfuscate, or try to change the subject, it’s a red flag. You might just want to keep looking.
This column is not intended as advice but rather education, commentary and opinion. Consult a professional advisor. If you have general questions about financial planning or investments, feel free to submit them to Andy at firstname.lastname@example.org.