Your financial advisor plays a significant role in how your financial future and, to some extent, personal happiness will play out in the years ahead.
Given the influence they bear on your life, you might think it important to understand what drives the decisions they make. But if you’re like most folks, you probably don’t.
Fortunately, finding out what motivates your financial advisor isn’t that difficult. With the three simple questions that follow you’ll get a little closer to understanding how your finances are being handled and if their choices are based on your future happiness and not just theirs.
1. How do you get paid?
Understanding how your financial advisor gets compensated is important as it can affects the rules they must adhere to and the advice they might offer.
There are a few different payment schemes with the two broadest (and most common) categories being commission-based and fee-based.
Commission-based advisors charge you a fee every time you add money to your account or buy or sell a product. A very traditional payment model, this method works great if you are taking a buy-and-hold approach and don’t need much in the way of ongoing advice. However, if your advisor is recommending moving your money around on a regular basis, you might want to reconsider the advice or even the relationship as the only person adding to their account in that scenario is the advisor.
A fee-based advisor typically doesn’t charge any commissions based upon transactions but instead charges a set percentage fee based on the assets being managed. Since the advisors compensation is based upon the account value, you both have the same goal: making you money.
The potential downside to this approach is that over time and depending on the percent fee being charged and how much proactive advice is being offered, the annual fee may end up being more than a one time commission up front.
2) What fees will I pay?
Ah, the hidden fees of financial management. A friend once described the cumulative effect of fees as like “being pecked to death by ducks”. I would modify that analogy slightly to “being pecked to death by invisible ducks” as most of us never see them coming but we sure feel them.
The reality is all investment products (mutual funds, ETF’s, annuities, etc.) have some sort of internal expense associated with them. While they’re all listed in each product’s prospectus, most investors don’t read them. However, a forthright advisor will openly share with you what the true cost of each investment is and how any associated fees may or may not impact your potential gain. Nonetheless, ask for this information in writing and clarify that the document you receive represents ALL potential fees.
3) What is your approach to investing and what specific services can I expect?
While it might sound like a “fluff” question, this one’s important. You need to be absolutely clear that you understand their investment approach is. Is it based on buy-and-hold, tactical rotation based upon the calendar quarter, or is it based on some other style? Do they use individual stocks and bonds, mutual funds, ETFs, or other products on a regular basis? Do they focus on financial planning and less on portfolio management or vice versa? A good advisor will be able to quickly and thoroughly articulate their style and give you a sense of ‘fit’. But just to be sure, ask for this information in writing and be wary of anyone who shies away from answering your questions.
While these three questions alone won’t ensure your financial future entirely, they can go a long way to helping you choose and stay with the right financial planner.