For many of us, we know we need to be saving and investing for retirement, children’s education expenses, and other short- or long-term financial goals, but we do not feel comfortable making investment decisions on our own.
This is where an investment advisor can help – but how do we choose an advisor with whom to work? How do we know this person will prioritise our best interests over generating fees for themself?
The truth of the matter is that we do not know this off the bat, and sometimes we have to start working with an advisor and build up trust over time. For such an intimate relationship, we need to be diligent through the decision process to ensure we select the right individual to entrust with so many personal details.
This article explores a protocol that can help as a guide through this important life decision.
A good starting point is asking friends, family members or colleagues if they would recommend their advisor, and why. The crucial element of the advisor-investor relationship is trust; without trust, investors will not feel confident that they are on the path to achieving their financial goals, and it will be a tumultuous ride for both parties. Asking for a recommendation from a like-minded individual may get you a step closer to finding an advisor that you trust. This is not always the case, but it can be a starting point.
The next step – and the most important – is to interview several advisors to see if you have a personal connection with them (this is important because this is someone you will be working with over a long period of time) and to ask some key questions to get an idea of how they run their investment business. When we say interview, we mean interview. Do not be scared of asking tough and difficult questions. Ask the advisor of any client complaints, ask them of performance losses. If asking such things face to face feels a little uncomfortable, send them questions to complete in writing and then discuss the answers in the interview.
Now, back to the personal connection, which is so vital. This will be discovered organically over time, but it can be accelerated with the right catalyst – in this case through some exploratory questions posed during the interview process. Below, we go through several of these questions, and what we should be on the lookout for in an advisor’s responses. These questions are not all-encompassing but serve as a starting point for those looking for direction in choosing an advisor.
You will, of course, also want to learn about the individual’s experience, education and credentials.
What is your approach to investing?
This response will give insight into how an advisor makes investment decisions, handles risk and manages portfolios. This answer can incorporate a lot of financial jargon that you may not fully understand. Ideally, the advisor will discuss a comprehensive wealth plan to meet your long-term investment goals and risk tolerance, which will be reviewed and modified as you go through various life stages.
You need to drill down into this response to get a good understanding of what he means by his version of financial jargon. For example, how would a “comprehensive wealth plan” (insert whatever term he used) benefit me?
Get more detail on the specific type of securities the advisor manages. Will you be placed in one of just a few generic portfolio models that the advisor runs for his clients, or will you have a custom-built portfolio, targeted to your exact goals?
Customisation is not always necessary, and can come with additional costs, particularly if your goals are straightforward; but the more complicated your individual financial situation becomes, the greater the need for a custom model. Ask what type of clients the advisor typically works worth to determine if they will be able to provide advice appropriate for your circumstances.
It’s a red flag if the advisor focuses mainly on beating market performance. You want someone to be focused on meeting your specific financial goals. Focusing solely on performance tends to lead to taking undue risks, which may not be in line with achieving your long-term goals. Also be wary about people who say they “beat the market”. See what performance benchmark they are using and consider if it is appropriate.
How do you charge fees?
There are a lot of ways that advisors get paid. They may charge commissions per trade, a percentage fee on total assets invested, performance fees, or their firm may pay them a flat salary.
Ask about trading costs, and whether these are all-encompassing in the quoted fee schedule. They may also have flexibility to charge differently on different types of investments. There is no one right answer, but it is important to understand how you are being charged. Comparing fee structures across the advisor interviews can give you a gauge on whether each is charging fairly. Fees should not be the primary driver of this decision, but it is certainly an important aspect.
You should also ask if there are any additional fees embedded in the underlying securities that they would purchase for your portfolio. Exchange-traded funds (ETFs) and mutual funds have internal expense ratios, and some funds may also have front- or back-end fees associated with them. Some securities may have a spread baked into the offer price.
Ask the advisor for full transparency around all fees included in their recommended portfolio, and if there are any penalty charges for exiting a security within a specific timeframe. The advisor likely will not be recommending investments in this initial meeting (they need to get to know your investment goals first), but it is good to set the expectation early around what information you will be looking for when reviewing the recommendation.
Maybe consider asking them what the average total expense ratio is for their clients in the past few years. If they do not know, they should. If they cannot or, more probably, do not want to answer, that is a red flag.
Can you describe the service plan for a client like me?
Giving the advisor a brief overview of your current financial situation and your goals can help guide the response to this question and it can give insight into the client experience. This should lead to a discussion addressing some of the following questions (and if these are not addressed, they are natural follow-up questions for you to ask): How often can I expect to hear from you and how will you communicate with me – email, phone calls, face-to-face meetings? How do you measure success with client relationships? How often will we revisit the Investment policy statement governing my portfolio?
You can also ask what other resources are available to you if you become a client. The advisor will not be an expert in all financial matters; will you have access to experts in other specialised areas, such as estate planning, tax planning, personal banking? If these things are important to you, be sure to choose an advisor with a trusted network of experts.
Some advisors work independently, and others are part of a larger team. Ask if he or she would be the only advisor working with you, or if there are others that may manage the relationship on a day-to-day basis. If so, request to meet the primary relationship manager that you would work with.
There are probably a thousand questions that could be asked, perhaps should be asked. What we want to encourage you to do is ask many questions so that you can become comfortable with the person you are selecting. Do not be rushed into the decision-making process.
Not all advisors are created equal; indeed, not all are trustworthy. Remember, it is your money and you have the right to expect the advisor to put your interests first. Speaking of which, make sure you ask them two final questions: The first, “Are you a fiduciary?”, which is simply a fancy way of asking whether they have a legal responsibility to do what is in your interest as a client, ahead of their own interest. It may seem odd that this is even a question, but you would be surprised.
The second is whether they adhere to any ethical standards? Here we must declare an interest.
This article is written by a CFA charterholder in a segment produced by the CFA Society Cayman Islands. Every CFA Charterholder must attest annually to ethical behaviour. Why wouldn’t you want your advisor doing the same?
This article was written by the board of the CFA Society Cayman Islands.