Frequently Asked Questions
Q: What are the keys to a good relationship with your financial advisor?
A: There are five key ingredients to a good relationship with a financial advisor. The financial advisor should be understandable, patient, trustworthy, professionally credible and an educator on the world of investing.
Q: What do you mean by "understandable?"
A: Your advisor should be able to communicate with you in ways which help you understand how your money will be handled. Ask questions until you feel comfortable with your comprehension. Always remember, it is easy to take a simple subject and make it sound complicated, but difficult to make a complicated subject sound simple. Better advisors can do this.
Q: Why is patience important in a financial advisor?
A: Better advisors will not hurry you into investing your money. They will wait until you are ready. Remember, there is absolutely no reason an advisor should compel you to invest within a certain time frame.
Q: How can I gauge a financial advisor’s trustworthiness before I begin a relationship?
A: If an advisor tells you they are trustworthy, they probably aren’t. Most will demonstrate this through their actions, eye contact and body language. Be careful; many "professional" sales people can put on a good show. Ask for referrals, and pay particular attention to referrals you know. Otherwise, all you’ll get is the advisor’s best clients.
Q: How do I judge professional credibility?
A: This is demonstrated by appropriate levels of education, experience and technical competence. Deal only with college educated, professional designated (CFP, ChFC, or CFA) individuals with at least five to ten years’ experience actually handling client investment accounts. Advisors should be literate in portfolio management software, and demonstrate a general understanding of the markets, the economy and historical returns.
Q: Why is a financial advisor expected to be an educator?
A: Your investment advisor should tutor you on how the markets interact, what a "conservative" portfolio is versus an "aggressive" one, why your portfolio looks like it does, and why changes are made in your account. He or she should explain the negative and positive attributes of your current investments, make sensible recommendations and do all of this in writing.
Q: How do fees paid to a financial advisor affect returns and value provided to me?
A: It is important that you understand exactly how your investment advisor is compensated. Fee-based advisors will typically charge you an annual fee based on the value of your account. If your account is $1,000,000 and the fee is 1.00%, then you will pay that manager $10,000 per year. Make sure this is the only way they get paid. If they receive compensation for transactions, 12(b)(1) fees, or deferred sales commissions, ask them to deduct it from your fee. If they don’t disclose this to you up front, find someone else.
Commission-based advisors will typically charge a commission based on the investments purchased for your account. If your account is $1,000,000 and the commission is 3.00%, then you might pay that advisor $30,000 the first year and .25% to 1% ($2,500 to $10,000) each year thereafter in 12(b)(1) expenses that come out of the fund. You must receive value for the fees or commissions you pay. When you cannot see value, find someone else.
Q: What level of service can I expect from a fee-based advisor?
A: Fee-based advisors have incentive to be attentive to you and your portfolio. If you select a fee-based advisor, you should expect a certain level of service, including the reporting covered elsewhere in this FAQ. If you are not satisfied, make your concerns known. Fee-based advisors may have the ability to be more objective in their recommendations because they are not specifically compensated for transactions. Fee-based advisors may also be limited in their selection of potential investment vehicles, so check out product availability. They may also be more research-oriented and more interested in keeping you as a client, since they get paid on an ongoing basis. Finally, most fee-based advisors require a minimum investment of $100,000 or more.
Q: What level of service can I expect from a commission-based advisor?
A: Commission-based advisors have greater incentive to be attentive up front, and generally have no minimum requirements. Understand, however, that they may also get paid an annual 12(b)(1) fee from fund companies. Competent commission-based advisors will treat you in an objective manner, but beware that sales commissions attached to specific investment products may cause your interests to diverge from those of your advisor. Watch out for inappropriate investments. Commission-based advisors typically rely on someone else’s research in order to free up time to make more sales. Also, be aware of deferred sales charges.
Q: How do I know what’s happening with my investments?
A: You should expect to receive periodic reports from your advisor. Good reports provide you with more information; more information gives you a better understanding of the process; and better understanding helps you sleep at night when the market is declining. Make sure you receive a sample performance report from your advisor before investing.
Q: What should be included in (and excluded from) periodic reports from my financial advisor?
A: Updates should be provided quarterly, or at least annually. Reports should contain commentary, portfolio returns for the period, portfolio returns from inception and a statement of the value of the account at the end of the period. Most importantly, reports should provide a simple, direct comparison of the performance of your portfolio relative to an appropriate index (S&P 500, EAFE, etc.). An executive summary should be provided discussing the markets during the period, what went on in your account, unusual events, why certain investments performed poorly or well, and anticipated changes. Simple, one- or two-page reports which clients read and understand are far preferable to impenetrable 50-page tomes which are ignored.
Q: Why is a financial advisor’s research capability important?
A: Research is the cornerstone of a logical, well-thought-out investment strategy. If your advisor is not involved in the research function to some degree, then you should ask to meet the person(s) responsible for constructing your portfolio. The advisor’s commitment to research is key. If they don’t put time or value into it, then you won’t get value out of it, and you should look for someone else.
Q:What should I ask regarding research?
A: Here is a brief list of research-related questions:
- Do they have people on staff whose sole daily function is studying the market?
- What type of investigation do they perform?
- Are they value–or growth-oriented?
- Do they believe in Modern Portfolio Theory? Passive asset allocation? Active asset allocation?
- Do they publish their own research, or rely on outside sources? If they do it themselves, ask for samples.
- What are their data sources? If they do not have access to historical data on the markets and investment categories, global data, macroeconomic data and stock prices, then they are probably not doing useful research.
- What type of computer systems do they have?
- What software is used for analysis? If they can’t answer these questions readily, then they are probably not up to speed on investment research.
Q: How relevant are the financial advisor’s historical returns?
A: Historical returns are just that – historical. They may or may not be indicative of the returns you can expect to receive in your portfolio. Here are some guidelines to help in your decision making process:
- Similar Portfolios: Ask for returns of an account that is similar to one that may be put together for you.
- Composite of similar portfolios: Ask for returns of the composite of similar portfolios. That is, the total of their balanced portfolios, individual stock portfolios, growth stock portfolios, and so on.
- Style / Strategy: The advisor should be able to provide you with statistical and historical information on the style or strategy which they will use to manage your account. They should also be able to describe in a simple and straightforward way their style of asset allocation or stock picking.
Before or After Fee Performance: When you receive performance reports on all of the above, make sure it is clear whether the returns are reported before or after fees. Performance before fees enables you to determine how the investment advisor has done relative to an appropriate index. After-fee performance helps you determine if the fees are worth it.