There should be natural skepticism when a financial advisor creates a list of the best and worst questions to ask a financial advisor. It sounds a little like game show fixing of the 1950s where some contestants knew the questions before they were asked. However, experience provides a unique advantage. We have heard insightful questions and we have also heard the questions which, if asked of an ill-intentioned advisor, can doom a new relationship towards a terrible outcome.
The mission here is to suggest the questions that can be asked to help people make wise financial decisions and avoid bad ones. There is admittedly not one right way and so there are no perfect answers to these questions. The right answers present the honest truth and a coherent explanation. The wrong answers are more focused on closing a sale than on truthfully answering the question. Legendary Wall Street Journal columnist Jason Zweig described well the unfortunate incentive for ill-intentioned financial advisors to mislead the public, “In the short run, you can make a little money by lying to people who want to hear the truth, or a lot of money by lying to people who want to be lied to. But you can’t ever make any money by telling the truth to people who want to be lied to.”
Best Questions to Ask a Financial Advisor
We advise prospective clients that they should focus on three things in the search for a financial advisor – the three P’s: People, Pay, and Philosophy. Who are the people you will be working with, how are they paid, and what is their philosophy on planning and investing? The best questions you can ask a financial advisor tend to examine these three issues.
What is your approach to financial planning?
We find that many people begin their search for a financial advisor because they want help managing their investments and do not appreciate the nebulous concept of financial planning. Because it is more profitable to sell investment management with a hint of financial planning, many advisors are investment advisors first and only offer limited help in financial planning. You have to first determine if you want comprehensive financial planning guidance or just investment advice. If you’re just after investment management, you should not pay the same rate as you would for comprehensive planning.
If you determine that you do want comprehensive financial planning, it is useful to understand how the planner thinks about certain topics. Ask whether she suggests permanent life insurance or term insurance. What does he think about using HSAs? When do annuities make sense or not make sense? What is the advisor’s view on Social Security claiming strategies, balancing college savings with retirement savings, Roth conversions, and wills versus revocable trusts? You importantly need to ask questions to help evaluate if the financial planner is knowledgeable on the subjects that impact you and whether his or her philosophy makes sense.
Describe your investment philosophy?
You should know whether the advisor picks individual stocks or uses mutual funds and ETFs. Ask the advisor to explain why. If he/she uses mutual funds, are they active or passive? If you’re looking for an exciting investment strategy that will fulfill your thirst for adventure and cocktail party conversation, make sure that is what you are getting. Does the advisor use asset location for tax efficiency or do the accounts mimic one another? How frequently is the portfolio rebalanced and how are asset allocation decisions made? What are the advisor’s views on stock options and their usage in portfolio construction?
It is also useful to understand whether portfolio changes are decided by the advisor or others in the firm and if the investment discipline is founded on the skill of the advisor(s) or on an evidence-based approach. You then have to do some research to understand what approach you want. The important thing is that you have a good understanding of how the advisor plans to invest your money and that this fits with your personal philosophy.
What experience or credentials do you have?
You have reason to be alarmed if an advisor deflects this question by citing how his or her education comes from years of experience and actual real world training, not silly textbooks or academia that teach impractical hypotheticals. There is certainly something to be said for real-world experience but consumers need to demand a minimum level of competence, which is not required in financial planning as it is in other professions. Would you consider surgery with a doctor who did not pass the boards or never attended medical school? If your answer is no, then you should think twice about handing over your life savings to someone who does not have the commitment and/or expertise to ascertain the CFP® designation. At a minimum, the CFP® designation should be a requirement to help screen advisors who take their career and advice seriously from those who do not. Additional credentials such as a CPA, CFA, JD, or CLU can also be of use. Read more on the topic of credentials and minimum standards for financial advisors.
Are you a fiduciary? How are you compensated for your services and advice?
Most consumers are unaware that financial advisors operate under two very different legal standards – a fiduciary standard and a suitability standard. If you don’t know the difference, you should and you should know under which standard the advisor you’re interviewing abides. You should also know all the details about how an advisor is compensated and what conflicts that compensation creates. Don’t be afraid to ask if the advisor receives any non-financial compensation (free vacations) or for the advisor to explain all the major conflicts of interest. Finally, evaluate whether the fee is in line with investment advisors or financial planners who provide similar services. Read more on the fiduciary standard, why it matters, and what you should know to protect yourself.
Who do you serve? What type of clients do you specialize in serving?
If you are having heart issues, you see a cardiologist. If you are being sued, you hire a defense attorney. If you need financial planning advice, you should find an advisor who works with and has expertise in the matters that impact people like you. Families with a large estate and complex estate planning needs should find an advisor who works with high net worth clients and knows the ins and outs of GRATs and CLATs. Mid-career corporate executives with children to send to college should find an advisor who understands college saving strategies, FAFSA forms, employee stock options, and deferred comp plans. You should also understand the typical size client that the advisor generally works with so you know in advance whether you are going to be a small fish or a really big fish. The key point is – you are likely to get far more benefit out of working with someone who has unique expertise in people like you.
If we work together, how should I evaluate you as a financial advisor?
This is one of our favorite questions because it demonstrates a well-informed consumer and the discussion that follows determines whether both parties are in alignment on what makes the relationship successful. An investment advisor who is really only managing investments should describe the relevant indices for comparing performance and the appropriate time period to use for evaluation. This advisor should also explain the level of risk that should be expected and show how performance and risk will be communicated on a quarterly or annual report so that the client can properly evaluate the advisor.
Alternatively, a comprehensive financial planner is going to be more challenging to evaluate because many of the recommendations in places such as tax planning or estate planning will take a lifetime to properly evaluate. In these cases, it is important to know how the planner is going to help you reach your goals. Will he help with year-end tax planning or regular estate document reviews? Will she regularly review your life, health, disability, and long-term care insurance? Read more on properly evaluating your financial advisor.
What one question should I have asked today that I didn’t ask?
This is a great closer, whether you’re interviewing a financial advisor or a summer intern. Let the advisor decide what he or she thinks you need to know and what important topic has not already been covered.
Worst Questions to Ask a Financial Advisor
What kind of investment return do you expect to make over the next 12-24 months?
Admittedly, this is a better question than asking what investment return the financial advisor expects to achieve over the next 3-6 months – but not by much. The trouble is that if you ask what return the advisor expects to make in the future and you use the numerical answer to compare multiple advisors, you are almost certainly going to end up with a bad outcome.
We recently met with prospective clients in Atlanta who were interviewing multiple financial planners and made it known that their hiring decision would be largely based on who could promise the highest returns over the next 3-5 years. Incentives in situations such as these are immediately set by the potential client for the advisor to:
- project likely unachievable double-digit annual returns and find ways to justify;
- use the high projected return in the financial plan and set likely unachievable expectations about when the prospective client can retire or how much the prospective client can spend; and
- build a risky portfolio that had nothing to do with the prospective client’s risk tolerance, time horizon, tax situation, or ability to take risk.
There is arguably no surer way for a financial planning relationship to end badly than by setting unrealistic expectations and employing a portfolio that does not fit at all with the client’s risk appetite. It actually can be useful to ask what returns the advisor expects in the future but you want to hear a coherent explanation of how he or she estimates long-term market returns and then uses these return assumptions within your financial plan. It can be instructive to understand if the advisor merely uses historical market returns or takes a building block approach and then what assumptions go into the components of return.
If the advisor’s answer to the question is simply that he has made 10-12% historical returns over the past five years and expects to continue to do this in the future, then you have found a good time to politely end the conversation.
Where do you think the market is headed from here?
This question is generally prefaced with, “I know you don’t have a crystal ball but…”. Humans have an inherent thirst for forecasts so it is natural to find a purported financial expert and ask his or her prediction for the future. The dirty Wall Street secret is that while experts may offer confident opinions, no one has a good clue of how the stock or bond markets will perform over the next few months or even the next year.
Expert-sounding predictions are seductive. Just like a kid who refuses to give up a belief in Santa Claus, everyone would like to believe that someone knows what is going to happen. Unfortunately, many investors succumb to relying on predictions and the idea that successful short-term market timing is possible, despite overwhelming evidence to the contrary. The harsh reality is that there are three types of investors: those that don’t know the future direction of the financial markets, those that don’t know that they don’t know the future direction of the financial markets, and those that know that they don’t know but pretend that they do. Read more about the lure and evidence of predicting investment returns.
What kind of safe investments with good yields do you use because I can’t afford to lose money heading into retirement?
There is naturally a desire to invest in safe assets that will not lose money and have a reliable high yield. However, the truth is that such investments do not really exist. Safe investments such as continuously rolling 90-day US Treasury Bills or FDIC insured savings accounts pay rates below the level of inflation. The market pays investors for taking risks and an investor should be extremely skeptical of an advisor who promises high returns with little risk. You cannot safely make 4% in a world of near 0% cash and 2% bonds. Be very skeptical of advisors who promote the allure of safe high yields in a low yield world.
If you ask this question and the advisor promises to provide safe investments with good yield, it is time to look for another advisor. There are plenty of horror stories of high yielding “safe investments” that turned out not to be safe including the likes of enhanced money market funds, Master Limited Partnerships (MLPs), structured notes, and a hedge fund run by Bernie Madoff. Read more about the inherent flaws of investing for yield.
Agree or disagree with the questions above? Did we miss any of the best and worst questions to ask a financial advisor? Let us know in the comments box below.