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13 Questions Investors Should Ask Before Choosing A Financial Advisor

Think Agency

The Department of Labor (DOL) recently issued new rules requiring investment professionals (brokers, registered representatives and financial advisors) to act as fiduciaries when managing client retirement accounts. This specifically pertains to the advice given to those transferring 401(k) plan assets into an Individual Retirement Account (IRA).

Previously, while your 401(k) was protected by ERISA (The Employee Retirement Income Security Act of 1974) regulations, your IRA was not. The new rules provide additional protection to your Rollover IRA by applying the fiduciary standard to the advice you are set to receive.

Simply put, fiduciaries must act in your best interest. They are required to put your needs ahead of their own. Previously, brokers and registered representatives were governed under the Suitability Rule, which permitted them to recommend investment vehicles that paid them more than other identical investments. This was legal as long as the investments were suitable for you as a client. They did not have to be in your best interest.

Choosing A Financial Advisor

When it comes to finding a financial advisor, do not settle for the first financial professional you meet. Your retirement is on the line here, so you should interview several different people. Keep in mind; YOU are interviewing the advisor, which means you MUST ask questions to make sure the financial representative you are meeting with will be working in your best interest. You need to see if he/she is meeting new DOL rules and regulations. Once you’ve spoken to several different financial representatives, compare their answers to determine which one best fits your needs.

To help you determine who might be a good fit for you, here are 13 questions you should ask a potential financial advisor (and the appropriate answers, so you know if what he/she is telling you is legal, ethical and professional):


1. Are you a fiduciary?


The answer to this should always be yes.


2. Is your company a registered investment advisor? What are your credentials? May I please have a copy of the firm's Form ADV with your credentials and experience in your Brochure Supplement?


Investment advisors file the Form ADV with the Securities and Exchange Commission (SEC) and state securities authorities. It provides important information an investor should know about an investment advisor.

Credentials should include registrations (licenses in securities), CFP (Certified Financial Planning designation), AIF (Accredited Investment Fiduciary), CPA or CFA. The advisor is required to provide the ADV Part 2 with the advisor’s Brochure Supplement.

You should also check out your potential advisor at the Financial Industry Regulatory Authority’s (FINRA) BrokerCheck.com.


3. Do you have a formal agreement with me that outlines your responsibilities and mine? Does it state in writing that you are functioning as a fiduciary and must legally put my interests ahead of yours and your firm’s?


You should have it in writing that the advisor is acting as a fiduciary. Each party’s responsibilities should also be included. These documents are very important and should be read very carefully.


4. How are you compensated? By fee? Fee and commission? Commission only?


Fee-only is the best option, but you need to know what the fee is based on. Typically it is the amount of money under management. Commission-based compensation can be problematic because there could be a conflict of interest if the advisor gets paid more on a commissionable product than by a fee.


5. Who do you use as a custodian (the company that will hold my investment account. Examples: Charles Schwab, Pershing, National Financial)?


Bernie Madoff's firm was the custodian, investment manager and advisor. The appropriate answer is that the advisor uses a custodian that is NOT affiliated with his/her firm.


6. Do you have any financial arrangement with the custodian? Does the custodian compensate you for using its services?


No, the custodian should not be compensating the advisor or his/her firm for services.


7. What are your fees? What are the fees and/or trading costs charged by the custodian? What are the internal costs of any mutual funds you recommend to implement my investment account? How do they compare to other mutual funds with the same investment objective? Are there breakpoints or reductions in fees for certain dollar amounts? Are all my accounts included in that fee schedule or is the fee for each account calculated separately?


ALL fees should be disclosed in writing at the onset of the relationship. This includes the fee schedule, trading costs and any custodian account maintenance fees, as well as internal expenses for mutual funds/insurance products/REITs.


8. What types of investments do you use with your clients? Stocks, bonds, mutual funds, REITS, insurance?


This will tell you the advisor's philosophy. Individual stock and bond portfolios generally are less diversified and more expensive, due to trading costs, than mutual funds. REITS can be unregistered, expensive and risky. Retirement clients, in particular, won't get sufficient diversification in an individual stock and bond account. Mutual funds, by contrast, can offer a massive range of diversification.


9. How do you decide what I, as a client, should have in my account(s)?


Very important question. How DOES the advisor select investments? Does the advisor or the firm have a process by which they select the prudent investment managers? If the advisor does NOT use outside experts, what are his/her credentials and experience in making investment selections? As a fiduciary, the advisor MUST maintain objectivity. If advisors are making the investment decisions, how do they "fire" themselves if the recommendations or selections don't work out?


10. Do you prepare an individual Investment Policy Statement showing the various investments you would recommend for me and the percentages of each? What is the philosophy behind these decisions?


NO client should use an investment advisor who does not prepare an individual Investment Policy Statement. It is the road map for the investment accounts and measures the risk tolerance, time frame and objectives of the client. This ensures that the choice of investments and asset allocation are compatible with your best interests.


11. Do the mutual fund companies compensate you or your firm for recommending them? If so, how much? Are you limited in any way to what you can recommend to me? Can you use no-load funds?


This is important because it discloses conflicts of interest and any biases in the advisor's choice of investment vehicles.


12. Do you rebalance the accounts? If so, how often?


Rebalancing a portfolio is critical to the ongoing success of the client. It prevents the portfolio from moving away from the original asset allocation determined by your Investment Policy Statement.


13. Do you take discretion over my account?


If the answer is yes, walk away. No one should give an advisor carte blanche to manage their money. Decisions should be made with the client's full knowledge and understanding of all risks, costs and tax consequences, if applicable.


Get The Answers You’ve Been Searching For

Finding a financial advisor should be an interview process. If the financial advisor is unable to answer these direct questions, he or she might not be the best financial advisor for you. If you would like to speak with the knowledgeable Investment Advisor Representatives at American Financial Advisors about your best retirement options, contact us today.

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