WASHINGTON — Sometimes we just don’t know the right questions to ask. This is especially true when it comes to the relationship between investors and their financial advisers.
As financial advisers, we have access to amazing amounts of information, but most investors just rely on their monthly statements for details about their accounts. Monthly statements are near worthless. How can you judge a long-term relationship based on a monthly snapshot?
A better way to access the quality of the relationship you have with your adviser is to ask him four easy questions:
1. How much did I pay you last year?
If you work with a fee-only adviser, in most cases, you pay him a percentage of the assets he manages, an hourly fee, or a combination of both. Some independent or dually registered advisers can charge a fee for managing assets and make commissions on investment or insurance products that they recommend.
People are usually surprised to learn about hidden trailing fees or commissions earned by advisers at some firms. Of course, not all advisers at these institutions receive this revenue, but it’s important to know where the conflicts of interest may lie.
A great example of hidden fees is 12b-1 fees. These are fees (usually 0.25 percent) that advisers can make on many mutual funds. Clients do not see these fees on their statements because they’re paid to the adviser directly from the mutual fund company. Does this create a conflict of interest? Likely no, but it’s important to be aware of this hidden revenue stream.
We often meet with prospective clients who don’t fully understand what they’re being charged and how their current adviser makes money. That’s a scary thing to think about as a consumer. It’s always best to ask your adviser or those you’re interviewing how they are compensated, and if there are any conflicts of interest.
2. What is my total performance for the past three years?
If you rely on your monthly brokerage statement for your account information, you’re probably not seeing the whole picture. Performance reporting is fairly standard for this industry, and your adviser should provide a performance report, typically on a quarterly basis, but not all performance reports are alike. This information should be easy to see and understand and clearly show how you are doing. If it’s not, then how do you or your adviser know if you’re on track to meet your goals?
Not beating ‘the market’ with a broadly diversified portfolio is acceptable, but ask if there are parts of the portfolio that your adviser positioned to potentially beat ‘the market.’ How have they done? (Be sure to confirm what your adviser considers ‘the market’ to avoid confusion and miscommunication.)
3. How much risk did I take and how do you know whether this is appropriate?
As advisers, we have access to the measurements of risk taken in client portfolios over the longer term — perhaps three years. You should know this information; the performance number is not enough. Without knowing the actual volatility in the portfolio, you are halfway in the dark.
Keep in mind that there is no test or questionnaire developed today that can absolutely show the exact amount of risk anyone should take. That said, there are good tools that your adviser can use to quantify how you feel about risk. Here’s the important part: A risk assessment is not a stand-alone measurement, but a helpful tool to frame the conversations you should be having with your adviser about risk. These discussions should include how much risk (think market downturn) you can withstand in the portfolio along with your income needs and the goals for your money. Only then will you know whether they have a good feel for how much risk is right for you.
4. How are you investing in your firm for the future?
I think this is one of the most important questions to ask your adviser. In the past year or two, did he bring on new advisers or support staff to better serve you, or just bring on more clients? How your adviser is deploying his resources will tell you whether he is investing in new technology to improve response times and accuracy, in more support staff so he can spend more time with you or in advertising and marketing to enlarge his client base.
If your financial adviser is open and transparent, and if you’re comfortable having conversations with him — the really challenging ones when times get tough — then you know the relationship is a good fit. If not, it may be time to find a new financial adviser.
