This post is a follow-up to yesterday’s discussion about fee-only advisors as opposed to commission-based advisors.
Many people tend to ask the wrong questions when shopping around for a financial advisor. For example–as I mentioned yesterday–many people tend to focus entirely on how an advisor makes his or her money.
Other people tend to spend a lot of time focusing on which particular investments the advisor has recommended to existing clients. They ask questions about what his/her favorite mutual funds or stocks are at the time. The problem with this line of thinking is that it’s based upon the faulty assumption that the most important thing an advisor does is help you choose investments.
What advisors really do: Educate and Coach
The first role of an advisor is to help educate you as to what steps you’re going to have to take to reach the goals you want to reach. It’s not the advisor’s job to come up with some brilliant plan to make you rich or to pick 5 mutual funds that are going to crush average market returns. Most of the time, the best thing an advisor can do is help you figure out how to meet your goals without needing to rely on above-market returns.
The second (and more important) role of an advisor is to help you stick with your plan. It’s not that hard to figure out “To reach X dollars by year Y, I need to invest $____ every month.” What is hard is not messing everything up by selling out when the market tanks. Having somebody to provide reassurance at those times–times like right now!–can have a significant impact on your long-term success.
So what should somebody look for in an advisor?
It seems to me that the most important thing when choosing an advisor is how well the advisor will be able to fulfill the roles outlined above.
Ask your advisor some questions about her investment philosophy. Then while she is answering, pay attention to how well you understand what she’s saying. If this person can’t explain things to you in a way you understand, there’s no way you’ll have the confidence to rely on her when the time comes.
The second thing you should look for is a bit less tangible, but at least as important. Find somebody you can trust. Ask yourself this question: “If my portfolio had just gone down 40% in the last 3 months, and this person was telling me that I need to just stick with our investment plan rather than take my money out of the market, would I be able to believe him? Would I have sufficient trust in the plan we designed together to be able to stick with it?” If you can’t answer “Yes” to that question, you should probably keep looking.
What about you: Do you work with an advisor? And if so, how’d you choose him/her?
Like this article? Sign up for free daily updates, or if you’re new to investing, you may want to pick up a copy of my book on Amazon.
{ 5 comments… read them below or add one }
I happen to believe that the intangibles are the most important factors when looking for a financial advisor–or any kind of financial professional. You hit the nail right on the head in your advice of making sure the professional explains things in plain english. There is a big difference between being experienced/educated and being able to convey things in a manner that is easy to understand from a client standpoint.
I expand on this line of thinking in a post from my own blog called
What makes for a good financial professional?
This is a very insightful assessment of the role an advisor can play in the lives of their clients, and think the perception of our industry as “brokers” (which I think influences the ‘cost’ and ‘product’ conversations about the industry) is slowly changing, as people realize they’re not quite sure how to make their dreams a reality.
Your comment about reaching goals “without needing to rely on above-market returns” is especially well-considered.
Eric makes a great point too…someone in the business of giving advice should be expert at conveying very complex concepts (which he/she should have the capacity to comprehend) in very understandable, relevant terms. I’ve always said that your hired advisors (financial, legal, and health) should be teachers on par with your best teacher growing up.
If the purpose of advisors are to educate and coach, you can find sources that will do that for you and with you, without charging you a fee. There are online options like Thrive, that does the things mentioned above: set up goals and advise to keep on top of them and offer helpful information that is personalized for each person. Sure, it might seem less convincing to get advice from a screen than a person, but if the information is similar, why not take the option that’s more flexible and free?
Eric and D, thank you both for your kind words.
Aya, I’d say that you’re right, for some people anyway. Many people don’t need financial adviors.
You’re absolutely correct that all of the information necessary to invest successfully is available online.
I’d argue though that the most important role of an FA is to provide emotional reassurance during difficult times in order to keep you from making mistakes. And–for some people at least–emotional reassurance from a website just isn’t going to cut it.
Mike, you’ve made some helpful points here, but there are some important omissions. First of all, not all fee-only advisers are paid from a % of client assets. Some are paid hourly, or on a project basis. Second, if an adviser’s compensation depends on selling mutual funds or annuities, how can he or she escape a conflict of interest? You’re right that trust is key, but a compensation system with inherent conflicts of interest built in can’t inspire much trust: if your doctor could only get paid by writing you a prescription from which he got a commission, wouldn’t that make you wonder about his advice? Third, a good financial adviser should give advice about more than which mutual funds to buy – things like minimizing taxes, getting your children’s college educations paid for, etc.
I’m biased about this, BTW; I’m a fee-only financial planner.