Original Article by Henry (Bud) Hebeler for Market Watch.
After just a couple of meetings, a professional adviser gave me suggestions that increased my savings many fold in the following 40 years.
I thought I knew all I had to know after listening to “professionals” who gave free presentations — thinly disguised events to sell their services or products. On the other hand, the few hours with a Certified Financial Planner (CFP) revised my thoughts on investments dramatically. He got a flat fee and would make nothing from my investments. He also gave good advice on insurance and estate planning.
Finding a good financial adviser
It isn’t easy to find a truly low-cost, competent and honest financial adviser. People usually ask friends or business associates who they use. Some use a CFP; others use a broker, insurance sales person, or tax accountant. People usually like their adviser, but often for the wrong reasons. Their advisers may have great personalities, can be very attentive and always remember their birthdays. However, they may put their clients into high cost investments that benefit the adviser more than the client. Unfortunately, clients aren’t aware of this.
If possible, it’s important to compare several professional adviser candidates. There are a number of Internet sites such as napfa.org or fpanet.org that offer professional names for people within or near your ZIP Code. Most of these planners will have websites from which you can get an initial impression.
It is harder is to select one than to find candidates. Below are some questions I recently gave to friends to ask potential advisers. The feedback I got was that the candidates weren’t used to this type of questioning — but the advisers responded to almost all of the questions. The tone and quality of the responses made it relatively easy to determine which candidate to select. On behalf of a recently widowed friend, I asked these questions of an adviser she was considering. I did this by email and got sufficient answers to make a judgment.
It’s important to know what you want from an adviser. Do you want the adviser to be responsible for all of your financial affairs such as managing your investments, preparing an estate plan and its associated documents (wills, living wills, trusts, durable power of attorney, etc.), handle your insurance, or even do your income tax? At the other extreme, do you just want to hear a different perspective and get some suggestions?
It’s also important to remember that the kind of service you want may mean a very longtime association from which it may be difficult to extract yourself, particularly if the adviser has invested your money in funds not available to the general public or if the adviser retains virtually all of your records. If you have some amount of financial knowledge, you might choose to use an adviser as a consultant only. In that case, your questions can be simpler with a focus on the responses you get from the adviser’s references using a similar service. You’ll also find what you may get for the adviser’s charges.
It is a good idea to begin an interview with a brief description of your personal situation including the ages of family members and a summary of your income, savings and debts. Often the advisers will give you a questionnaire to answer before the meeting. That done, you might ask the following questions and take notes. Some of the questions may not apply to your situation.
1. How old are you?
If you are older, you may want a younger adviser who will outlive you. If you are young, you may want an older adviser who has been through difficult economic times.
2. What is your educational background?
Look for a Certified Financial Planner (CFP), likely with Registered Investor Advisor (RIA) credentials. Some Certified Public Accountants (CPA) with Personal Financial Assistant (PFS) degrees have suitable qualifications as well. Avoid brokers, insurance agents, real-estate promoters, business associates, relatives, golfing partners and hairdressers.
3. How long have you been an adviser?
Experience counts a lot in the financial field, especially the experience gained in periods with plunging markets.
4. Do you accept fiduciary responsibility?
This is a legal term meaning they have a fundamental obligation to provide suitable investment advice and always act in your best interests, not theirs. They should also be willing to give you a written statement that they accept this responsibility.
5. Have you been sued or have any reported legal actions?
This useful page on the Financial Planning Standards Council site reports recent disciplinary actions.
6. What is the smallest, average and largest portfolio you manage?
Some advisers only take high-net-worth clients. That may not be suitable for you.
7. Could you give me three clients’ names, phone numbers and email addresses as references?
It’s important to call these references. Ask them how they found the adviser, the length of time they have been served, what kind of help they get, what they believe are the adviser’s strong and weak points and whether they would recommend that adviser to someone in your situation.
Questions about the financial firm
8. Describe your firm.
You will want to know the number and skills of associates, whether this is a stand-alone firm or part of a large company, the amount of money they have under their control, the kind of clients they serve, and who will help when the person you are interviewing isn’t available.
9. Exactly what services do you perform?
Services could include retirement planning, manage securities, estate planning, tax planning, insurance, long-term-care advice, newsletters, and so forth.
10. If you use specific individuals or firms to assist such as an estate attorney, accountant, or broker, who are they?
Ask the personal questions above about them too.
11. What investment firms do you use in your practice?
Vanguard, Fidelity, T. Rowe Price, and Schwab are among the better choices. Dimensional Fund Advisors funds are low costs but may make it difficult to extract yourself. Be cautious if the answer for investments is an insurance company.
Questions about fees and costs
12. How much do you charge for your service? Do you offer different levels of service?
Fee-only advisers are best for most clients. Professionals usually charge about 1% of investments managed each year. A fee of 1% is neither a small charge for what may be limited effort on the adviser’s part nor a small percentage of your annual growth. It can easily be a third or more of your annual returns which can translate to a loss of more than half of your nest egg at retirement or even more when elderly.
It’s very important to understand what you are getting if you decide to turn your investment management over to someone for a fee. Investments compound at the return rate which is interest plus dividends plus appreciation less investment costs and less professional fees, each as a percent of investments. You need net returns greater than inflation for true growth.
An important reason to consider turning your investments over to a professional is a failure to do well on your own. You can get a good idea of your own performance over the years with the free, Excel based, Annual and Compound Return History program.
To check out your own performance with this program, it’s good to have several years of investment annual deposits, annual withdrawals and end-of-year balances as well as a computer with Excel. Many people use it just to track the history of their savings balance.
13. What are the total costs and fees for typical stock and bond funds you would recommend?
Costs are likely to be the lowest from fee-only advisers who don’t take commissions, don’t get rewards for selling particular funds, don’t receive 12b-1 kickbacks, don’t sell funds with front-end or back-end loads. They also advocate low cost providers like Vanguard, Fidelity TIAA-CREF, or T. Rowe Price, recommend broad market index funds or exchange-traded funds (ETFs), and have low turnover to minimize trading and brokerage costs.
The average mutual fund cost is 1.25%. Low cost funds have costs less than 0.5% of the investment balance each year. Broad index funds, based on major market indexes like the Standard & Poor’s 500 Index SPX +0.05% , which has stock in 500 of the largest U.S. companies, and the Russell 2000 Index RUT -0.13% , which has stock in 2000 of smaller companies, bought from low-cost financial firms can be significantly lower. Costs are in addition to an adviser’s fee.
Questions about investments
14. Do you have different models or investment pools dependent on client’s risk tolerance?
Risk usually relates to the decisions you would make in a volatile security market and the amount of money you might be willing to lose in a market downturn. It’s usually measured with a series of standard questions, but it’s important to know the degree to which the adviser tailors your investments.
15. What allocation guidelines do you use? For a person of my age and what you observe about the things I have told you, what rough percent of equities (stocks and real estate) would you allocate in a portfolio?
The more equities, the higher the risk. Younger people can employ a higher percentage of equities because they usually have higher long-term returns but comes with more volatility.
16. Do you count home equity as part of an allocation?
I personally don’t think they should because I believe a home is an investment of last resort, perhaps convertible to a reverse mortgage when elderly at which point it is a debt, not an investment.
17. Do you count capitalized future payments from Social Security, Pensions, or Annuity payments as part of an allocation?
Again, I don’t think they should because the discounted value of all future payments is huge in comparison to the size of most people’s savings. Since financial advisers are prone to classify such “investments” as fixed-income, that means your savings would have to be 100% equities, a decidedly risky position.
18. What are the important economic risks you think we need to be concerned about, and do you suggest some investments that might alleviate these?
Answers could be about inflation, taxes, health and death.
19. What kind of investments do you recommend?
Good responses include index funds, real-estate investment trusts (REITs), highly rated bonds, certificate of deposits (CDs) and a portion of money markets. Be cautious when the replies seem to promote managed funds, individual stocks, a directly owned real-estate property, reverse mortgages, commodities, long short funds, partnerships of any kind including master limited partnerships (MLP), options, hedge funds, investments with limited withdrawal privileges, collectibles, thinly held securities, and annuities with high costs and lots of fine print that provide flexibility for the insurer but not you.
Also be VERY cautious about replies that imply the adviser can do much better than the S&P 500 index with the adviser’s selection of equities. Very few professional beat the index, and it’s rare when they beat it for several years in succession.
If you believe you wouldn’t understand the responses, take someone with you or try to remember the responses and talk to a knowledgeable person later.
20. On a scale of one to 10 where one represents a pure buy-and-hold investor and 10 represents a market-timer, where do you put your clients?
1 through 4 would be a satisfactory answer while a number 5 through 10 implies that the adviser thinks he can foretell the future and even its timing.
Questions about planning
21. How often do you evaluate my situation and provide an up-to-date forecast?
A satisfactory answer is yearly.
22. Does your retirement forecasting include discrete financial events like a real-estate purchase or sale, death of a spouse and subsequent survivor benefits or other large financial events?
If it doesn’t, it isn’t a very complete analysis.
23. Is your planning model based on a constant return and inflation assumptions or does it include the effects of variable returns and inflation?
Neither will give you a perfect answer. Constant returns and inflation in forecasts don’t include the effects of a retiree having to make a withdrawal in a down market year. In contrast, Monte Carlo computer models vary returns every year using statistics of the past in numerous iterations. Some vary inflation too. Monte Carlo analysis gives a “success probability” assuming that the statistics of the future will be the same as the past, something that many forecasters believe doubtful.
William Bernstein, a highly respected analyst and author, suggests using no more than a 6.5% return for equities and 3% for bonds . With results from my own programs, I lean toward using the actual returns and inflation for each year starting with 1965 because I feel we will face similar conditions with periods of high inflation and serious volatility.
Since none of us can really forecast the future, what’s important is to do a new forecast each year using the most recent balances and future events as you see them at the time to adjust your savings or spending accordingly. Future events should include the need for some long-term-care and death of a spouse with consideration to survivor benefits.
24. Does your retirement forecasting account for federal and state income tax and taxes on interest, dividends and capital gains?
Again, if tax rates aren’t considered, it isn’t a very compete analysis.
25. Do you think you would be a good adviser to me? Why?
You ought to think about what kind of answers you would want before the interview. Then, as you get responses from the advisers, you’ll have a better idea whether this adviser is suitable for you and may be a better fit than the others you are considering.
Your first visit should be free. You may want to make a phone call or two afterward to clarify a point or cover something you forgot. If you are corresponding by email, make sure that you set up a personal, face-to-face meeting at the adviser’s place of business as well. If you feel quite uncertain about making an adviser decision, perhaps you can bring a trusted friend, relation or associate with you.
It really pays to do due diligence to find an adviser. It’s much like a marriage in which separation or divorce may be difficult. That’s particularly true when the adviser has control of your account (instead of requiring your approval before any buy or sell action), provides multiple services in addition to financial planning such as estate planning or income taxes, invests in funds available only to his firm or gives you scanty periodic information. The easiest relationship to sever is one where the adviser gets together with you periodically to look at your investments and tax return, recommend changes and answer questions. So instead of being like a spouse, the adviser is more like a marriage counselor.