Your choice of financial adviser might be the single most important decision you ever make, short of your spouse or maybe your doctor.
In my opinion, a good adviser can help you protect the savings you’ve spent a lifetime building, and – with good planning and maybe a little luck from a healthy stock market – grow it into a proper nest egg.
But how do you choose?
Let’s take a look at some traits that in my opinion you’ll want to look for, as well as three questions you’ll want to ask any prospective candidate.
How do you get paid?
In my view, this is arguably the most important question you can ask because it can be a major indicator of conflicts of interest.
The trend of recent years has been toward fee-based advice, generally based on the amount of assets under management.
A fee-based adviser will generally charge you 1% to 1.5% of the value of the account. So, if you have a $100,000 account, you’ll pay something in the ballpark of $1,000 to $1,500 per year. You will also pay commissions for all trades associated with the investments your adviser makes.
The old model for adviser compensation was via sales commissions. The adviser got paid up front via sales loads on mutual funds and annuities, via a trading commission on a stock or via a markup on a bond.
There are serious implicit conflicts of interest in the commission-based model, as the adviser has every incentive to churn the account or to sell products with the highest possible commissions (annuities salesmen are notorious for this).
The Department of Labor “fiduciary rule” was supposed to address potential abuse, but its implementation has been repeatedly delayed and, in any event, it would mostly only affect IRA accounts.
In my view, as a general rule, you want a fee-based adviser becausethere are inherently fewer potential conflicts in that compensation structure.
A fee-based adviser buys for you. They do not sell to you. And I think that’s an important distinction in terms of the adviser’s incentives.
What’s your succession plan?
If the president of the United States dies in office or is incapacitated, the vice president takes over.
There is a plan in place and absolutely no ambiguity as to who’s in charge should the worst happen.
I think you should have similar confidence in your financial adviser.
Who is running the money?
Once you’ve covered the preliminaries, it’s time to get into the nitty gritty of how the adviser plans to invest your money.
On this count, every adviser is a little different. Some position themselves as relationship managers and delegate the actual money management to outside managers.
Some advisers instead choose to run their own in-house investment strategies. And a lot of advisers fall somewhere in the middle, managing parts of the portfolio themselves and delegating other parts to outside managers.
All these approaches are perfectly fine. But I think the adviser needs to be able to explain to you why they allocate the way they do.
Perhaps they feel comfortable running a stock portfolio but feel a bond portfolio is better managed by a specialist in that area. Or perhaps your adviser feels that he or she adds the most value by being a “manager of managers” and spending their time finding the best manager for a given strategy.
If your financial adviser uses outside money managers, ask about fees. Are you paying fees on top of fees, or does your adviser compensate the money manager with a portion of the fees he or she collects from you?
Along the same lines, make sure they explain to you where your money will be held in custody. Ideally, they will tell you a third-party custodian you’ve heard of, such as TD Ameritrade (AMTD), Fidelity or any number of other popular brokers.
If you don’t recognize the name of the custodian – or if you don’t receive statements directly from the custodian – I think you should think twice about keeping your money with that adviser.
Ultimately, your choice of financial adviser will come down to trust, which can be subjective and based on emotion.
But by asking the right questions, you make the process more objective and ultimately feel a lot more comfortable with the outcome.
A version of this article first appeared at kiplinger.com. See: 3 Things You Should Always Ask a Financial Adviser.