Joe Arns* says one of the goals of working with a financial advisor is to earn more on your investments, but you should also ask four key questions about your advisory relationship.
Regardless of how strong your relationship is with your financial advisor, it’s important to periodically evaluate whether your needs are being met.
Investors often judge the success of the relationship based upon whether their account balances are growing or shrinking.
Of course, one of the goals of working with a financial advisor is to earn more on your investments.
But to only judge the success of your relationship by one metric is to do yourself a disservice.
In addition to inquiring about investment performance, investors should ask four key questions about their advisory relationship.
Does your advisor’s specialty match your biggest financial advice needs?
The title “financial advisor” is used by professionals with a range of qualifications and credentials, many of whom often specialise in different financial services.
The first step in assessing your current financial advisor is determining whether their professional focus matches your primary financial advice needs.
Do you need help getting your financial life organised?
Do you want someone to assess your readiness for retirement and help recommend insurance?
If so, you probably want a financial advisor with a financial planning focus.
Do you primarily need help with tax planning and managing your cash flow?
An advisor with a strong accounting background might be best for you.
If your current financial advisor doesn’t have expertise in the areas you care about most, determine whether their firm has the necessary resources for them to draw from in serving those needs.
Does your advisor understand and know you?
Once you’ve assessed your advisor’s fit for your needs, determine their level of expertise in something even more important — you.
They should have a very good sense of your past financial experience, attitudes toward money, investment risk tolerance and longer-term goals.
Ideally, your advisor has spent hours meeting with you on the phone or in person and has asked you a lot of questions.
Hopefully, your dialogue has been supplemented with risk tolerance questionnaires or other forms to document your inclinations and objectives.
All of this “getting to know you” work is important to ensure the advice your advisor provides is appropriate.
This work becomes critical when financial markets are under stress or when your personal circumstances change.
The greatest value most financial advisors provide their clients is making sure they stick with a financial plan that is best for them over the long run.
If the advisor fails to understand their client, there is a much higher probability the client will fail to stick with the plan when unpleasant events occur.
Does your advisor provide long-term realistic expectations?
Financial advisors are not oracles.
They can’t predict what financial markets will do over the next six weeks, six months or six years.
But they can and should provide you with realistic expectations of what your investment performance might be over longer periods.
Be most wary of financial advisors who simply point to past performance as an indicator of the future.
Financial markets are forward looking, and a reliance upon the past is dangerous when the world changes.
Be careful not to judge a financial advisor by your account’s performance over a period of less than five years.
Business cycles and periods of mania and panic determine investment performance over shorter time horizons.
Over the longer run, however, performance is more likely to reflect the underlying fundamentals of the chosen investments.
Over longer horizons, you’ll want to know if the performance of your investments is similar to those of an index of similar investments.
This is called benchmarking.
Ideally, your portfolio returns will exceed those of the chosen benchmark.
Frequently, your investment returns will slightly lag the benchmark as financial advice fees are usually deducted from your account.
If your investment performance is several percentage points below the benchmark, you’ll want an explanation from your advisor of the factors that led to the underperformance.
Importantly, the same is true if your portfolio performance is several percentage points above the benchmark.
It is especially important to understand if superb results were a consequence of excessive risk taking that may be out of step with your risk tolerance.
Does your advisor charge reasonable fees?
An appropriate fee for your account will depend upon the services provided.
Most advisors charge a fee based on the percentage of assets managed.
Fee percentages tend to be higher for smaller accounts and lower for larger accounts with an industry average of approximately 1 per cent.
To determine whether the fee for your account seems reasonable, you’ll need to consider the amount of time you spend with your advisor, the value of their expertise, and the customisation level of the service provided (greater customisation of your investment portfolio or financial plan requires more of the advisor’s time).
Another way to look at fees is to determine whether you are likely to come out ahead financially with an advisor versus going it alone.
We project an investor with a balanced portfolio of stocks and bonds likely will earn 2–4 per cent annually after inflation.
An investor with a conservative portfolio mix paying 2 per cent per year for advice, for example, may be earning next to nothing after advisory fees.
Find the right advisor for you
Did you answer yes to all four questions?
Congratulations, you’ve got a great financial advisory relationship going.
But if the answer to any of these questions is no, it may be time to talk to other financial advisors to see if you can find a better fit.
* Joe Arns is the founder of Reason Investments.
This article first appeared at www.investopedia.com
