The first thing you’d do would be to talk to a lot of other families like you. If they’ve worked for years with a financial advisor and are happy, that’s a pretty good start.
Then you’d send out an RFP (request for proposal) to the small handful of recommended advisors. What Mr. Moneybags is really looking for in his RFP is disqualifying characteristics, attributes of an advisor that make him or her a non-starter. You should do the same thing.
So here are a few questions to help you weed out advisors who are — or are likely to be — non-starters.
No. 1: Are you a fiduciary? The answer you’re looking for is a simple “Yes.” Advisors who are fiduciaries — mainly RIAs (registered investment advisors) — are required to put your interests ahead of theirs. Other advisors merely need to give advice that’s “suitable.” “Suitable” sounds like a nice word, but in the financial business it means, “I can rip you off 20 ways to Sunday as long as I disclose it in the fine print.” Fiduciary advisors are a small minority of the profession, but you should focus your search there. As the old joke goes, “It’s the 99 percent of rotten apples who give the other 1 percent a bad name.”
No. 2: Does anyone pay you but me? If the advisor’s only compensation comes from you, it’s you he or she needs to please, and no one else. But most advisors receive compensation from so many sources hostile to your interests it would make you dizzy just trying to count them. The main culprits, however, are (a) front-end loads charged to you by mutual funds and paid to the advisor, (b) trailing fees (called 12b-1 fees) paid by funds to the advisor, and © “revenue sharing” agreements paid to the advisor by fund companies. A few years ago, the brokerage firm Edward Jones had almost 240 mutual fund families on its platform — a nice selection of choices for its brokers. But an investigation found that 95 percent of the client money went into exactly seven fund families. Those were the seven that — surprise, surprise — made large revenue-sharing payments to Edward Jones.
No. 3: Do you focus on financial planning or investments? Most advisors will say they do both, but I’ve never run into one who was really good at what are two very different activities. If you need help with budgeting, refinancing your mortgage, or deciding between a Roth and a traditional IRA, an investment guy isn’t going to be much help. If what you really need is good risk-adjusted returns, you’re unlikely to get them from a financial planner.
But wait, you are thinking, shouldn’t I ask about credentials (CFA, CFP, etc.), education, experience, and so on? Sure, but only after you’ve eliminated the advisors who might be trouble. If an advisor has an incentive to enrich himself, even though it harms you, all the credentials in the world aren’t going to save you. Remember that the great rip-off artists in the financial world have usually been credentialed out the wazoo.
People sometimes argue that there are conflicted financial advisors who rise above temptation and do a good job for their clients. True enough — I even know one or two — but life is too short to play Russian roulette with your money. Stick with fiduciary advisors paid only by you.