5 critical questions to ask a financial advisor

  • The new federal fiduciary rule may have an uncertain future, but investors can ensure their advisors have their best interest at heart by regularly asking key questions.
  • Fiduciaries — advisors sworn to act in a client's best interest — will charge an easy-to-understand management fee based on the total investment amount they are managing.

Personal finance
Jose Luis Pelaez inc. | Getty Images

After what seemed like a never-ending series of delays, speed bumps and other challenges, the Department of Labor's fiduciary rule finally went into partial effect on June 9. Although it still has many loopholes, at its core the rule requires financial advisors to act in the best interests of their clients when advising on retirement investment accounts.

This may sound obvious — after all, what investor wouldn't want the best advice possible? Yet many advisors are required only to make "suitable" investment recommendations. And when it comes to your life savings, "suitable" just isn't enough.

To protect yourself and your retirement, it's important that you understand the type of advice you're getting when you meet with your advisor. Here are the key questions you should ask.

1. Are you a fiduciary?

The best way to find out whether an advisor has your best interests at heart is simply to ask, "Are you a fiduciary?" This is the single most important question you can ask. If you don't get a straight yes-or-no answer, that's a sure sign something isn't right.

We feel strongly that investors should work only with fiduciaries. However, if you choose to work with a broker or someone who is not a true fiduciary advisor, make sure you understand exactly what criteria is being used to decide which investments to offer you. Would you hire a doctor who is paid a bonus for prescribing a certain type of medicine rather than what you actually need? Of course not.

You should hold your advisor to the same standard. Ask detailed questions about why he or she is recommending each fund or other investment, including whether a commission is being earned by selling it to you. If your advisor is also a broker, he or she may only be authorized to sell certain products, which could impact objectivity.

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2. How do you make money?

Every financial advisor — fiduciary or not — has to make money somehow, but the devil is in the details. If your advisor's answer about his or her business model is vague or takes more than 30 seconds to explain, that's a major red flag. You should never buy anything, especially financial advice, if you don't fully understand the costs.

Most fiduciaries will charge an easy-to-understand management fee based on the total investment amount they are managing for you. Typically, this fee is between 1 percent and 1.5 percent of assets under management.

If you're not paying this kind of management fee, you may be paying a commission every time you buy or sell a stock or mutual fund. Each trade can cost a different amount, and some advisors may be incentivized to sell different — and more expensive — share classes. You may also be paying additional hidden fees on everything from a broker's administrative expenses to account service charges. These fees matter. Even a tenth of a percentage point in extra fees can add up to hundreds of thousands of dollars over the lifetime of an investment portfolio.

3. How do you use technology for my benefit?

As surprising as it may seem in the 21st century, many advisors still build portfolios based on the answers people give to written questionnaires about their goals and risk tolerance, as opposed to modeling an investor's entire financial life with a tech-driven tool. While things such as goals and risk tolerance are certainly important, they are just a small piece of the larger picture. Advisors should know what is happening with their clients' entire financial lives.

Find out if the technology your advisor uses is taking in new financial information daily. Does it track changes in your account balances, transactions and holdings? The average affluent household has between 15 to 20 financial accounts, including investments, credit cards, checking accounts and more. An advisor must be able to see how these pieces fit together in order to build a truly diversified portfolio that achieves your goals and evolves as your life changes.

"The fiduciary rule is a long-overdue step toward bringing the interests of investors in closer alignment with the interests of their financial advisors, but it's just the start."

Using information from a questionnaire one time only or even once a year simply doesn't work. If you want to lose weight, you need a scale to show you how you're doing. Similarly, if you want to achieve your retirement goals, you need to know how much you're earning and saving each day.

4. How do you help me with taxes?

A good financial advisor should do more than just recommend investments. One important service they should offer is optimizing your portfolio for tax purposes. Ask your advisor about how she will decide whether to allocate certain investments to your taxable account versus a nontaxable account, such as an individual retirement account.

Also, ask advisors about select mutual funds. Some funds tend to have high internal turnover, which can lead to capital gains taxes. Tax efficiency can increase annual portfolio returns by up to 1 percent, which can equate to hundreds of thousands of dollars over a 30-year period. Why send this money to Uncle Sam if you don't have to? Remember, investing is not just about the money you earn, it's about the money you keep.

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5. What other services do you provide to me?

In addition to tax optimization, ask if your advisor will provide advice on assets he or she doesn't manage, such as your 401(k) plan. Will you be assisted with estate planning? Charitable giving? Planning for your children's college? Management of your stock options? These things can make or save you money, providing added value for the fee you pay.

The fiduciary rule is a long-overdue step toward bringing the interests of investors in closer alignment with the interests of their financial advisors, but it's just the start. Investors can protect themselves and their portfolios by asking the right questions and taking their assets elsewhere if they don't like the answers.

— By Jay Shah, CEO, and Bill Harris, founder and chairman of Personal Capital

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