Sizing up your financial adviser

Some self-directed investors go it alone, while others like to work with a financial adviser. Still, investors who know they want help often don’t know where to start when trying to find a financial adviser.

In my opinion, when it comes to personal finance, choosing the right adviser is one of the biggest decisions one can make.

Aside from the obvious considerations — academic and professional credentials, fees and long-term track record — here are five additional things I believe you need to mull over before handing over your money to a financial professional.

How does the adviser make money?

Advisers can be compensated in many different ways, including a flat fee, hourly, as a percentage of assets, or by commissions on the investments they recommend.

In my opinion, you should be wary of financial advisers who deal mostly or exclusively in recommending mutual funds. The reason: Mutual fund providers often pay advisers for steering clients into their products, which is a conflict of interest for advisers, potentially incentivizing them to recommend mutual fund investments when they may not make sense for an investor.

That’s not to say mutual funds don’t have a role in some portfolios.

In my opinion, a clear conflict of interest is at work here. Even worse, some financial advisers don’t disclose those commissions and then also collect a management fee from their clients. That’s called double dipping.

How have their clients done in bad years like 2002 or 2008?

In my opinion, it’s easier to make money when times are good, like the current historic bull market rally. But I think you should check and see how the adviser fared during down markets.

This can help you determine how well the adviser manages risk, and how well he or she protected clients in bear markets.
Even legendary investors like Warren Buffett stumbled during the financial crisis.

Yet, I think that experience can be useful for advisers with an ability to think critically about their mistakes and learn from them.

Does the adviser guarantee a certain return?

If so, they may be in violation of SEC rules regarding “promissory language” in marketing materials.

In my view, guaranteeing a fixed rate of return is a red flag.

Does the adviser promise to beat the market every year or boast about past winning investments?

You’ve probably heard it before: Past performance is no guarantee of future results. There’s a reason you often see this line in financial marketing literature. It happens to be true.

If a financial pro keeps touting his best investments from last year, I think you should ask him or her about the recommendations that flopped, and why.

Investing is a risky and uncertain business and every year is a new game. Beware of cherry picking.

Gut check: Do you really trust this person?

Meeting face-to-face with a potential adviser is worth it to get an impression and see if your personalities match up. I think you want to be comfortable with your financial adviser.

Does he or she take the time to listen to you and thoroughly understand your retirement needs and risk tolerance? Do they communicate regularly? Do they respond to concerns in a timely manner? Find out.

Otherwise, you will be entrusting your wealth and future to a stranger who does not understand your needs and risk tolerance.

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