10 Questions to Ask a Financial Advisor

Article Highlights:

• Investing can sometimes require professional advice; it's important to ask the right questions.
• Understanding an advisor's investment philosophy is crucial, whether it's active or passive investing.
• Explore the services they provide and how they can benefit you long-term.
• Discussing compensation and costs can reveal a lot about the advisor’s motives.
• Establish a good relationship with your advisor to ensure aligned interests and goals.

Now, when it comes to investing, many people prefer to do it themselves.
But there are times when you might want to get advice from a professional.
And indeed there are lots of services out there which you can use.
So in this video, what I'm going to do is say if you are going to go to one of these advisors, what are the 10 questions you should ask them in order to make sure that it's a good fit for you and that you're going to be happy with the service that they provide?
Because often it can be an expensive service, so you don't want to make a mistake.

Now in this video, I won't deal with how to find one of these advisors.
You can look online, of course, find a financial advisor using Google, but there are also services out there which you can use online which match you up with an advisor, such as Unbiased or VouchedFor.

So let's start off with the first question, and this is: What is your investment philosophy?
Which sounds quite vague and philosophical, but in fact it's a very practical question.
For example, if you've listened to many of my videos, you know I'm a big fan of passive investing where you simply track markets using very cheap funds.
Alternatively, you could go down the active approach where you pay a fund manager more.
The fees are usually higher to stock pick and beat the market.

Now the vast majority of evidence shows that once you subtract the fees over a 10-year period, say about 80% of active managers fail to beat the benchmark, their passive equivalent fund.
And this is evidence from the S&P Index versus ActivePort, which is published regularly.
And this result is true almost for every region globally and it applies to multiple markets.
So it's not just about stock funds, it's also true of bond funds.

So the question is, are they into active investing or passive investing?
And if so, what's the evidence behind that philosophy?
If they are going to go down the active route, then what benchmark are they comparing those active funds with?
That's very important.
Often they use a very weak benchmark which is easy to beat.
If you use a global index like FTSE All World or MSCI All Country World Index, that's actually performed very well and it's beaten a lot of these very expensive actively managed funds.
So just be sure that when they say we beat the market, what market are they beating and over what period have they beaten that market for a particular fund manager or if they're providing the actual choice of funds for their service?

Another question might be: What suite of funds do you consider and how do you select those funds which you potentially offer your clients?
What's the due diligence behind it?
What's the rationale, and what would lead you to actually drop one of those funds if it started underperforming?
And a good question is always, Do you invest in those funds yourself?
Because if they don't eat their own cooking, that's always a red flag.

The second question is: Are you independent?
Now, this will be slightly different in the US, as we'll see in a moment, but in the UK, there's a very specific meaning of what an independent financial advisor is.
So if they are an independent financial advisor, what that means is that they can give you unbiased advice from a very large suite of companies which offer lots of products.
Whereas if they're a restricted advisor, they'll only be able to offer you a restricted range of products from a restricted range of providers.
That's not necessarily a bad thing.
It may be that the providers, even for a restricted advisor, might be able to provide you with everything you need.
But just be aware of that distinction.

Now, in the UK, the system under which we operate, the legal system, is one of suitability.
You tell the advisor your circumstances and they match you to a portfolio which they will tell you is appropriate.
If it turns out not to be appropriate, then you can complain to the financial ombudsman and you could be able to get compensation.
Now, in the US, the regime's slightly different.
They have something called fiduciaries.
And this is a much more stringent way of approaching advice, in my opinion.
Instead of just ticking legal boxes to show that they've done their due diligence to match you to the right portfolio, a fiduciary literally has to put your interests above theirs.
Now, this produces a much better alignment of interest between you and your advisor.
I dream of the day when UK advisors will also be fiduciaries in the strict sense.

Now, I'm not saying that some of them don't have that mindset.
I think many of them do, and they literally want the best for their clients.
But for others, it is just an asset gathering game.
So it's a job of gathering clients and then servicing them as little as possible to maximize profit.
So hopefully these questions will help you avoid that kind of advisor.

Another great question is: What services do you provide?
Because it could be that you only want a restricted piece of advice and that's it, it's just one transaction and you're done.
Other people will want an advisor to manage everything for them forever.
They just don't want to know really about how their money's invested.
The service, which everyone thinks about, is investment advice, where they take your circumstances and match you to a portfolio which they think is appropriate for your financial goals.

Now, it turns out that that choice of funds is something they're not particularly good at, as we'll see later.
More useful, I think, are things like retirement planning.
Coming up with a plan and showing you how to execute it, and if you want, they'll execute it for you.
How much do you have to save in order to be able to retire?
That's often a question people ask.
And using cash flow modeling tools, an advisor will be able to come up with an answer to the question.

Another thing they can help with is tax planning.
It's almost impossible to know all the ins and outs of the tax system in any country, but it makes sense to use that tax system as efficiently as possible and they'll be able to advise you how to do that.
Part of that is estate planning.
If you want to leave money to your children, your family, or some third party, how can you do that?
Tax efficiently?
And they can help with that in some cases.
Other advisors specialize in particular things such as mortgage advice, which mortgage is going to be best for you given your circumstances, or possibly insurance, which insurance is best for your home, for your car, for your life, and they can advise about that in some cases.

Some advisors will also be able to help you on things like budgeting and saving.
How can you tweak your expenses so that you have more money to save for retirement?
So it's probably worthwhile asking what their specialties are and whether they provide the services which you require.
It may just be that you want one of them, for example, such as transferring your pension, and you just want advice about that specific thing.

Now we get to a kind of awkward question, which you might be slightly embarrassed to ask, but which is probably worthwhile asking: How do you think you add value?
Now, a piece of research by Vanguard, which I found really fascinating, tried to put numbers on this.
They tried to do research to see which services provided by advisors produce the greatest increase in wealth for their clients.
And the absolutely shocking one is asset allocation.
In other words, deciding how much goes into stocks and bonds, or maybe commodities, real estate, any other asset class.
Vanguard's estimate of the return added value?
There was zero.
There was no added value at all.
Whereas the most important value add, the biggest value add numerically, was coaching, behavioral coaching—stopping you from doing crazy things during market crashes.
For example, a good advisor should try and get in touch with you if markets crash and say, "Look, don't panic, don't sell. This is a sale you should be buying, not selling."
Or if there's a huge euphoric rally, they should try and avoid you piling into the next shiny red ball.

So if it's an advisor where they actively try to teach you what to do rather than just telling you what to do, I think that's a really important thing.
If you add it all up, it comes to a potential gain of 3% per year.
So hopefully the value add will be greater than the fee that they're going to charge you, so that net you'll be better off than you were.

Now, it's useful to be able to talk to other people in a less formal way than you would with a financial advisor.
And our community offers a way to do that.
Turns out we have some advisors in the community itself and some ex-finance people, a huge amount of collective knowledge, plus people who are just new to investing.
So if you want to learn more about that, just go to our website pensioncraft.com and there'll also be a link in the description below.

Another question to ask is: How are you compensated?
Now, many advisors use an ad valorem fee.
In other words, it's based on the value of the pot, which they're going to advise you about.
And there was research done by the Financial Conduct Authority in the UK which showed that the upfront fee for that for a financial planner was 2.4% of your assets under management upfront.
And then there's an ongoing fee of 0.8% per year, and that's pretty hefty.
If it's £100,000, we're talking about, then the upfront fee would take away £2,400 on day one.

Another source of information is Unbiased, which is one of those advisor directory services in the UK, and they found that advisors typically charge between 1% and 2% of the pot that they're discussing with you.
So for example, 2% of your pension pot.
But they also note that if you have larger assets, then the fee goes down often.
Now, if you want specific jobs done, they can be relatively cheap.
So for example, if you want help setting up an ISA, the fee for that on average according to Unbiased, is £300.
If you want advice on a defined benefit transfer, which is worth about £100,000, the fee for that on average is about £2,500 to do so.
These are percentage fees.
If you have a very large amount of money that you're going to be talking about, then a flat fee probably makes a lot of sense.

So another red flag to look for is to look on their website for the advisor you may approach and see if they're upfront about their fees.
If fees don't register on their front page of their website, well, why not?
They should do.
And some advisors charge a flat fee, which I think is a much fairer model, or perhaps an hourly fee depending on how much work they do for you.
I think it's kind of crazy to charge 10 times as much for a 10 times larger pot.
Is that because the quality of advice improves tenfold?
I don't think so.
So I think a set fee for a set piece of work makes more sense.
Or perhaps an hourly fee model, which is what you'd get from other professional services like a lawyer.

Now, when I made this list, I threw it open to all of our members in Pension Craft, our community, and they came up with loads of questions.
Some of the questions here came from them, but this one came from an advisor who I happen to be friendly with.
And I think it's just a brilliant question because it's open-ended: Is it better to pay off a mortgage or invest your money instead?
And his point was just brilliant.
If the advisor is adamant that one is better than the other, he is likely a charlatan.
The correct answer in my view is something like "What do you think?"
Or "It depends" if the decision is emotional or economical.

Now I've made videos about whether it's better to pay off your mortgage or invest, and I agree, it's a psychological decision.
A lot of people like the comfort of owning the bricks and mortar that they live in.
So really you could ask any of these A or B questions and see if they come up with a really definitive answer.
And if they do, well, maybe they're not the right person.
They should argue both sides, I think.

And this leads on to another great question, which is: What will our relationship be like?
Some advisors, I'm told, only speak to you once a year and it's just to check up to see if everything's okay.
Of course, this minimizes their costs and maximizes their profit.
The more they're speaking to you, the less time they're spending gathering assets and increasing their AUM.
And of course, that's going to reduce their margins.
Other advisors are much more interactive and it's much more of a collaborative relationship.
Again, to quote my advisor friend, he says clients are better served by a trusted, collaborative partner who admits they don't have all the answers rather than someone who does think they have all the answers.

Or maybe that you don't want that kind of relationship, a long-term one.
All you want is a short-term steer to get you started.
Do you have enough to retire?
Is this portfolio okay or is it too risky?
What should my tax structure be?
How am I using all my tax allowances?
Is there something which I'm missing?

So really it's a matter of checking that the relationship is what you want it to be.
And if it's not, then just find somebody else.
There are lots of advisors out there.

Another question which is really informative but they may not be willing to answer is: Why did your last few customers leave?
It'll never be the case that an advisor will always be matched up perfectly with their clients.
There will always be disgruntled people who didn't think they got what they expected or who simply were just a bad fit.
But it's always interesting to know why those people left.
Now you can go by recommendations.
The difficulty there is that what you want from the advisor may be very different from someone else.
I often hear from people who say, "A friend of mine told me this advisor was good, but when I tried them, it just wasn't great at all."
So while a recommendation can be useful, it's not always necessarily going to point you to an advisor that's good for you.

Now, each advisor will probably have a typical customer in terms of their age, but also the amount of money that they manage for their typical customer.
So if you go to an advisor who usually deals with billionaires, and you only have a few hundred thousand to invest, they may not be the best fit for you.
They may not be good at crafting a portfolio or advising people who have less to invest.
Or perhaps they specialize in people pre-retirement or post-retirement.
So it's best to know what typical client they're serving to ensure that you fit into that niche.
Because that way there's more likely to be a fit between you and the services they provide.

Now the final question.
And yes, this came from one of our members and it was a bit tongue-in-cheek.
There's a lot of banter in our community.
Of course, the question is: Do you have a yacht?
Now, I always think if an advisor is very, very wealthy, it's not necessarily because they're very good at their job.
It might be because they're charging very high fees and their heart's in the wrong place.
If their goal is simply to make as much money in this career as possible, and it's not going to be to service their clients and give their clients the best outcome, then that could be a problem.

There was a very good finance book written about 50 years ago called "Where Are the Customers' Yachts?"
The point being that the finance industry is very good at lining its own nest, but maybe not so good at lining the nest of its clients.
So maybe just look in the parking lot and see what kind of car they drive and just try and sound them out about what their motives are.
Again, my advisor friend came up with a great question to do with this theme, which is: Where do you plan to be in 10 years' time?
So he's saying that if they have an investment philosophy and plan to be around in 10 years' time, that's much better than someone who's just about to retire themselves, they're tired of the profession, they want to sell up, and so they're not going to craft you the best long-term plan.
Instead, they'll be focused on quick wins which are going to be more profitable for them.

So I hope that's helped you come up with your own list of interview questions for your financial advisor.
I think if you are going to have a long-term relationship with them, then it's important to get that fit right.
And it is a relationship, and it is something where you will have regrets later on if you get it wrong.

Now, our community is also a good place to have accountability and to speak to other people when you're feeling a bit unsure about a particular topic or some piece of news or just want to have a laugh, because as you saw, we have some tongue-in-cheek remarks as well about yachts.
But if you do want to learn more about joining our community, just go to our website pensioncraft.com and look at premium membership.
And as always, thank you for listening.