Choosing a financial advisor: An investor's checklist

Before you start researching advisors, ask yourself these five questions.

Christine Benz 25 August, 2017 | 5:00PM
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Think back to the last time you bought a car. Did you buy the same car your sister owns because she likes hers? Did you shop for $16,000 Honda Fits, $85,000 Land Rovers, and everything in between? Did you head into the dealer with no knowledge of prices, fuel economy or vehicle safety features?

Heck no, right? Buying a car isn't for Sunday drivers, so you no doubt started the process by thinking about your needs, wants and budget. You then homed in on two or three vehicles that fit your criteria. You probably did a little bit of homework, reading up on which cars receive the best ratings and taking a test drive or two. Only then did you steel yourself for the trip into the dealer to make the buy, praying for the shortest, most painless car purchase possible.

What's surprising is that many investors take the former tack when choosing a financial advisor, being amazingly haphazard even though, over a lifetime, their financial-advice engagement could be far costlier than a car. They begin by soliciting advice on advisors from people who may or may not know what they're talking about and who may have needs that are completely different from their own. They don't let their own needs, wants and budget drive the process, and they often don't do much homework.

Why are investors so laissez-faire about finding financial advice?

A key reason is that the financial advisory profession is an awfully big and confusing tent. It encompasses people who are focused primarily on investments and those who construct comprehensive financial plans. Commission-based brokers can call themselves financial advisors, but so do many fee-only folks who never touch commissions.

The industry hasn't necessarily helped distinguish the flames of confusion, and the financial advisory space remains a wild west of confusing titles, designations and compensation schemes.

The good news is that selecting an advisor who's a good fit for your needs doesn't have to be an overwrought process. A lot of guides to choosing an advisor focus on questions you should ask the advisor--compensation schemes, designations and whether the advisor is a fiduciary. Those are hugely important issues, but the real first step when seeking an advisor is to think through what you're looking for: your goals in seeking an advisor, what sort of relationship makes sense given those goals, and how much help you expect to need on an ongoing basis, among other issues. Armed with that information, you can then seek advisors who fit your self-made description.

Here are the key questions to ask yourself.

Question 1: Are you seeking help with your whole financial life or your investment portfolio?
A key fissure among financial advisors is focus. Many financial advisors devote a lot of time and energy to managing portfolios: determining asset allocation, selecting investments, and so forth. In fact, that may be the one and only thing they will handle for you, or they may tackle nonportfolio aspects of your financial life, but do so only tangentially.

Another big contingent of advisors -- financial planners -- concern themselves with holistic financial planning: setting and quantifying financial goals, paying down debt, determining insurance needs and investing appropriately for education and retirement, among other tasks. Financial planners know investments, too, but investment selection and portfolio monitoring aren't all they do.

Those distinctions may seem obvious to people inside the investment industry, but many consumers aren't aware of them. They might think of financial planning as interchangeable with investment management and advice. And it's true that the lines between the professions have grown blurrier in the past few years. Investment advisors are increasingly focused on providing holistic financial planning, as some consumers consider the investment-advice piece to be more or less a commodity and are seeking broader expertise.

If you're seeking holistic planning advice: A financial planner is appropriate if you're seeking broad financial-planning guidance -- on your investment portfolio, but other parts of your plan as well. Seek out someone who calls him/herself a financial planner and ask prospective planners if they've earned the certified financial planner or similar designation. Some financial planners are also fiduciaries; to be sure, ask the planner about that before hiring him/her.

If you need investment advice first and foremost: If you think your financial plan is in good shape overall but you need help selecting and overseeing your investments, an investment advisor may be the way to go. Such individuals are frequently registered investment advisors or are employed by a firm that is. The gold-standard designation for this type of advisor is the chartered financial analyst.

Question 2: Are you seeking advice on a few specific issues or do you need help with your whole plan? Do you need one-time/periodic help, or ongoing assistance?
Once you've determined whether you're looking for investment advice or financial-planning advice, the next step is to consider what specific items you need help with. Decide if you're seeking advice on a few specific issues, or problem spots, in your plan, or if you expect to need ongoing assistance. Knowing whether your needs are surgical or more encompassing can help you be an efficient consumer of advisory resources.

If you're seeking advice on just a few issues: If your needs are focused--for example, you'd like a review of the viability of your retirement assets given your anticipated spending but then you'll be set for the next five years or so--you'll want to seek an advisor who is willing to work with you on a per-project basis. Financial planners are more likely to employ hourly or per-engagement billing than are investment advisors. Hourly rates for financial planners often range from $150 to $300.

If you're seeking broad and ongoing financial help: If you expect that your advice need will be ongoing, paying a recurrent fee--say, annually--may be more cost-effective than paying for advice on an a la carte basis. Most advisors who charge in this way levy their fees as a percentage of your assets; the percentage may decrease the more assets you have under management with an advisor. Another model that is gaining traction is the so-called retainer model, whereby you pay your advisor a monthly or annual dollar-based fee rather than a percentage of your assets--much as you would do with a gym membership or cable TV.

Question 3: How hands-off (or hands-on) do you wish to be?
In a related vein, ask yourself how much of a role you'd like to play in managing your finances going forward. Do you want to be part of the planning process and handle certain parts of your financial plan yourself, or would you like to delegate most of the decision-making?

If you're willing to handle certain aspects of your plan on your own: Obviously, the more work you're willing to do yourself, the more you should be able to shave off the advisory fees you pay. Investors who would like to do at least some of the heavy lifting for their plans should consider paying an advisor on an hourly or per-project basis rather than an all-in fee for encompassing services.

If you'd like to delegate: This setup can make sense for very busy people who simply don't have the time or inclination to participate in the planning/investment-management process. It's also something to consider for older investors who are concerned about the possibility of cognitive decline and its impact on their ability to manage their own finances or investment portfolios. Paying an advisor a percentage of assets annually or hiring one on a retainer basis can make sense for delegators.

Question 4: How comfortable are you with technology?
While many advisors still meet face to face with their clients in their offices, technology is changing the advice industry fast. Robo-advisors employ computer algorithms to deliver often-very-low-cost investment advice. Most human advisors also rely heavily on various software programs to craft their client plans. Many advisors are also employing technology to facilitate interactions with their clients. For example, they may use portals to share information with their clients (and vice versa), meet with them via video conference and respond to client queries via text message.

If you're very comfortable with technology: You may be able to shave your investment-management fees by employing some type of technology-driven advice such as a robo-advisor. Some financial planners employ a hybrid model, charging their clients for customized financial-planning advice while outsourcing the investment-management piece to a very low-cost robo-advisor.

Even if cost-cutting isn't your main goal, technology such as video conferencing can enable you to meet with advisors who specialize in a specific area, such as financial planning for small-business owners, even if they don't live in your same geographic location.

If you'd like more face-to-face interaction: Focus your search on financial advisors who work in your same locale. The Financial Planning Standards Council website allows you to search for financial planners by geography as well as many other criteria.

Question 5: Do you have a specific investment philosophy you'd like to see your advisor employ?
Are you a believer in the benefits that can accrue to index funds and ETFs thanks to their often-low costs and tax efficiency? Or do you like to employ actively managed funds and/or individual stocks in the hope of beating the market? Do you want your advisor to be strategic in managing your asset allocation (i.e., long-term and hands-off), or more tactical in his or her strategy? Thinking through your investment beliefs and articulating them to a prospective advisor is a crucial step, especially if you're leaning on the advisor for ongoing investment guidance.

If you have a specific investment philosophy you'd like to see the advisor employ: If you're reading, it's a good bet that you have developed a set of investment beliefs that you'd like to see embedded in your plan, even if you're delegating the specific decision-making to an advisor. Be sure to quiz any prospective advisor on his or her investment approach.

If you're open to allowing the investment advisor to ply his or her own strategy: Even if you don't have a strong view of how you'd like your assets to be managed, it's still important to ask some questions about strategy. Is the advisor clear and transparent about his or her approach? Does the advisor employ low-cost funds or more expensive ones? How much attention does the advisor pay to tax efficiency? Taking the time to understand your advisor's strategy can help you stick with the program through varying market conditions.


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About Author

Christine Benz

Christine Benz  Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

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