You don’t want to choose just anyone to manage your money. Selecting a qualified, experienced financial advisor should take time and careful consideration. And though you may know what you are looking for in a financial advisor – location, availability, expertise – you may not know what red flags to avoid. Here we detail how to vet a financial advisor and the 5 most important red flags to avoid before selecting a financial advisor.
How to Vet a Financial Advisor
Before we get into the most important red flags to avoid, let’s examine how to vet a financial advisor and what a typical interview process looks like.
- Perform Due Diligence
Google displays more than 530,000,000 results for the keyword, “financial advisor”. So how do you whittle down the list to only the most qualified and legitimate advisors?
First, begin by setting guidelines that will help you weed out non-contenders. You may be looking for a financial advisor that is fee-only versus fee-based or an advisor that is within 20 miles of your home. Whatever the guidelines are, write them down and use them as a baseline to remove anyone that falls outside of the parameters.
Once your list has been narrowed down, begin due diligence. When vetting a financial advisor this means investing their background, credentials, and experience. Here are a few reliable tools we recommend to ensure your prospect list contains only the most trusted advisors:
- Financial Industry Regulatory Authority (FINRA) BrokerCheck
- Investment Adviser Public Disclosures
- SEC Action Lookup
- Understand Compensation
There are primarily three types of compensation structures – fee-only, commission, or a combination of both (also known as fee-based)..
Fee-only advisors set a price for their service, either as a flat rate, hourly fee, or percentage of assets. Advisors compensated via commissions are known as registered representatives of broker dealers, and they receive a commission on the financial product sold to the client. Advisors can also be a combination if they charge clients a set rate – whether hourly, flat rate, or percentage of assets under management – and also make commission for additional services or product offerings. These are known as fee-based advisors.
There are advantages and disadvantages for each compensation model (we examine here!), but what is most important is having full insight into how your advisor is compensated.
Beyond the advisor’s standard compensation, there may also be something called indirect compensation, also known as “soft dollars”. “Soft dollars” are not explicitly monetary in nature, but represent something of value to the advisor (e.g., access or discounts to software or tickets to a ballgame).
Knowing about the different types of compensation can help you ask the right questions to understand possible conflicts of interest and what the advisor does to mitigate those conflicts.
- Differences in Motive
Advisors can follow two standards, the suitability standard or the fiduciary standard.
Those who follow a fiduciary standard, like Prudent Investors, make financial decisions in the best interest of their clients. This means that their duty is to the client first and foremost.
Advisors who follow a suitability standard have a bit more flexibility. The suitability standard allows registered representatives to sell products that are appropriate; however these products might not necessarily be in the client’s best interest.
For example, an advisor under the suitability standard could recommend a product or service that is financially rewarding for themselves so long as that recommendation is also financially suitable for their client. Contrast this to an advisor under the fiduciary standard. The advisor would be prohibited from making the recommendation if the product or service is not in the best interest of the client.
- Prep Interview Questions
Now that you have some background on the prospective advisors, it’s time to form your interview questions. If you are a trustee or professional fiduciary, we’ve curated this helpful Financial Advisor Interview Guide that captures the top 11 interview questions to ask during your vetting process.
If you are an individual or family embarking on the financial advisor vetting process, you may also want to ask them questions such as:
- How often do you meet with clients to review investments?
- How closely is my portfolio reviewed and how often do you evaluate?
- What type of tax considerations do you take into consideration when financial planning?
- How do you measure financial success for your clients?
- In an economic downturn, how do you communicate performance and goals with clients?
Financial Advisor Red Flags to Watch For
Now that you’ve built your prospect list and conducted a round of interviews, let’s talk about the most important red flags to watch for in a financial advisor.
- Not Forthcoming in Their Compensation Structure
It’s not uncommon for the advisor’s fee to not be listed on their website or even during a cold-call, but what is uncommon is an advisor not sharing how they are compensated or their fee-structure during an interview.
Advisors who follow a fiduciary standard must disclose how they are paid upfront. If a prospective advisor is not willing to share their flat fee, hourly rate, or commission model, that should automatically raise a red flag.
Instead, focus on those advisors who are open and willing to detail their compensation structure. This will help you avoid any unexpected fees or issues farther down the road.
- Alarming Background Report
Performing due diligence in the early stages of your vetting process should weed out anyone with an alarming background, but what type of red flags should you be looking for during due diligence?
Here are just some of the red flags that will pop up on the lookup databases outlined above:
- Employment history
- Regulatory actions
- Past arbitrations
- Complaints filed
- Negative marks, like misconduct
- Firm disclosures
- Conflicts of interest
- Tax liens
These databases also include the individual advisor’s years of experience, education, number of clients, certifications, and billing process. Having this information handy can help you verify the information they are sharing during an interview is accurate. An easy way to search these databases is through investor.gov, as the homepage has a handy search box to check out an investment professional.
- Pushing a Specific Service or Product
Having clarity into what type of standard the advisor follows will help you understand why the advisor may be recommending a particular service or product. Those who follow a fiduciary standard will not make recommendations for personal financial gain over your best interest, so if you’re getting the feeling an advisor is pushing a product or service solely to make commission it’s okay to ask whether commission is involved. If the answer is yes, red flag.
- Communication is Lacking
We get it, people are busy. Still, a dedicated advisor will make time to resolve any questions or issues within a timely manner. If you’re feeling ghosted by a prospective advisor during the initial interview process you can likely expect that this is how they treat their clients, as well.
To avoid communication issues, incorporate communication and ongoing dialogue as part of your interview process. Ask the prospective advisor whether they perform quarterly or yearly performance reviews, preferred methods of communication, and typical turnaround times for account questions. If their answers don’t align with your guidelines, it’s best to move on to an advisor who more closely matches your communication style.
- Not on the Same Wavelength
Before conducting your interviews, it’s best to have an idea of what you’re looking to gain in the advisor-client relationship. It could be you are looking for assistance with retirement planning or overall financial planning. Whatever service you’re looking for, be sure that the advisor has experience within that sector, offers realistic advice, and isn’t introducing themes or terms that are unrelated to your overarching goals.
If you find the advisor is straying too far from the services that you’re looking for this could be a red flag. First, try redirecting them back to the original conversation points. It could be that they are suggesting strategies that will ultimately help you achieve your goal that you may be unfamiliar with. If this doesn’t feel like the case, perhaps the relationship is mismatched and ultimately not the advisor you want to sink time and effort into.
While these top 5 red flags will help you weed out any shady prospects, there are certainly other considerations when selecting a financial advisor to help you reach your financial goals. Ultimately this relationship will be long-lasting, so be sure to select an advisor who you feel comfortable with and enjoy communicating with.
Prudent Investors can help you simplify your life through a financial planning process tailored to your goals. We understand the financial planning process can be overwhelming. Our advisors are here to help walk you through strategies that will benefit your financial outlook. If you are looking to partner with a financial advisor that puts your needs first and will take the time necessary to work hand-in-hand with you to achieve your goals, we invite you to connect with our team for an introductory consultation.
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