Understand a financial advisory firm's specific plan for managing your investment portfolio.
Before you hitch your assets to the wrong financial advisory firm's wagon, make sure you know where it stands philosophically and strategically on investment management.
Mutual fund companies in the past have positioned themselves as an easy way for independent financial advisors to punt the investment management function to a well-known firm. Large firms have much bigger research and marketing budgets than smaller, independent advisors could ever amass. So if investors recognize the fund company from national TV commercials and advertisements, the path to their acceptance of investment ideas is that much clearer.
Then, the advisor is free to focus on financial planning and investment advice and leave the investment management to others.
While there is a lot to be said for having an efficient portfolio management structure in place for the benefit of clients and advisors alike, it raises the question: Is that actually in your best interest as the client? Or is it walking a fine line between fiduciary and "suitability," which means that it might not be the best path for you, but it is sufficient in response to your financial objectives.
Understanding your advisor's investment philosophy – how that advisor approaches risk, market bubbles and other aspects of the financial markets – can help ensure that the advisor is a good match.
Here are four questions to ask financial advisors about their firm's investment management process:
What can you tell me about your investment philosophy for clients. How did you develop it and who influenced that development:
You want to make sure that the marketability of the firm's philosophy is not taking priority over how well the approach matches your personal objectives and risk tolerance.Many advisors claim to be independent, but when it comes to the investment management part of the business, you need to make sure that the advisory firm's actions match its rhetoric.
How do you prepare for the inevitable periods when the account will fall by a significant amount?
Historically, when markets fall hard, they fall in unison. Bear markets do not differentiate between low-cost index investments and others. That's when investment process and strategy become so important.
Understanding how your advisor prepares for and handles market downturns will give you peace of mind when the inevitable happens.
What proprietary products do you use and how do you choose them?
For instance, if a behemoth exchange-traded fund company is running everything for the advisor, are there good reasons for that from the client standpoint?
If the ETF company is so large and efficient that it can knock the cost of investment management down for your advisor, are some of those savings ending up in your pocket? Does the advisor have more incentive to put your assets with the ETF company than you do?
Do you understand specifically, and can you explain to me, why every move is made in my portfolio. Can you relate it back to the broader objectives you have for managing my wealth? Can you document it for me?
This is of increasing importance to financial advisors as regulators are raising the bar in this area. In other words, knowing what you own is more vital to your advisor's job than ever before.
The bottom line is that investors can protect themselves by being thorough at the start of the relationship with an advisor. History is littered with advisor-client relationships that went sour despite a solid rapport and good intentions. Getting clarity on how your advisor's investment process works goes a long way toward preventing misunderstandings.
If your advisor is putting as much thought into investment strategy as she is into the financial planning end, you'll be all the better positioned for the inevitable bear market or price correction.