Red flag

Financial advisor red flags

What’s one of the most important relationships in your life?

Maybe your spouse, your parents, or a close friend. Not far behind, though, should be your financial advisor. You rely on them to guide you through your most important financial decisions. Yet it is very hard to evaluate a financial advisor.

We often work with a financial advisor because we are not experts. But, in many ways, you need to be an expert (or at least well-versed) to assess the quality of a financial advisor and their recommendations.

Finding the right financial advisor is tough. Maybe you rely on a recommendation from a friend or colleague. But are they an expert?*

Below I share a few red flags. If your advisor does any of these things**, be wary.

1) Tells you they can beat the market or promises you a certain return.

If they can beat the market, why aren’t they retired to their villa in the south of France? Why are they sharing their best ideas with you? Very few individuals have the skill to consistently beat the market over time.

2) Offers you proprietary (their own) funds vs. cheaper alternatives.

You can construct a diversified portfolio with annual management fees of less than 0.2% to 0.3% per year. Vanguard and others offer core market exposure for less than five basis points (that’s 0.05%). Other red flags are using funds with 12b-1 fees, sales loads, or surrender charges.

3) Pushes you to purchase whole life insurance.

Term insurance is better for the vast majority of people. Maybe the advisor will promote the investment or tax benefits of whole life insurance or variable annuities. Or they’ll say, “all my other clients have it” (yes, because the advisor sold it to them!). Or, my personal favorite, “well, I own it.” Trust me, there’s way more money in whole life insurance for the advisor than for you.

4) Works for an insurance company or broker-dealer.

No matter what they say, they are “encouraged” and likely compensated for selling you the parent company’s products. Of course, great people work at many of these places, but there’s no way for them to overcome the bad incentives. To succeed, to make money, they need to do what’s best for their company (not you). This also includes advisors affiliated with fund companies; they have a tendency to load you up with their company’s funds.

5) Can’t tell you exactly how much you are paying.

This includes management fees, sales commissions, referral fees, etc. If they don’t know or won’t tell you, you are almost certainly paying more than you think. Fee-based and fee-only sound similar but they are not the same thing. Fee-based means they earn fees (from you) as well as commissions (on products they sell you). In other words, they are also getting paid by someone else. If they are fee-based, ask (yourself, at least) if they are recommending a product because of how much it pays them. Or, better yet, work with a fee-only advisor.

6) Is not a fiduciary (or evades this question).

A fiduciary must put your best interests first. If they are not a fiduciary, whose interests do they get to put first? Their own or their company’s. Working with a fiduciary is not a guarantee of fair (or competent) treatment but it is better than the alternative.

7) Lacks qualifications.

Financial planning is complicated. That’s why you are seeking an expert. Even experts don’t have all the answers (and be careful of anyone who claims they do). And it is surprisingly easy to get a securities license in the U.S. Good financial planning, on the other hand, requires a long-term commitment to education. Look for the following designations: CFP®, Personal Financial Specialist, or CFA.

Avoiding the above red flags doesn’t mean you’ve found a great advisor. I think the best thing that you can do – whether you manage your own investments or work with an advisor – is to educate yourself. Start with the basics and then read at least one book a year as a refresh. Here is my recommended reading list for individual investors.

* you should also watch out for referral arrangements – i.e., a professional who refers you to a firm or a specific advisor in exchange for a “revenue share.” You may never know this arrangement exists unless you ask. Referral arrangements aren’t always bad but you should absolutely know if one exists.

** this is not a comprehensive list; for example, if they don’t custody their assets with a reputable third party, that is a big red flag. There can be decent advisors that fail certain of these tests but the odds would be stacked against you.

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