To help protect themselves from being taken advantage of by financial sales professionals, retirees should ask the following questions about the financial professional seeking to provide them with investment advice or sell them an investment product:
“Are you a fiduciary, and how are you registered?”
“This question is critical as advisors can be dually registered and operate as a broker AND a fiduciary, though they’ll still tell you they’re a fiduciary,” says Eric Presogna, Owner and CEO at One-Up Financial in Erie, Pennsylvania.
For over two decades now, the Securities and Exchange Commission (“SEC”) has allowed brokers to register as Investment Advisers and provide both types of services. Prospective clients often find this dual capacity confusing, but the difference is significant. SEC-Registered Investment Advisers must act in a fiduciary capacity, while brokers are under no similar obligation. Why is this distinction important?
“Advisors who possess a fiduciary duty to their clients are required to put their clients’ best interests above their own at all times,” says David Rosenstrock, Director and Founder of Wharton Wealth Planning in New York City. “Many people are surprised to find out that this obligation isn’t required of all advisors. In fact, most advisors aren’t required to act as a fiduciary in all their interactions with a client. Advisors who are not fiduciaries often follow the suitability standard, but that only requires that they give clients advice deemed ‘suitable’ for their situations; thus, it offers fewer protections/safeguards to clients. The term fiduciary is still not widely known and understood.”
If you’re not sure what “fiduciary” really means and it’s not clear what type of professional service your potential service provider plans to offer, there are other paths for you to take to make sure the provider is legally required to always act in your best interest. To determine this, you’ll need to dig a little deeper into the person’s certifications and licenses.
“Some red flags that an advisor doesn’t always act as a fiduciary include a Series 7 license and a Series 63 or 66 license,” says Rosenstrock. “If a financial advisor has a Series 7 license, that individual is allowed to collect commissions from the sale of investments, which means that professional doesn’t always act in a fiduciary capacity. A Series 63 or 66 is another license that a financial advisor needs to collect commissions on product sales.”
“How long have you been doing this, and what are your qualifications?”
Many advisors rely on word-of-mouth advertising because it entails an endorsement from the referrer. While this may sound ideal, it doesn’t mean you shouldn’t do your own due diligence. After all, just because someone is friendly doesn’t make that person competent.
“It is important for a retiree to understand the professional background and qualifications of the financial professional seeking to sell them an investment product,” says Garett Polanco, CIO at Independent Equity in Fort Worth, Texas. “This can help the retiree determine whether the professional is knowledgeable and competent in the field and whether they can be trusted to provide sound financial advice.”
If the professional is a Registered Investment Adviser, you can do your own research on the individual or the firm by going to the SEC’s website. For brokers, you’ll need to go to a different website.
“If the advisor is a broker, check the broker’s credentials at FINRA’s Broker Check website,” says Coconut Creek-based financial author Craig Kirsner. “Also, look at the broker’s website and search for the broker online. Does the broker seem to have a good reputation? If there are a lot of people with the same name as the broker, use quotation marks around the name to limit the search. Check the broker out with the Better Business Bureau. Also, go to the broker’s Google Maps location and see what the reviews are there.”
“Where will my money be held?”
Bernie Madoff got away with his scheme for so long because he not only invested the assets but he provided all the reporting on those assets. To maximize your safety, you’d prefer to have the custodian that holds your assets be a different firm, independent of the advisor’s firm.
“You should ask where the money will be held,” says Kirsner. “Make sure it’s held at a reputable firm or large, highly rated company. Make sure you will have access to see your funds at this firm and only write the check payable to that firm.”
“How do you get paid, and are there other costs I will be paying?”
Speaking of writing checks, never sign the dotted line until you know not only what the advisor is getting paid but what your out-of-pocket fees are for any products that the advisor may place you in. (Note: products can include mutual funds, insurance contracts, and anything other than stocks and bonds.)
“It is important for you to understand the costs involved in any investment product, including fees and commissions,” says Polanco. “This can help you determine whether the product is a good value and whether it aligns with your financial goals.”
Don’t be misled about mutual fund expense ratios. These are not out-of-pocket expenses and are already incorporated into the return data you see from the mutual fund company. It’s similar to a stock return which already includes the operating costs of that company. What matters are the transaction costs and holding fees, which are not part of the operating costs or expense ratio. These can add up and place more pressure on the performance of your investments.
“Most of the issues are related to cost, which creates a high hurdle rate for the underlying investments to clear before the investor makes decent money,” says Stephen Taddie, Partner at HoyleCohen, LLC in Phoenix. “By that I mean, if the cost of the product is 3% annually, the underlying investments need to make 7.50% for the investor to net 4.50%, which by comparison is currently available from a 10-year U.S. treasury bond. If the product is touted as being able to produce a 6-8% rate of return, then underlying investments need to produce 9-10% for that to happen. The follow-up questions with regard to investments would be focused on understanding how the investments will earn that rate in this environment. Often, the risk taken within the product is more than you would take on your own in individual securities.”
“What is your investment philosophy?”
Finally, and to continue the line of reasoning implied by Taddie, you need to explore the particular investment style practiced by the advisor you’re considering.
“Your adviser should go through all the key components of financial advice, such as how, when, where, and why to invest in what,” says Bruce Mohr, Senior Investment Advisor and Credit Consultant at Fair Credit in Decatur, Georgia. “A good investment strategy and a track record of sound investment management are requirements for a financial advisor. Your overall financial health depends heavily on your investments, so you should deal with an advisor who employs strategies you are at ease with. They should be able to properly describe their investment philosophy, plan, and guiding principles utilizing an evidence-based approach. For instance, I believe that diversification is important and that investing in the long term is best.”
If you invest in products instead of individual stocks and bonds, you’ll also want to make sure there are no restrictions, surrender fees, etc. or other repercussions should you decide to end the relationship with the advisor and liquidate the investments that the advisor has placed you in.