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During my career I’ve been interviewed several hundred times by potential clients.  In almost every case during the interview the prospective client runs out of questions very quickly.  Investors just don’t know what to ask.   You can find many good questions with the aid of a Google search and every advisor will be able to answer them.   But what about questions that could separate the good from the exceptional?

It would not be an exaggeration to state that skill and knowledge of your investment advisor can have a significant impact on your future.   Ideally what you’re looking for is someone who can guide your assets smoothly in good times.  Then, not be surprised and unprepared during the bad times.  You’re not looking for perfection as it doesn’t exist.

Take most sales pitches with a grain of salt, the interviewee may sound convincing but how do you really know?  You have to ask the right questions and below are a few that should help your process.

These questions are really designed to be directed to professionals who actually manage client assets such as RIA’s or portfolio managers. If you’re interviewing a Financial Planner  they may not be able to answer one or more.  FP’s are commonly generalists and defer client assets to products such as mutual funds, insurance or Exchange Traded Funds so they may not have the necessary expertise.

  1. Are you a fee based advisor or do you work on commission?” Commission-based advisors or brokers may not follow your investments performance as compared to a fee-based advisor.  In general, they’re salespeople who represent a brokerage firm. Fee-based advisors should work to protect your assets in down markets and grow them in good times, since their fees are based on total assets under management.
  2. Of the assets you have under management are they mostly allocated to mutual funds, ETF’s (Exchange Traded Funds) or individual stocks or bonds?” If the advisor answers mutual funds, ETF’s or the basket approach used by FolioInvesting or any other Robo (Betterment) the odds are very high that the advisor is a generalist.  Generalists are not prepared to get granular regarding your portfolio.  Maybe you believe single digit long term returns are fine.  But if you’re looking for long term returns in excess of 10% or more you’ll need an advisor with talent and expertise.Not every active portfolio manager will beat the major indices even though it’s really not that hard to do. Just don’t assume they all do well, most don’t. The good ones can answer the questions below and why wouldn’t you want a good one?
  3. Assuming you’re looking for an advisor familiar with Socially Responsible Investing: “Tell me your philosophy about socially screening a potential investment?” At some point the advisor should ask what your boundaries are or how pragmatic you can be.  Be advised that the only way to be sure you have a diversified portfolio that is free of objectionable investments is via individual stocks and bonds.  With individual securities you’ll have input. 
  4. Once you’ve screened out the objectionable investments: “Please tell me how you select companies that pass the screen into a portfolio?”  Or, “Do you have an investment style that you can tell me about?” Advisors who use individual stocks should have a proven method or algorithm to select their client investments.  Without a systematic approach the returns will be more luck than skill and you’ll probably be better off with an Index fund.  Beware of the advisor who tells you their system is extensively back-tested.   Extensive back-testing leads to curve fitting or confirmation bias.  These heavily tested systems will likely fail in the future.   The best systems are relatively “loose” and have some discretionary room for the advisors experience and judgement.
  5. Ok, I’ll admit this next question is a “gotcha question” but every good advisor should be able to answer this one correctly:  “Is the position size of a new position in portfolio based on a % of account assets or volatility?” Position weight should always be based on volatility.  The most volatile investments should have the lowest % allocated to them.  For more information on position sizing see Van Tharp.
  6. The classic: “Can you demonstrate a long term track record?” The SEC and state regulators frequently frown upon stating track records under the assumption that all returns by advisors are random.  Managers and styles can run hot and cold but the best ones learn to adapt and evolve.  If they can produce a track record ask if the use of margin or leverage was employed in the portfolio.   Margin or leverage can increase the rate of return but it comes with exponentially rising risk.
  7. Every great investor or advisor has an insatiable curiosity and is a reader.  We always want to improve which will be reflected in our client accounts.  Ask “What is the last good book or white paper you’ve read regarding investing and what did you learn from it?”  
  8. This is a simple question but it’s also the most revealing and the important on this list. Most advisors or financial planners fail their clients regarding long term risk.  They fail their clients by either lack of knowledge or failure to understand risk. “How will you protect my assets during the next recession?” It’s been 9 years since the last major recession induced bear market.  That means many advisors have never actually experienced a bear market with client assets under management. If the planner or advisor tells you that bear markets can’t be predicted or you get a disorganized word salad then reject the advisor.  Learn to understand what an Inverted Yield Curve is.  Otherwise be prepared to lose 35% or more of your portfolio some point down the road.   Remember the law of numbers: If you lose 35% of your portfolio it will take a 50% return to break even again and that takes years.