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Five Questions To Ask Your Broker

09/15/04 02:20:56 PM PST
by Nathan W. Slaughter

How can you choose an investment advisor who's right for you?

Learning the intricacies of the capital markets and formulating a sound investment strategy can be a daunting task. Even experienced investors may have questions when it comes to portfolio construction and asset allocation. What percentage of my 401(K) should I devote to international investments? Should I choose blue-chip European stocks, or roll the dice on speculative small-caps in the Pacific Rim?

Others may have broader questions regarding financial planning concepts. Is my money better off in a Roth IRA or my company's retirement plan? Given my tax bracket, should I be looking at municipal bonds, or would high-yield corporate bonds make more sense? Should I contribute more to my daughter's 529 plan?

With tens of thousands of stocks, bonds, exchange-traded funds, annuities, mutual funds, CDs, and other investment vehicles to choose from, complex and ever-changing tax legislation complicating matters, rising interest rates affecting the fixed-income arena, and uncertain global macroeconomic trends underpinning a volatile stock market, is there any wonder why so many investors are seeking the guidance of financial professionals?

A financial advisor can help show you the big picture, and draw a road map for your financial success. Together, you can build a portfolio that is aligned with your short- and long-term goals, risk tolerance, and investment time horizon. To achieve this, your advisor will likely ask you many questions, but first, there are five you should be asking.

How do you get paid?

Most financial professionals, whether they go by the title of advisor, broker, registered representative, wealth manager, or any other moniker, derive their income from commissions, fees, or some combination.

Conventional wisdom sometimes dictates that commission-based advisors are more interested in increasing their own wealth than in building yours — that each trade they make on your behalf removes money from your side of the ledger and places it in theirs. Certainly, there are some unscrupulous advisors — just as there are dishonest people in any profession — who may trade excessively (this practice is known as churning) to generate more commission dollars. However, most work hard to earn your trust, if for no other reason than to keep your business and possibly receive referrals.

On the other hand, fee-based advisors charge a fixed percentage of assets under management. For example, a $50,000 account with a 1.5% management fee would cost you $750 per year in fees, which are typically deducted quarterly. Under this arrangement, most transactions are free of charge, and the advisor has a vested interest in seeing your account grow.

Which is right for you? That depends on how actively you trade your account. If you are a buy-and-hold investor, you may come out ahead just paying a few up-front commissions and then leaving your account on autopilot. Why continue to pay quarterly fees if you don't have to? However, if you trade on a more frequent basis, then commissions will likely begin to add up, eroding your returns. If this sounds like your style, consider a fee-based account that allows limitless, commission-free transactions.

What is your investing philosophy?

Regardless of whom you appoint to manage your investments, ultimately, their task is the same: to make you money. For this reason, you may want to know your advisor's fundamental investing philosophy. Does he or she have strict criteria for selecting stocks, mutual funds, or separately managed accounts? Does he have a qualitative and quantitative screening process to weed out underperforming investments from consideration? If so, ask him to elaborate on his methodology.

You may want to better understand your advisor's views on load versus no-load funds, index versus actively managed funds, diversification, tax efficiency, and other similar issues that may come into play. The bottom line: no one can guarantee profits, and everyone makes mistakes, but if you are handing over the reins of your portfolio, you deserve to know how the advisor intends to manage your money, and what he or she looks for in an attractive investment.

What types of financial products and services do you provide?

In the old days, the barriers separating banks from insurance companies from brokerages kept things fairly straightforward. These days, your car insurance agent is happy to provide mutual funds, your stockbroker may tout a new cash management account with check-writing privileges and a debit card, and your banker has brochures for a term life insurance policy.

It is important to learn what type of advisor you are dealing with. Some advisors are from the old school of stockbrokers, and have little use for mutual funds, annuities, and retirement planning. This is fine, provided you are only interested in building a portfolio of individual equities. Others may primarily be tax advisors who have begun to offer ancillary services such as asset management. Increasingly, though, most wealth advisors take a comprehensive, consultative approach, and can assist with anything from taxes to insurance to college funding.

Where do you get your research?

In the past, there have been instances where a company's investment banking division presented possible conflicts of interest with the research it provided. Large brokerages seldom issued sell recommendations on companies with whom they had an investment banking relationship. Now, increased regulatory scrutiny and mandated objective research from third parties has alleviated this concern.

Nevertheless, most advisors spend the majority of their time prospecting for new clients, or meeting with the ones they already have, rather than scouring the market for investment ideas. Some conduct their own independent research/analysis to a certain extent, but most rely on other sources. The more research a broker has at his fingertips, the more tools he has to steer your portfolio in the right direction.

Many top-tier brokerages maintain a recommended list of select stocks, picked by their in-house research department, with a verifiable track record against a given benchmark. If so, ask to see recent performance, but keep the results in perspective. Whether the performance is dynamite or middling, it does not necessarily indicate how well the broker will perform for you.

Where do we go from here?

As a former advisor, the top complaint that I heard from prospective clients was some variant of "My old broker took my check, and I never heard from him again."

It is vital that the lines of communications with your advisor be kept open. The markets are volatile and can turn on a dime. Underperforming investments need to be assessed, and possibly liquidated. Asset allocations need to be periodically rebalanced; year-end tax planning needs to be discussed. These are just a few of the reasons you should stay in regular contact with your advisor.

The harsh reality is that $1 million accounts will nearly always be given preference over $1,000 accounts. Whatever the balance of your brokerage account, don't be dissuaded from asking your advisor about his service policy. Most are honest and forthcoming.

If someone tells you point-blank that your account is below their radar screen, respect that and find someone else.

These five questions can go a long way toward determining whether an advisor is right for you, but they are only guidelines. It is likely that there are other concerns or issues you would like to see addressed. A professional advisor/client relationship can often be a harmonious (and profitable) partnership that lasts for many years. In a world where there are no guarantees, exercise prudent judgment over the one facet of your portfolio that you can control: Take the time to find a competent, trustworthy financial advisor.

Nathan Slaughter is a freelance financial writer. He may be reached at

Current and past articles from Working Money, The Investors' Magazine, can be found at

Nathan W. Slaughter

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