Six Questions Every Proactive Investor Should Ask Their Financial Advisor

And Some Basic Math!

I felt compelled to write this article after recent meetings with two different clients. In each case, they entered into investments where high fees virtually guarantee they won’t be able to reach the projected returns, let alone their own personal goals. We’ll get to the basic math portion in a moment.

According to an article by noted attorney and investment education advocate, James W. Watkins, III, there are 19 different questions to ask your current or prospective financial advisor.  Given 19 is a rather large number, we are going to focus on six of these questions. We did touch on this in our recent post, Avoiding The Wolf of Wall Street, and this is an effort to give you additional support in this important area.

  1. Will you be acting in a fiduciary capacity in working with my account(s)?
  2. Would you be willing to agree to fully and completely disclose in writing any and all actual or potential conflicts of interest in connection with any advice or recommendations you provide?
  3. Would you be willing to disclose, in writing, both the nature and amount of any compensation, of any kind, that you receive in connection with any advice and any product recommendations you make, including commissions, fees, 12b-1 fees, referral fees, finder’s fees, trips and conferences?
  4. Are you willing to disclose, in writing, the terms of any and all revenue sharing arrangements that you, your firm, or your broker-dealer have with any other companies?
  5. In cases when you do recommend proprietary products of your firm, your broker-dealer, or an affiliated company, would you be willing to provide me with a list of comparable no-load mutual funds and/or exchange traded funds?
  6. Regardless of the eventual outcome, have you or your firm ever been the subject of a legal or a regulatory action? If so, are you willing to provide, in writing, the date(s) of such proceeding(s), the parties involved in the proceeding, the court or regulatory body in which the complaint was filed, the nature of the claimed offense, the eventual outcome and the amount of any judgment or settlement paid?

In question #1, the Fiduciary Question has received quite a bit of notoriety due to the Department of Labor recent rule. It’s purpose is to “Address Conflicts of Interest in Retirement Advice, Saving Middle-Class Families Billions of Dollars Every Year.” This is something we have covered and discussed most recently in “Is Your Financial Advisor Working For You?”

Questions 2 – 5 all are related to costs, fees and compensation, and this is where we get into the aforementioned Basic Math. I’m not going to pick on any particular financial services company, but what I’m about to describe represented $237 billion in investment in 2015, and about the same amount in 2014. That’s approximately $474 billion invested in the last two years (yes, that’s the beginning of Basic Math)! The product is annuities, and I’m going to illustrate two real-life variable annuities, some of which was in an IRA.

More math:

  • The financial advisor/agent received a commission of approximately 6-7% of your investment up front. If you invest $100,000, that’s $6 – 7,000. While they are quick to point out it doesn’t come out of your original investment, you are confronted with steep “surrender charges” in the event you want to take your money out. Typically these start out at 8 – 8.5% in the first year, and they decline by about 1% per year. In other words if you invest $100,000 and for whatever reason which to take the funds out in year 1, you will pay about $8,000. There are other strategies to get your money out that lessen this charge, but you need to keep you money in this investment for a longer time period.
  • While most people understand at least roughly the above expenses, here is where additional Basic Math is brought to bear. The following are Annual Expenses in a Variable Annuity, and are very common:

So using this as an example, if you invest $100,000 in this, you will be paying approximately $3,390 PER YEAR! If you consider the return of the S&P 500 in 2015 of 1.40%, that means you would be losing -1.99%! Obviously in better markets you would receive a positive return, but keep in mind you have 3.39% (or more) deducted each year.

In fairness, some of these expenses go into various riders and guaranteed annuity payouts, etc. However Basic Math illustrates how difficult it is to make money in these investments. In particular from our perspective, these have no place in any Qualified Retirement Plan such as an IRA.

There, I got it out of my system. Here’s a good resource piece written by a fellow CFP®, Jonathan Duong, “Variable Annuity Fees – A Guide to Help you Understand How Much You are Paying.” He outlines a concern we hear frequently, “how come my account isn’t growing?” and the reason for this article.

Please, seek out a second opinion before investing your hard-earned money into one of these investments. There are at times a place for them, but they are dramatically overused in my opinion. When looking for a second opinion, my recommendation would be a colleague from the Garrett Planning Network, and certainly we’re happy to assist you at Financial Freedom Planners!

“If you want to work the rest of your life, that’s your business.  If you don’t, that’s ours.”

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About Charles Roberts, CFP®

Founder & CEO, Financial Freedom Planners™
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