The first good question to ask a potential broker would be “How are you compensated?” Not every financial advisor is compensated the same way. Some of them are compensated on a commission basis, which is per transaction. Every time they make a recommendation for you and you agree, they get paid. Some of them are being paid a percentage of assets under management. If you have a million-dollar portfolio and they make 1%, they are going to make $10,000 a year.I strongly suggest you to visit Network Finance to learn more about this.
You can determine what you are looking for based on what kind of investor you are. If you’re a buy-and-hold investor, maybe a commission model makes sense for you because maybe you’re only doing two or three trades a year. If you’re trading a lot and you’re having a very active relationship with your advisor maybe the assets under management model makes more sense. But ask the question first and foremost so that you know and it’s not ambiguous.
The second question to ask is “does the financial advisor have a fiduciary duty to you.” Ask them that exact question because the brokerage industry will take the position that they don’t. Their obligation to you from their perspective is to make an investment recommendation that’s suitable. That’s a much lower bar because sometimes an investment could be suitable for you but not necessarily in your best interests. So just ask your financial advisor, “Do you consider yourself to have a fiduciary duty to me?” Let’s figure this out at the beginning of the relationship to make sure you know where you stand.
Another question you should ask is, “Who are you registered with?” A lot of financial advisors out there are sort of independent and they’ve got a “doing business as” business, wherever their offices are, but they are registered to sell securities through a larger brokerage firm. Find out who that is. Do some research to make sure that you’re getting involved with a brokerage firm that has the types of supervision and compliance that you would expect.
There are two types of brokerage firms. There is the Morgan Stanley model where they have a hub of brokers in a major city. Maybe 30-40 brokers in one office. There are compliance people, there are supervisors, there are operations people – all in the same localized office. In my experience you see less problems in that type of situation because all the supervisory people are right there.
On the flipside, there is the independent model – it’s an advisor in an office someplace and their compliance is in Kansas City or Minneapolis or St. Louis or wherever. The supervisor comes to the office once a year and audits the books and reviews the activities of the advisor for the prior year. These visits are usually announced well in advance. Obviously the supervision in that context is very different. And that is the type of firm where we see more problems.
You want to make sure you’re getting involved with the right firm. That the firm is overseeing your financial advisor, protecting you, making sure that if they are doing something wrong, they will catch it before it’s detrimental to your accounts.
Another good question to ask, “Have you ever had a dispute with your client?” If they say yes, ask him to explain it to you. Nobody is perfect and you can’t keep everyone happy so if you’ve got a hundred clients and you have been in the business for 10 years you might have somebody who’s been upset with you at some point. But it may not rise to the level where it concerns you, but ask about it, talk about it.
Ask about their investment background and their objectives. Not every financial advisor does it the same way. You want to make sure that their goals are consistent with yours and their approach is consistent with yours.
And finally you should ask “do you have insurance?” The brokerage industry does not require brokerage firms or financial advisors to carry insurance. Many of them do but they are not required to do so. Why that can be significant, of course, is in that worst-case scenario and you have a dispute with your advisor, you want to at least be with a financial advisor that if they do screw up you’ve got some protection. So ask them “do you have E&O insurance for this?” If not, that is a red flag. Either just because of collectability concerns if you get into a situation where you need to sue your advisor or it might be a suggestion that they are not operating their business in the best way possible because certainly financial advisors should have E&O insurance.