1. What is an investment advisor and what does one do?
Investment advisors primarily help clients select investments for their portfolio which are appropriate for their situation, goals, and risk tolerance. I like to describe it as putting your portfolio on autopilot. Investors can change course at any time, or even take over manually, But otherwise, investment advisors pilot their clients' portfolios automatically on an ongoing basis.
More and more investment advisors are also providing financial planning services. Financial plans help determine which investments are most suitable for a client given their situation and goals. It's a vital step for clients who are not already experienced with investing in the markets.
2. What's the difference between an investment advisor and a financial advisor?
"Financial advisor" is a broad and vague term that includes investment advisors, financial planners, and many unrelated professionals like insurance agents. But only some are licensed to recommend stocks, bonds, and funds. That takes a securities registration, held by an investment advisor or a broker. Many people with a "financial advisor" title sell products which are not investment securities, such as life insurance or fixed annuities.
Investment advisors are also the only ones who can both advise on securities and carry an ongoing fiduciary duty to their clients.
3. How are investment advisors paid? What's the average cost?
The classic investment advisory fee is 1% of assets under management (AUM) per year. The fee-for-advice model goes back more than a century. It is based on impartial advice for a fee on assets in order to minimize conflicts of interest that arise from commissions. AUM fees keep incentives aligned. Advisors are paid more when the client's portfolio grows, and less when it shrinks.
4. What are the fiduciary and regulatory responsibilities of investment advisors?
Investment advisors are required to provide advice in the best interest of their clients. This means that they must not recommend investments to increase the advisor's compensation. Generally, this also means selecting funds with lower fees. All conflicts of interest must be disclosed to potential clients. Check Items 5, 10, and 11 of the ADV brochure they provide.
But beware. Some advisors are "dually registered". The same firm or person can be licensed both as an investment advisor and as a broker. The catch is they can switch roles without necessarily telling you. They may act as your fiduciary advisor in one conversation and as a broker earning a commission in the next.
5. How can someone choose the right investment advisor for them?
Verify their fiduciary duty. Ask directly: "Are you a fiduciary on every recommendation you make to me".
6. When should someone hire an investment advisor?
It's never too soon to hire an advisor, particularly for novice investors who want to avoid costly mistakes. Another natural time, is when an investor begins shifting assets from equities to fixed-income in anticipation of retirement. This may commence 10 to 20 years before retirement. Advisors can help determine the appropriate mix of investments. Most retail investors have much less experience with bond investing, and this is an area where professional advice helps considerably.