You may wonder what a financial advisor does with your money and how this professional decides on the best investments and course of action for you. This article breaks down, step-by-step, exactly what a financial advisor does. You’ll understand what informs the advisory process and how the professional selects appropriate investments for you. In sum, this money professional has a detailed plan and system to help you construct your life today and tomorrow as well as how to grow your wealth.
The financial advisor is your planning partner. Together, you and the advisor set financial as well as personal goals and then figure out how to make them a reality. For example, you may want to buy a vacation home, or send Junior to a private university in 10 years. In order to accomplish your goals, you need someone to help these plans a reality and that’s where a financial advisor comes in.
Together, you and the advisor will touch upon many topics including; how much money you need to save, what types of accounts you need-retirement, trust, etc., debt and mortgage loans, types of appropriate insurance including long term care, term, disability, and more as well as estate and tax planning topics. (For more, see: Why Choosing the Right Advisor is Crucial.)
The financial advisor is also an educator. Part of the advisors task is to help you understand what is involved in meeting your future goals. The education process may involve detailed help with financial topics such as budgeting and saving in the most basic cases. On a more advanced note, the advisor will assist you in understanding more complex investment, insurance, and tax matters.
Step one in the financial advisory process is understanding your current financial health. You can’t properly plan for the future without knowing where you stand today. Typically, there is an extensive written questionnaire for you to complete. These questions help the advisor to understand your situation and make certain you don't overlook any useful information. (For more, see: What Type of Person Needs a Financial Advisor?)
The Initial Questionnaire
The advisor works with you to clarify your assets (what you own), liabilities (what you owe), income, and expenses. You’ll also indicate future pensions and income sources, project retirement needs and any long term financial obligations. All current and expected investments, pensions, gifts and sources of income will be listed and projected into the future. (For more, see: Shopping for a Financial Advisor.)
The investing component of the questionnaire touches upon the more subjective topics such as your risk tolerance and risk capacity. An understanding of risk assists the advisor when it’s time to determine your investment asset allocation. You'll let the advisor know your investment preferences as well. Do you prefer individual stocks and bonds, mutual funds, or a combination of both?
Included in the initial assessment is an understanding of other financial management topics such as insurance issues and your tax situation. The advisor needs to be aware of your current estate plan as well as other professionals on your planning team, such as your accountant and lawyer. Once you and the advisor understand your present financial position and future projections, you’re ready to work together and develop a plan to meet your life and financial goals. (To learn more, see Paying Your Investment Advisor - Fees or Commissions?)
The financial advisor synthesizes all of this initial information into a comprehensive plan.
The Financial Plan
The actual financial plan comes after you complete a questionnaire, participate in conversations with the advisor and learn about the process. Consider the financial plan as a roadmap for you financial future.
The plan begins with a summary wrap up of the key findings from your initial questionnaire. The plan will summarize your current financial situation including net worth, assets, liabilities, and liquid or working capital.
The financial plan also recaps the goals that you and the planner discussed.
The analysis section of this lengthy document drills down into several topics including: your investment risk tolerance, legal estate planning details, long term care risk and other pertinent present and future financial issues related to your individual situation. (For more, see: Standards and Ethics for Financial Professionals.)
Based upon your expected net worth and future income at retirement, the plan will create simulations of potential best and worst case retirement scenarios. It will look at reasonable withdrawal rates in retirement from your portfolio assets. Additionally, the plan needs to drill down into survivorship issues and financial scenarios for the surviving partner.
Other topics which must be covered in the financial plan include how much money you will need to meet your desired goals. The advisor must touch on the scary possibility of outliving your money and steps to insure that does not occur.
After you review the plan with the advisor and adjust it if necessary, then you’re ready for action.
Financial Plan Action Steps
The initial questionnaire and financial plan drive the next process.
The advisor will set up an asset allocation which fits both your risk tolerance and risk capacity. The asset allocation is simply a rubric to determine what percentage of your total financial portfolio will be distributed across various asset classes. The more risk averse individual will have a greater concentration of fixed assets and the risk taker will lean towards more stock assets.
Each financial advisory firm will act in accord with the company investment policy when buying and selling financial assets. The company’s investment policy drives their particular approach. The investment selection process varies among firms. Some financial advisors work with one fund company and limit investments to that provider. Others mix in individual stocks, bonds, and other types of financial assets such as commodities, real estate funds, and even alternative assets. It’s important for you, as the consumer, to understand what your planner recommends and why. (For related reading, see: Choosing a Financial Advisor: Suitability vs. Fiduciary Standards.)
A commonality among firms is that financial products are selected to fit in with the client’s risk profile. For example, a 50 year old man who’s already amassed enough net worth for retirement and is predominantly interested in capital preservation may have a very conservative asset allocation of 45% in stock assets and 55% in fixed assets. Whereas a 40 year old woman with a smaller net worth and a willingness to take on more risk in order to build up her financial portfolio may opt for an asset allocation of 70% stock assets, 25% fixed assets, and 5% alternative investments. While taking into account the firm’s investment philosophy, your personal portfolio will fit your needs; when you need the money, your investment horizon, present and future goals. (For more, see: 5 Things to Ask Before Hiring a Financial Advisor.)
You’ll receive regular statements updating you on your investment portfolio. The advisor will set up regular meetings to review your goals and progress. Frequently, you’ll meet remotely via video chat in lieu an of in-person meeting. It’s important to consult with your financial advisor when you experience a significant change in your life which might impact your financial picture. (For related reading, see: 3 Life Events That Can Ruin Retirement Plans.)
The Bottom Line
Not all financial advisors have the same level of training or will offer you the same depth of services. Thus, when contracting with the advisor, do your own due diligence first and make certain that the advisor can meet your financial planning needs. Check out his or her certifications before engaging the advisor. Make certain that you understand and agree with the fee structure and approach of your financial advisor. (For more, see: 7 Steps to Evaluate a Financial Advisor.)