You're vulnerable when trusting a financial advisor. First, dealing with money is sensitive in its own right. Second, financial markets are volatile and downturns happen, in spite of the best financial advisors. So how is the consumer able to figure out whether he or she is getting sound financial advice?
Look Out for These 5 Red Flags
Review these 5 warning signs to sniff out whether you may be getting bad financial advice.
1. Your advisor balks when you ask how he or she is paid. Financial advisors don’t work for free, and it's important to understand how yours is paid. In general, if your advisor is paid on a commission basis, then there’s greater incentive to work first for him or herself by recommending excessive buying and selling of securities. In fact, there’s a name for this type of unscrupulous behavior, it’s called ‘churning.’ (For more, see: Fee-Only Financial Advisors: What You Need to Know.)
2. Your advisor is not a fiduciary. The fiduciary standard requires your money steward to hold your assets in trust and manages the assets for your best interests, not their own.
Although not a guarantee of bad financial advice, advisors who are not fiduciaries have a strong potential conflict of interest. There is a laundry list of types of certifications for financial advisors; CFA, CPA, AIF, CFP, EA, CEBC, and more. Actually, there’s no universal designation for the financial practitioner. But one thing is certain, you want an advisor who puts your interests ahead of their own. (For more, see: What You Need to Know About the Fiduciary Standard.)
3. Your advisor promises an abnormally high guaranteed rate of return.
Financial markets are volatile and returns go up and down. It’s not unusual for the stock market to fall 10 or 20% one year only to rebound the next. The same holds true for the bond markets. Although there are fixed income products, such as certificates of deposit and annuities, with promised rates of return, if the advisor promises a higher than market rate of return, be wary. Risk and return are inversely correlated. In other words, in order to have an opportunity for a higher rate of return, you necessarily need to take on greater risk. Be skeptical when you’re offered a secure and high rate of return. (For more, see: How To Avoid Falling Prey To The Next Madoff Scam.)
5 Signs You’re Getting Bad Financial Advice
4. Don’t be swayed by pedigree. The advisor garners total trust because of their impressive educational background. There are unscrupulous advisors with degrees from prestigious universities. There may also be scammers in your church, alumni organization, or neighborhood group (See: Affinity Fraud.)
Affiliation doesn’t equal trust.
Harvard educated Gabriel Bitran, a former professor and associate dean of the prestigious MIT business school, along with his son, Marco, promised returns of 18% to 23% from their proprietary computer program. Their hedge fund, GMB Capital, siphoned money from their clients accounts and they ended up in prison. (For more, see: Affinity Fraud: No Safety In Numbers.)
5. Run, don’t walk if the advisor asks you to make checks payable to him or her personally instead of a a well regarded transfer agency or firm.
Understand proper investment management procedures. Watch out if you don’t receive monthly statements and/or the statements are not clear and easy to understand. If the firm’s investment communications do not include the name of investments in the account, yield of investments, market value and cost basis of the investments, then be wary. (For more, see: Top Financial Advisor Scams and How to Avoid Them.)
The Bottom Line
It’s your money and ultimately you must be responsible for vetting the financial professional. There’s never a ‘guaranteed’ perfect investment or financial advisor. Use good judgment and practice due diligence when contracting with professional money managers and advisors. (For more, see: Paying Your Investment Advisor: Fees vs. Commissions.)