The new year is a time to start afresh but as the saying goes, “those who do not learn history are doomed to repeat it.” So, when you meet your advisor or check on your portfolio next, ask your financial advisor these 12 questions to understand your portfolio’s history and to chart a path forward:
Ask your financial advisor these questions if you went through a life event
- Best ways to manage your finances together or separately, depending on your and your spouse’s wishes
- Any tax benefits and tax planning you could do jointly
- Any need to update account tile, change trusts or wills, or update insurance
- Talking to your advisor about a separation or divorce early on might spare you financial mistakes down the road
- Children and new dependents
- Strategies to pay for college like a 529 savings plan
- Opening a gift to minor account such as a UTMA or UGMA
- Update trusts or wills and life insurance
- New money
- Contact your advisor to invest any inheritance, insurance payout, business proceeds or lottery winnings
What are my returns after all fees?
Returns, also known as “performance” are incomplete if you are just looking at them before fees. Your total fee consists of fund fees and advisor fees. Fund fees are charged by the mutual funds and ETFs in your account. Typically, the returns that ETFs show are after all fund fees. Mutual funds also show returns after all fees, except for the sales load. A sales load is a charge you might pay when you buy a mutual fund or when you sell it. If the fund has any load, be sure to get performance net of it.
Advisor fees are charged by your advisor who manages your portfolio that in turn consists of many mutual funds and ETFs. So, when you see your total portfolio return, ask for the figure after all fees, including the advisor fee.
How do my returns compare to its benchmark?
A benchmark is a yardstick for your account so that you know how well you did. For example if you have a fund that generated 20% in return last year, you might think it’s great. But if you compare it to its benchmark, the S&P 500 Index that generated over 31%, now, you might not think it was so great.
Each fund you invest in will have its own benchmark. Similarly, your total portfolio also has a benchmark. Let’s say that based on your time horizon, you determined that you need to be 60% in stocks and 40% in bonds. Then, your benchmark could be 60% stocks and 40% bonds or 60% S&P 500 index and 40% Barclays Aggregate index.
You can also have more than one benchmark. If you cover your living expenses from your portfolio, these expenses could be your second benchmark. For example, if you need to make 5% in returns to support your lifestyle, then 5% could be your personal benchmark. If your portfolio is not covering this, talk to your advisor about what changes you need to make.
What changes did you make to my portfolio and how did they do?
One of the main reasons why we hire an advisor is to monitor the portfolio and change it as market conditions change.
When you first start your relationship with your advisor, they should brief you on the changes they might make as markets change.
There are mainly two ways of changing your portfolio. The first way is for the funds in your portfolio to change their investments as they see new opportunities or risks. For example a fund might sell some of their financial services stocks to buy tech stocks as they see opportunities.
The second way is for your advisor to add to or reduce the fund itself. For example, if they sense that the economy is stagnating, they might sell some of your non-US funds and add to more defensive US funds to start preparing for a global slowdown.
Ask your advisor what changes they made and what impact did it have on the returns. Did it add to the returns or hurt? Your advisor might already be communicating these changes to you proactively via newsletters or announcements on their website.
If you do this consistently, you might find that your advisor is sometimes wrong. Sometimes, the move they make turns out to be entirely wrong or premature. If this happens, ask if this was the right move given what they knew at the time, not in hindsight. Did they exercise good judgment given what they knew? Were the moves consistent with their process and what they promised you at the outset? Of course, you don’t want to be stuck with someone who consistently gets it wrong but if it happens once in a while, these questions will help you determine your advisor’s effectiveness.
What were my deposits, withdrawals and balance changes?
If you are investing with a certain goal like retirement or a large purchase, you should know if you are on track. Additionally, understanding your spending patterns will help you budget carefully.
A rule of thumb we often use in the industry is that as long as you withdraw 3-4% annually from your portfolio, it will leave your portfolio unchanged. That is to say that with this level of spending, you will neither grow, nor deplete your portfolio. Spending above these levels will likely deplete your portfolio overtime.
What are my total fees and what am I getting for it?
Of the many questions to ask a financial advisor, the one about fees is bound to be recurring.
Fund fees will be low if you primarily use passive funds like ETFs. But, if you use any active funds, it will be more. Active funds try to provide a return that is above a certain benchmark. As a result, they also charge more than their passive counterparts that merely mirror their benchmark.
The average fee for a domestic active fund is around .55% of assets under management and the average fee for a financial advisor is another 1.02%. So, say you invest $10,000 in an active fund, you pay $55 in active manager fee, plus another $102 in advisor fee for a total of $157 in fees. This may not seem so alarming but to illustrate the long-term damaging effect of fees, consider this example. In 20 years, 1% annual fees reduce a portfolio’s value by nearly $30,000, compared to a portfolio with 0.25% fee.
If your advisor is consistently beating their benchmark, even after fees, these fees may be justified. If not, the total fee figure will help you compare your advisor to others.
You might also want to ask what other services you are getting for these fees. Some financial advisors will provide extensive planning, tax, insurance, charitable services and many other services at no additional cost. If you need these additional services, it will be important to take them into account to evaluate your advisor’s fees.
Can you bring down the fees?
Explore options to bring down your total fees. If your advisor uses active funds, one way to bring down costs might be to use more ETFs. Some markets such as the US Large Cap are very efficient and there is little for an active manager to do to add value in this space. Hence, an ETF might be a more cost-effective choice to replace an expensive active manager.
What steps have you taken to reduce my taxes?
Your advisor should be taking steps to minimize your taxes. This includes doing tax loss harvesting throughout the year, whereby you take paper losses to offset any capital gains. It also includes using ETFs, where possible, instead of mutual funds. ETFs are generally more tax-efficient. Lastly, your advisor should put your investments in the right location. For example, ideally, your bonds should be in your IRA account, instead of your taxable accounts. In an IRA account, your bond interest will not be taxed, hence reducing your overall tax burden.
If I leave your firm, can I take my investments with me?
Ideally, you should have asked this question before beginning a relationship with your advisor, but even if you didn’t, it’s still advantageous to know this. This will be important if you need to change your advisor if you’re not happy with their service or if they are no longer in business.
If you are invested in ETFs or public mutual funds, you should be able to take your investments with you to a new advisor. Your new advisor will then, evaluate the funds and sell the ones not needed in a tax-efficient manner. But, if you have any private mutual funds or other vehicles that can’t be held outside, you will have to sell them with your current advisor, then transfer out the cash. This will trigger capital gains tax. If you’ve been in these strategies for a long time, your capital gains could be substantial.
So, to the extent possible, try to invest with an advisor, whose platform doesn’t require you to be in any private vehicles that can’t be held outside.
Is there any idle cash or is your portfolio out of balance?
Pay attention to any idle cash sitting in your portfolio from new deposits or dividends. These should be invested right away so that they start compounding.
As time passes, some of your holdings will appreciate and others will go down. This will cause your portfolio to be out of balance. For example, your 60% stock, 40% bond portfolio might become 70% stock and 30% bond as stocks appreciate. Your advisor should rebalance your portfolio by selling the appreciated asset (stocks in this case) and buying the asset that is down (bonds in this case).
What security controls do you have?
Increasingly, account security is becoming top of mind for financial advisors and clients because of the heightened security risks out there from scammers and thieves. Pay special attention to what controls your advisor has to prevent unauthorized parties from transferring money out of your account.
Is it time to review your trust plan, your insurance or your taxes?
Depending on how complex and large your assets are, your advisor can also help review your estate plan and work with a trust and estate attorney to make changes. They can review your insurance needs and suggest changes to close out any gaps. They can also do comprehensive tax planning and review past returns to optimize your tax strategy.
If you have any of the life events discussed above, you should definitely speak to your advisor about planning. If not, you might still want to review it every 4-5 years to see if you need to make any changes.