Your year end investment account statements are coming in. It’s annual review time and most people won’t even hear from their financial advisor. It is important to note, however, that you’re probably paying someone something for the pleasure of having your account. Now is the perfect time to hold them accountable.
Here is a list of 6 questions you should ask them regardless of your level of satisfaction.
1) What was your net return for 2012?
This is a pretty easy calculation that most of you can do for yourself. Simply take your beginning balances, adjust for deposits and withdrawals, and see how you ended up for the year. But that’s not the point. By asking your advisor to do the work it A) makes them evaluate how they did for you for the year and B) sends them the message that you’re paying attention.
Here’s a side note: In my 17 years in this business I can tell you that the vast majority of people don’t ask for this information and, thus, most advisors think that people are satisfied. But I can also tell you that most people I speak to would like to something different in their relationship with their money person be it communications, service, returns, whatever. Let your advisor know your expectations then see if they can deliver.
2) How did you do compared to various market indexes?
It’s important to know the nominal returns you got but it’s every bit as important to know them in the context of “compared to what?” You’re returns may have meet your expectations but if you were 100% long in stocks and only returned 5% against a 13% market you didn’t get paid for the risk you held.
Whether you underperformed or overperformed ask them why or how. It may be that they kept with a great deal of cash intentionally to reduce risk and preserve capital. That’s fine, but you need to know the thinking.
3) What work did your advisor do to minimize your tax burden?
It is not uncommon for people, especially those invested in mutual funds, to have larger capital gains than their portfolio performance would indicate. I recently did an analysis of an account where the book value of the portfolio had risen by 6% but the realized gains were 22%. The tax burden effectively cut the after tax return to a paltry 2.3% in a portfolio that was 70% equities and 30% fixed income. This makes absolutely no sense insofar as a portfolio of high grade insured municipal would have had nearly the same return with substantially less risk. If you’re advisor doesn’t do a periodic review of you capital gains positions it could seriously damage your real returns. And although taxes are not the purview of investment advisors they have the information to help you – and your accountant – make informed decisions. Make sure they know you understand this.
4) What are the indirect carrying costs of the assets in your portfolio?
This problem is particularly acute with mutual funds. Open ended fund managers charge management fees that range widely from fund to fund. These fees are disclosed in the (usually unread) prospectuses that you receive once a year but they are often neglected by the advisor. Funds charge anywhere between .25% to as high as 2% to manage your money. Considering that 70% plus of mutual funds under-perform the market, a big part is due to high fees. It’s also important to understand that within those management fees are often payments to your advisor known as 12b-1 fees. Your advisor often receives around .25% on your outstanding balances just for having the account. To me this is a huge flaw with owning mutual funds as your account executive gets paid whether they add any value or not. This might not be the case but you need to know how your advisor is getting compensated by you.
Unfortunately there a other costs associated with investing that need not be disclosed such as discounts on bonds. Making sure your advisor knows that you understand the impact of carrying costs to your returns will go a long way in increasing your net returns.
5) How did they decide what assets you should own for the period?
Asset allocation is big, big issue in portfolio management. There are basic rules of diversification that good advisors follow. The problem is that most managers don’t review how your personal situation may have changed over the year(s) nor do they think much about absolute exposure (total amount in securities vs cash) as they do about relative exposure (as in stocks v bonds.)
My experience tells me that most advisors do an OK job of this when bringing the account in (the sale) but neglect it going forward. Some plug your account into an automated re-balancing system which might work OK but often fails when you need it the most.
Regardless, you need to know.
6) How many accounts does your advisor manage?
I read somewhere that the average account executive has about 600 accounts in her/his portfolio. Their bosses might like that but the bigger the book the less attention you’ll be getting. A large book may show whether or not the institution is focused more on sales than service. It might also show the same for your account executive if, year-over-year, that number increases rapidly.
There are many other questions you should routinely ask about your account but this is a good place to start. As you become more familiar with what your advisor does and how she/he does it you will learn to ask better questions.
And, if your advisor can’t answer any of the above to your satisfaction it’s time to start looking elsewhere. This is your money and the financial community has to earn their pay. Demand it.