Do You Understand Your Advisor’s Recommendations?

April 21, 2015

I recently spoke to a friend who wanted to ask my opinion about her current financial advisor. Knowing that I have a slight addiction to chocolate, she offered me her homemade Godiva Hot Chocolate with a chocolate coated bottom for my trouble. Of course I would have offered my opinion at no cost, but who am I to turn down her homemade hot cocoa? As I listened, she started to describe how she was referred to him though a family friend so she did not feel the need to do a background check or ask him questions about how he gets paid. She took it on faith that if her family member recommended him then she would be fine.

The first thing that I noticed is that she was not really working with her advisor. She was taking instructions without being an active participant in the process. She had no idea of his background, his experience, how he was compensated or even the reason behind what was in her portfolio. I told her that the first thing that needs to be done is a background check on the financial planner and to get a clear understanding of his background, experience, how he gets paid, and what he is charging her.

If everything checks out okay, next would be to clearly establish what kind of relationship both of you will have and set some expectations. For instance, will you be simply buying a product or a service or will you be getting a comprehensive financial plan? Will the service include monitoring, the ability to call with questions? Also, how often will she hear from her planner?

This relationship is a partnership. As a partner, you should be involved in every step of the planning process. Your planner should explain the reasoning, pros and cons (there are always pros and cons to every choice), to help you make the most informed decision.

She then told me that he has a track record of a 10% rate of return in all markets, risk-free. This did not raise a red flag for her, but it raised a huge one for me. I asked what information he gave her about her track record. She said he showed her how he maintained a 10% rate of return through good and bad markets. I asked for the sheets and it turned out to be an annuity that in fact did not even give the rates of returns he promised.

I asked her if she knew it was an annuity and she said she was told it was a way to invest in the market with none of the risks. I told her that there are no investments without risks. A money market account has the risk of not keeping up with inflation, an annuity runs the risk of not having your money available when you need it, the stock market runs the risk of going up and down, and an advisor should explain the good and risks of all investments. Not to mention that my friend was in her early 30s, was fine with risk and likes the option of having her money liquid, the annuity information he sent her had a 15 year surrender charge.

She turned pale as she told me that she had no idea that the “investment was actually an annuity” and that she had signed the paperwork for an annuity. I asked her if she got her annuity policy and she said it was delivered a few days ago. I told her that she is in luck since she has what is called a “free look” period, which is the period of time after the delivery of the annuity policy to review it and decide if she wanted to keep it. If she did not, she could get a complete refund.

The “free look” period is generally at least 10 days from the time you receive the policy. You can find out your state’s free look period by contacting your state’s insurance commissioner’s website. Her state had a 10 day free look period. I told her to contact her state’s Department of Insurance directly if she had any problems. Luckily, that didn’t happen and she was able to get all of her money back.

The lesson from all of this is that when working with an advisor, you need to completely understand any recommendations they make even if you trust them. Any information you are given, if not understood, should be fully explained to you. Trust your gut instincts. If you are suspicious, check the broker’s record and ask questions about anything you are encouraged to purchase. You should not make any investment decision without understanding the investment, exactly how it fits into your plan, the good and bad (every investment has both) and how this is the best fit.