Evaluating an investment advisor is a difficult and stressful process. Some of the questions you should ask are relatively obvious: How much (and how) do you charge? What other fees might I see? What is your investment philosophy? Do you act as a fiduciary? Are you experienced in financial planning?
But beyond the basics, there are other areas you might wish to explore in making a final decision (or in evaluating your current relationship). These questions are a bit harder, but truthful and fulsome responses to these queries may help you reach a confident decision in selecting a trusted advisor.
– How do you manage risk? The single most effective risk mitigation strategy (and rule number one in portfolio management) is proper diversification. Ask about the manager’s philosophy and practice.
The most cost-effective strategy is to construct a core portfolio of broad index funds or ETFs. Equity index ETFs are the fastest growing investment vehicles and have long ago confounded the Cassandras who prophesied their demise. Still, a well-diversified portfolio of individual securities is appropriate for many clients. If the manager holds individual stocks and bonds, be sure to understand how many. It requires a minimum of 20-30 stocks across a wide spectrum of sectors and geographies to achieve reasonable diversification.
A concentrated portfolio of 10-15 stocks magnifies risks, especially if overweighted in specific sectors, and is appropriate only for aggressive investors. Remember, it’s nearly impossible for active managers to consistently outperform the market after fees, but easy for concentrated managers to badly underperform.