You may wonder what a financial advisor does with your money and how this professional decides on the best investments and course of action for you. This article breaks down, step-by-step, exactly what a financial advisor does. You’ll understand what informs the advisory process and how the professional selects appropriate investments for you. In sum, this money professional has a detailed plan and system to help you construct your life today and tomorrow as well as how to grow your wealth.
The financial advisor is your planning partner. For example, you may want to buy a vacation home or send Junior to a private university in 10 years. To accomplish your goals, you need someone to help make these plans a reality, and that’s where a financial advisor comes in.
Together, you and the advisor will touch upon many topics including how much money you need to save; which types of accounts you need (retirement, trust, etc., debt and mortgage loans); the kind of insurance you should have including long-term care, term, disability, and more as well as estate and tax planning topics. (For more, see: Why Choosing the Right Advisor is Crucial.)
The financial advisor is also an educator. Part of the advisor's task is to help you understand what is involved in meeting your future goals. The education process may include detailed help with financial topics. At the beginning, that could be budgeting and saving. On a more advanced note, the advisor will assist you in understanding complex investment, insurance and tax matters.
Step one in the financial advisory process is understanding your financial health. You can’t properly plan for the future without knowing where you stand today. Typically, there is an extensive written questionnaire for you to complete. These questions help the advisor to understand your situation and make certain you don't overlook any useful information. (For more, see: What Type of Person Needs a Financial Advisor?)
The Initial Questionnaire
The advisor works with you to clarify your assets (what you own), liabilities (what you owe), income and expenses. You’ll also indicate future pensions and income sources, project retirement needs and any long-term financial obligations. All current and expected investments, pensions, gifts and sources of income will be listed and projected into the future. (For more, see: Shopping for a Financial Advisor.)
The investing component of the questionnaire touches upon more subjective topics such as your risk tolerance and risk capacity. An understanding of risk assists the advisor when it’s time to determine your investment asset allocation. You'll let the advisor know your investment preferences as well. Do you prefer individual stocks and bonds, mutual funds or a combination of both?
Included in the initial assessment is an understanding of other financial management topics such as insurance issues and your tax situation. The advisor needs to be aware of your current estate plan as well as other professionals on your planning team, such as your accountant and lawyer. Once you and the advisor understand your present financial position and future projections, you’re ready to work together on a plan to meet your life and financial goals. (To learn more, see: Paying Your Investment Advisor - Fees or Commissions?)
The financial advisor synthesizes all of this initial information into a comprehensive plan.
The Financial Plan
The actual financial plan comes after you complete a questionnaire, participate in conversations with the advisor and learn about the process. Consider the financial plan as a roadmap for your financial future.
The plan begins with a summary wrap-up of the key findings from your initial questionnaire. The plan will summarize your current financial situation including net worth, assets, liabilities, and liquid or working capital.
The financial plan also recaps the goals that you and the planner discussed.
The analysis section of this lengthy document drills down into several topics including your investment risk tolerance, legal estate planning details, family situation, long-term care risk and other pertinent present and future financial issues related to your individual situation.
Based upon your expected net worth and future income at retirement, the plan will create simulations of potential best and worst case retirement scenarios. It will look at reasonable withdrawal rates in retirement from your portfolio assets. Additionally, the plan needs to drill down into survivorship issues and financial scenarios for the surviving partner.
A key topic that must be covered in the financial plan is how much money you will need to meet your desired goals. The advisor must touch on the scary possibility of outliving your money and steps to ensure that does not occur.
After you review the plan with the advisor and adjust it if necessary, then you’re ready for action.
Financial Plan Action Steps
The initial questionnaire and financial plan drive the next process.
The advisor will set up an asset allocation that fits both your risk tolerance and risk capacity. The asset allocation is simply a rubric to determine what percentage of your total financial portfolio will be distributed across various asset classes. A more risk-averse individual will have a greater concentration of fixed assets, and a risk taker will take on more stocks and other investments. All this will be adjusted for your age and how long you have before retirement.
Each financial advisory firm will act in accord with the company investment policy when buying and selling financial assets. The company’s investment policy drives its particular approach. (For more, see: Standards and Ethics for Financial Professionals.) The investment selection process varies among firms. Some financial advisors work with one fund company and limit investments to that provider. Others mix in individual stocks, bonds, and other types of financial assets such as commodities, real estate funds, and even alternative assets.
It’s important for you, as the consumer, to understand what your planner recommends and why. Watch for issues such as what sorts of fees you are paying, both for your advisor and for any funds bought for you. Ask why specific investments are recommended and whether your advisor is receiving a commission. (For related reading, see: Choosing a Financial Advisor: Suitability vs. Fiduciary Standards.)
A commonality among firms is that financial products are selected to fit in with the client’s risk profile. For example, a 50-year-old man who’s already amassed enough net worth for retirement and is predominantly interested in capital preservation may have a very conservative asset allocation of 45% in stock assets and 55% in fixed assets. Whereas a 40-year-old woman with a smaller net worth and a willingness to take on more risk to build up her financial portfolio may opt for an asset allocation of 70% stock assets, 25% fixed assets, and 5% alternative investments. While taking into account the firm’s investment philosophy, your personal portfolio will fit your needs; how soon you need the money; your investment horizon; and your present and future goals. (For more, see: 5 Things to Ask Before Hiring a Financial Advisor.)
You’ll receive regular statements updating you on your investment portfolio. The advisor will set up regular meetings to review your goals and progress. Meeting remotely via video chat can help make those contacts happen more often. It’s important to consult with your financial advisor when you experience a significant change in your life that might impact your financial picture. (For related reading, see: 3 Life Events That Can Ruin Retirement Plans.)
The Bottom Line
Not all financial advisors have the same level of training or will offer you the same depth of services. Thus, when contracting with the advisor, do your own due diligence first and make certain that the advisor can meet your financial planning needs. Check out his or her certifications before engaging the advisor. Make certain that you understand and agree with the fee structure and approach of your financial advisor. For example, how often will you meet and what kinds of reports will you receive? (For more, see: 7 Steps to Evaluate a Financial Advisor.)