401(k) Financial Advisor Checklist

LAST REVIEWED Apr 05 2019 13 MIN READ

By Damian Davila

More and more employer-sponsored retirement plans are including financial advising services. However, it’s not free — some employers are providing their employers the option to have a professional investment manager handle their plans for a 0.15% to 1.0% asset-based fee. If you have a lot of assets (into the six figures or more) outside of your 401(k), then it’s probably a good idea to get a financial advisor in general, since high net-worth individuals have a lot more to lose (and win) on the margin. However, this article is written more for the average person who is interested in learning more about financial advising services specifically for 401(k)s. We’ll review whether or not it’s worthwhile to pay for a financial advisor to handle your 401(k), what are key questions to ask if you were to hire one, and some alternatives to hiring a financial advisor.

If self control isn’t your strong suit, you may need a financial advisor

The body of research supporting the superior performance of passively managed funds over that of actively managed funds is very vast. Still, a major caveat is that you need to “buy and hold” an index fund for a long time and avoid selling low and buying high! For example, if the announcement of the results of the U.K.’s EU Referendum (better know as the “Brexit”) sent you in a trading frenzy with your 401(k), you would have been better off with a financial advisor to keep you accountable when managing your nest egg.

A study of 14 defined contribution plans with a total of more than 723,000 participants found that those participants paying for advice earned an average of 3.32% more per year than those managing their plans on their own. So, paying for the extra help could be a viable solution to get your retirement account back on track until you learn some restraint. Another key instance in which it can make sense to seek the help of a financial advisor are when you’re 10 or fewer years away from retirement age.

How much should I pay a financial advisor?

Having to pay 0.25% or 0.6% for a financial advisor may not sound like much. However, those charges can have a big effect on your 401(k) over a long period of time. Let’s assume the following investment options:

Fund AFund BFund C
Balance$10,000$10,000$10,000
Average Investment Return7%7.25%7.5%
Expense Ratio0.05%0.15%0.15%
Financial Advisor Fee00.25%0.6%
Balance After 20 Years$38,336.79$37,626.21$36,928.16
Balance after 30 years$75,062.61$72,985.37$70,963.74

Fund A is a passively managed fund, while Fund B and Fund C are actively managed ones. The logic goes that the higher expense ratio of Funds B and C is justified by their higher average annual returns. Seduced by the higher investment return, an investor tends to forget to do his homework and factor in all fees and charges. When was the last time that you actually sat down and read the prospectuses that your plan administrator mails you? And if you do read those mailers, do you make it past the list of historical average returns and dive down to the fine print listing all applicable fees? Remember that an active fund manager is going to select options with a higher exposure to risk, such as mutual funds and hedge funds, and incur higher expense ratios.

Here are the key questions to ask your financial advisor

Before you enroll the services of a financial advisor make sure to check for the following criteria.

What are the advisor’s certifications?

Make sure that you’re not dealing with a salesperson whose advice to you will be strongly influenced by the commissions they receive from specific funds and institutions. John Oliver explains in this great video about 401(k)s that a “financial advisor” is not an official title and can be used by anyone. Unless the individual actually holds professional credentials, such as Certified Financial Planner (CFP) or Chartered Financial Analyst (CFA), then they shouldn’t be calling themselves a financial advisor. Don’t hesitate to ask for credentials and don’t just take their word for it. Verify their membership from the online database from the body that issues their credentials. I wish you didn’t have to do all this research just to make sure a financial professional is being honest with you, but given the rampant amounts of misleading information in this field, it’s well worth doing your homework.

Does the financial advisor meet fiduciary duty?

One way to make sure you have a truly helpful financial advisor is to ask them this simple question. This will help you identify whether the financial advisor is legally required to put your interests before theirs. For more information about fiduciaries: What is a Fiduciary and Why is it Important? Before April 10, 2017, financial advisors managing retirement accounts aren’t legally required to serve as fiduciaries. So, until that date it’s best to double check for fiduciary duty and enquire whether or not the professional can provide a signed letter of intent.

How is the financial advisor compensated? (i.e., What are their motivations?)

You’re looking for a few key things:

  • Figure out how predictable the fees are. Instead of charging a percentage, some financial advisors opt for a flat fee making it easier for you to keep track of charges.

  • You want to identify any potential restrictions to the type of investments or firms that are considered for your portfolio.

Be wary of a financial advisor refusing to disclose their list of applicable fees and sources of income. They are likely to be highly incentivized to focus on funds paying the highest commissions to him.

What are the characteristics of their current clients?

This may sound like a silly question but it’s an important one because it can provide you a clear idea of whether or not you two would be a good match. If the financial advisor only has worked with single, high-earning individuals in the finance sector, then he may not be too familiar with the needs of a married couple with moderate income and three young children.

What are the requirements to work with the financial advisor?

A financial advisor may set a minimum of investable assets and you’ll want to make sure you qualify.

Who will actually work with me?

Just because you’re interviewing with a specific financial advisor, it doesn’t mean that that same person will actually be the one working with you and your money. Inquire whether or not the financial advisor will be the one taking care of your account, who will take care of you if that’s not the case, what is the average account load of advisors within the firm (i.e. how much attention will your account be getting?), and whether or not the financial advisor has a succession plan in place. These questions will help you evaluate financial advisors and make an educated decision.

Alternate option: Robo advisors

If you’re not interested in estate planning, are just starting out your 401(k), or still have many years until retirement age, you could use a 401(k) robo-advisor instead of a human financial advisor for significantly lower costs.

Leveraging algorithm-based portfolio management, a robo-advisor calculates personal risk tolerance through a quick survey and automatically adjusts asset allocation based on market movements.

For example, Human Interest’s robo-advisors use time-tested investment theories espoused by the world’s leading financial economists, including modern portfolio theory, efficient market theory, and the capital asset pricing model. Other types of investments, especially when your assets spread out across multiple types of funds and timelines, generally do require more expertise and individual attention when it comes to financial advising.

401(k)s, on the other hand, are definitively a long-term investment with very specific parameters and a few best practices that are often more effective in algorithm form than human maintenance. The main advantage of robo-advisors is that they invest in an emotionless manner, which increases returns by 0.4% per year according to Yale’s Chief Investment Officer, David Swensen. The periodic rebalancing strategy set by a robo-advisors can prevent a jittery 401(k) holder of adjusting his plan without a clear strategy.

Many studies have shown that investors trying to time the market incur costs between 1.5% and 4.3% per year. Additionally, robo-advisors allow you to keep investment fees in check because they are typically low-cost and the plans using robo-advisors don’t require the high account minimums that plans using their human counterparts do.

The bottom line

Nobel Memorial Prize in Economic Sciences, Paul Samuelson said it best, “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas”. When you lack the ability to follow a systematic way to build your nest egg, a financial advisor can help you to learn the required consistency to invest. Whether you use a human or robo-advisor for managing your finances and 401(k), just be rigorous about making sure that the additional fees don’t eat into your returns and you’re receiving financially sound guidance. *Related articles:

If you want to set up or switch to an a 401(k) that’s great for employees and employers, let your company know about Human Interest.

Damian Davila is a Honolulu-based writer with an MBA from the University of Hawaii. He enjoys helping people save money and writes about retirement, taxes, debt, and more.

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