The most important document to check if you’re going to hire a money pro (or have one on the payroll already) is Form ADV.
Form ADV is the key disclosure document that investment advisors must file with the U.S. Securities and Exchange Commission and state securities authorities.
What is Form ADV and who files it?
A combination business profile, resume and rap sheet, Form ADV contains:
- A description of services offered, the types and number of clients served, and the amount of assets managed.
- An explanation of fees and billing practices.
- A rundown of the company’s history and principal players’ certifications, education and work history.
- Any disciplinary actions (regulatory or judicial) taken due to misconduct.
It’s not just individual financial advisors and firms employing advisors that are required to file Form ADV. Even the online portfolio management companies known as robo-advisors, where clients might not even interact with a human advisor, must have Form ADV on file.
» Not sure who to hire for help? See our guide to choosing the right kind of financial advisor.
What to look for
There are two parts to Form ADV. Part I is a fill-in-the-blank form that lays out the information mentioned above plus more details about the advisor’s background and business.
Part II is what the SEC calls the “narrative brochure” and contains the meat of what you want to know.
This isn’t a fluffy sales brochure diluting any dirt with vague language. It’s a plain-English explainer about the person or firm you’re considering entrusting with your money.
Pay particular attention to the sections that cover:
- Fees charged and how compensation is structured.
- Potential risks for clients (exposure to volatile securities, for example).
- Potential conflicts of interest that could affect the recommendations they make.
- Disciplinary information (against the firm, advisor or key personnel in the company).
- Whether the individual or firm has filed for bankruptcy.
If an advisor gets a commission from a particular company for selling its products, you’ll see the relationship disclosed in Form ADV. If they are paid based on a percentage of assets managed or via fee-only services, that will be spelled out.
Don’t be surprised to see red marks on an advisor’s record. According to a paper from the National Bureau of Economic Research titled “The Market for Financial Adviser Misconduct,” 7% of financial advisors have been cited for misconduct. Among the largest advisory firms, more than 15% of employees involved in the money advice business have been cited. If you see disciplinary actions listed for the person or firm you’re considering, that’s a sign to continue your search for help elsewhere.
Go beyond the background check
Advisors you’re considering hiring should readily offer a copy of Form ADV very early in the get-to-know-each-other process. Consider it a red flag if they don’t.
Similarly, existing clients should receive an updated version annually and whenever material changes are made.
Beyond Form ADV, if you’re hiring a human advisor there are ways to ensure the person you hire not only does right by you, but is the right fit:
Are they reputable in other areas of their field?
If a provider offers other financial services beyond investment advice, check out their reputation via the appropriate regulatory entities. Here’s how to do a background check on other types of advisors, including accountants, financial planners and insurance salespeople.
Are they good at explaining things?
Most financial advisors offer a free consultation with potential clients. Use that opportunity to ask the advisor to describe her philosophy, fee schedule and services offered. That can give you a sense of how well your personalities mesh and help you ensure that the terms haven’t changed since the last ADV filing. (To help you get started, here are 10 questions to ask a financial advisor.)
Are you comfortable asking questions?
Even after you’ve hired a money pro, don’t stop asking questions. One good one to ask is why the advisor recommends a particular product over the alternatives. You want to make sure that they’re pitching the insurance policy or mutual fund from XYZ company because it’s the best one for you, not because it pads their bottom line. If they are a fiduciary they are required to put the client’s best interests before their own. You can check whether an advisor is a fiduciary in Form ADV, which is one more reason it’s essential to review this important document.