Many financial advisors are fiduciaries tasked with prioritizing and addressing their clients’ financial needs. However, advisors being fiduciaries can’t always keep you away from unsuitable, out-of-date, or poor financial advice.
That is why it’s essential to educate yourself, use common sense, and ask questions whenever you get financial tips or suggestions.
While an advisor recommends an investment to you, that does not mean it would benefit your current financial state. You need to take a deeper look into it because, after all, it’s your money that’s going to be invested and affected by macroeconomic and non-macroeconomic factors.
To give you an idea of what is considered a poor piece of financial advice, here are three recommendations often provided by financial advisors that are pretty questionable or confusing, along with some idea of what the advisor should have told their clients instead.
“The Investment Has Little to No Risk”
It’s concerning to hear from your financial advisor that a particular investment carries little to zero risk when, in reality, every investment has its own set and degree of risk. There is no such thing as a risk-free investment.
Moreover, every investment has risk warnings and disclaimers to provide investors with legal protection. The disclaimer can usually state that the security is Not Federal Deposit Insurance Corporation (FDIC) insured, May lose value, and No bank guarantee.
If an advisor tries to downplay the risk of investment in an asset, they may not be acting in your best financial interest. Should that be the case, the best thing you can do is stop working with them and find a new, more reliable financial advisor.
Honesty should be crucial to advisors who genuinely want to help their clients do well and make money from investing, even more so when discussing risks their clients may be subjected to if they put money into certain assets.
While not worrying about risks could make your investing easier, your finances might take a pretty heavy blow in the process. Risk must always be considered, and your financial advisor should be honest with you when it comes to that part of investing.
Moreover, being aware of the fact that investing always involves risk needs to be an integral part of the advisor’s plan for you and your investment dollars.
It will also help if you have your own perspective on an investment’s level of risk, which you can do by conducting a backtest. Backtesting involves reviewing your investing history to hypothetically see how your current portfolio would have performed under different, unfavorable situations.
Performance history offers no assurance that you would profit in the future, although it can provide you some idea, more so when you combine it with information about the market’s current situation.
“Invest in Active Funds”
While active funds, particularly mutual funds, can provide certain investment strategies some advantage and help curb portfolio volatility, they’re not exactly budget-friendly.
Actively managed investments can generate less volatile returns compared to passive investments. They are an excellent investment option for investors seeking a steady profit flow or immediate access to their money.
Plus, active fund managers’ practice of regular trading often makes them better at minimizing losses than passive fund managers during declining markets.
The downside is that active funds are expensive, often charging high fees, and may be subject to capital gains tax due to the many trades the managers need to make, as per the active strategy.
On the other hand, passive index funds have proven to perform better than active funds over the long term. Passive managers’ hands-off method usually results in lower fees and more returns during surging markets.
Still, that is no reason to avoid a financial advisor recommending active funds altogether. The important factor is whether the management style suits you, be it an active fund or a passive fund.
You also need to know how the advisor’s management style supports their suggestions to you. An advisor may recommend active funds and be able to explain to you the reason, but they must also be experienced enough to determine when it’s feasible and when it’s not.
Knowing your needs, risk tolerance, and time horizon can help you decide whether the potential rewards of investing in actively managed funds are more significant than the potential costs.
A financial advisor who keeps pushing you to choose active funds even if it’s not appropriate may not be suitable for you.
“Your House is Also an Asset”
While a house can provide some financial backing, not every home can be treated as an appreciating asset or an investment.
Such a view is something that advisors should clarify to their clients. Telling each of them that their house is an asset may give them a hard time understanding the difference between an actual investment and a false one.
Assets bring in profits. Therefore, your home can be considered an actual asset if you bought it intending to sell it to make money within two or more years.
But if you don’t yet have plans to sell it, your house is not an investment. Instead, you and your financial advisor should see it only as a place you live in at the moment.
Moreover, it’s important for you to understand that your home is a liability rather than an investment if you’re still making monthly payments on it and not receiving any money in return.
Seeing your house as an asset when it’s not yet one may give you an inaccurate idea about your financial position. Therefore you should keep your home out of the equation. That way, you can give yourself a nice present when you sell it for a profit and not be in a tough spot if you don’t.
To Sum It All Up
Overall, assessing a financial advisor’s suggestion doesn’t need to be an overwhelming, difficult task. With the help of the internet, you can find a considerable amount of investing-related information.
Schooling yourself about investment options suitable for your situation can help you separate helpful pieces of financial advice from ones that are not.