(MoneyWatch) Unlike brokers, financial advisers are fiduciaries who should put your best interests ahead of theirs. As this is sometimes not the case, it pays to be vigilant about red flags.
1. Does your financial adviser use the wrong benchmarks? Is he comparing your return to that of the S&P 500 index? If so, ask him if this includes the dividend component and whether you have any small or midcap stocks in your portfolio. By picking inappropriate benchmarks, advisers can create the magical illusion of beating the market.
2. Does she steer clear of the word "cost"? If you haven't already done so, ask your adviser how much you are paying in total fees and whether this includes all fees, such as the underlying expense ratios of mutual funds and annual trading costs, which do not show up in the expense ratio. Most will avoid discussing costs like the plague.
3. Does he put you in bonds while you are paying down a mortgage? A mortgage is exactly the opposite of a bond. But if your adviser tells you to pay off your mortgage, there are less assets for him to charge you on. Paying off or paying down your mortgage is a risk-free way of making two or three times the return of a high quality bond or bond fund.
4. Does she use the term "income" when referring to an annuity? With an annuity, you exchange a chunk of money for a cash-flow stream, often for the rest of your life. When your adviser says you are getting 6 percent income, that's downright false. Nearly all of the cash received is in fact a return of your principal.
5. Does he refuse to put things in writing? Advisers sometimes tell clients complete falsehoods in a conversation but anything in writing must go through "compliance." If what you're hearing is something like "there are no costs" or "this investment has little risk," ask for it in writing. If he says no, send an e-mail saying asking him to confirm any critical statements. If he again says no, ask yourself why.
Any time a dollar changes hands, conflicts of interests arise. As a planner, I know very well what they are. My advice is to watch out for these warning signs and never follow investment advice blindly.