A good financial planner is an invaluable resource. A financial planner can give clients expert guidance, and help them craft an overall financial plan that can lead them to wealth.
Continue Reading Below
Unfortunately, not all financial planners have their clients' best interests in mind. It's fairly easy for a financial planner to be tempted by the possibility of large commissions and recommend actions that shouldn't really be the client's top priority. Some of the suggestions that your financial planner should be making to you include:
1. Pay off high-interest debt
Long-term returns on stock investments average around 7%. A really good, or really lucky, financial planner may be able to beat this number, but not by much. So if you're paying more than 7% interest on your debt, then putting money into investments instead of into paying down debt will result in negative returns. (The interest on your debt will cancel out the returns from your investments, and then some.)
So it makes sense to pay off all your high-interest rate debt before you go sinking all your money into investments. High-interest debt includes any credit card debt. Depending on your credit score and the interest rate environment, it may also include secured debt, such as car loans. Once you've gotten rid of your expensive debt, you can move on to a new financial priority.
2. Fund an emergency savings account
It's very risky to put every penny of your savings into non-cash investments. If something goes wrong in your life and you suddenly need some extra cash, it's much easier to get what you need if part of your savings is already in cash. All you need to do is transfer the money into your checking account, or write a check, and you're good to go.
If all your money is tied up in investments such as stocks, it'll take longer to get at that money in an emergency. First you have to decide what to sell, then you have to put the sale through, and then, finally, you can move the funds into your bank account. And if you have to sell in a hurry, you'll likely end up paying a steep price in capital gains taxes. So before you start buying investments, make sure you have at leastthree to six months' worth of expenses tucked away in the form of ready cash.
Image source: Getty Images.
3. Fund your 401(k)
Unless your financial planner is also your 401(k) trustee, he or she has nothing to gain from telling you to contribute to your 401(k) account. However, funding retirement accounts typically is the next most important step after getting rid of debt and building an emergency savings account.
The sooner you put money into a tax-deferred retirement account, the more time it has to grow to fund the retirement of your dreams. And because that money grows tax free in the 401(k), it can outperform the same investments from a standard brokerage account.
You shouldn't necessarily put every penny into a 401(k) and completely ignore non-retirement investments, but you should know how much you'll need in retirement savings, and contribute enough to reach that goal by the time you're ready to retire. If you have extra funds to invest over and above that minimum requirement, then by all means direct them to a standard brokerage account.
4. Buy and hold index funds
Out of all the countless investing strategies that have been proposed since stock markets were invented, buying an index fund and holding it indefinitely is still thought to produce the best returns over the long haul. Of course, this simple buy-and-hold strategy won't make your financial planner a lot of money -- financial planners make their commissions off transactions, so many will urge their clients to churn their investments on a regular basis, and thus generate more commissions.
Unfortunately, even if your planner chooses really great stocks for you, the transaction fees and capital gains taxes you'll pay on an active portfolio will take such a huge bite out of your returns that it's unlikely such an approach could beat a simple buy-and-hold strategy. For example, say that an index fund would return 7% per year and has fees of 0.2%, while your financial planner chooses stocks that return 10% per year, but generate 4.5% expenses in fees, commissions, and taxes. The actual return on the two portfolios becomes 6.8% for the index fund versus 5.5% for the active portfolio. Clearly, the index fund would be the better choice.
5. Find a fiduciary
Your financial planner may or may not be forthcoming about their status as a fiduciary. A financial planner who is also a fiduciary is required by law to put your best interests ahead of his or her own. That's why it's so important to make sure a potential financial planner is also a fiduciary. If you ask and the answer is no, say thanks, and move on to a planner who is. Given the enormous impact a financial planner will have on your entire life, do you really want one who won't put your needs first?
The $16,122 Social Security bonus most retirees completely overlook If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $16,122 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after.Simply click here to discover how to learn more about these strategies.
The Motley Fool has a disclosure policy.