Some pundits are sounding the alarm for a correction, citing the new highs set by broader equity markets and the recent surge of money into stocks by retail investors.

There may be some merit to their call as history has shown that the average mom-and-pop investor tends to buy market tops and sell market bottoms, likely due to human emotion and a financial community keenly willing to profit by it.

Fortunately, there is a way to protect yourself by simply asking the following five questions about the person currently advising you on the management of your investment portfolio.

1. How are they being compensated?

Most investors do not realize that the majority of advisors in Canada are paid by investment firms to sell their particular financial product(s).

As a result, an advisor may be highly incentivized to sell the mutual fund that pays the highest commission while the investor will likely not notice since the fee is embedded within the mutual fund’s net asset value.

Additionally, once advisors purchase the fund for their client, they will get paid as long as the investor continues to hold that fund.

Therefore, the market environment always tends to be rosy and a great time to buy.

Instead, look for advisors who charge a flat fee and purchase funds that do not have an embedded trailer fee and sales charge, whether upfront or deferred. This way their interests are more aligned with yours.

2. Are they selling near-term performance?

Another downside to a commission-based compensation structure is that advisors will focus on what is easiest to sell and that often means those funds with the strongest recent performance.

Charles Ellis, a highly respected academic and investment professional, hit the nail on the head when he said the mutual-fund industry incubates hundreds of new mutual funds, but only advertises the ones with the strongest performance.

“The major fund management organizations will have 300, 400, even 500 different mutual funds in being, he said. Guess which ones get advertised? If I had 500 children, do you think I would be able to find one that is pretty damned terrific? I think so.”

3. Are they offering near-term predictions?

Investors are often comforted by near-term predictions. Consequently, advisors will often seek out economists, market strategists and stock analysts who provide positive near-term forecasts. The problem is that no one, even the experts, can predict near-term moves in the market.

4. What are they doing to manage risk?

The problem with trying to beat the market is that you end up taking on more risk, which, in the end, will cause more harm than good to a portfolio.

To determine the overall risk of your portfolio, ask your advisor for the historical standard deviation and then divide it into the specific return generated less a risk-free rate such as the current 90-day T-Bill rate. This will provide a good indication of how much return was achieved per unit of risk taken.

Also ask what is being done to manage the risk in your portfolio. Look for more specific strategies than just asset allocation and diversification.

This is where advisors can be very useful in spending time protecting your portfolio against near-term risks while investing for long-term gains.

5. How have they positioned your portfolio in the past?

Keep a logbook of your portfolio and periodically review the timing of your purchases and sales of the underlying investments with your advisor.

Doing so allows you to identify how diversified your portfolio is, but, importantly, determine what your advisor is actually doing to manage your money.

Martin Pelletier, CFA, is a portfolio manager at Calgary-based TriVest Wealth Counsel Ltd.