As I wrote previously, the financial advisor ecosystem can be surprisingly complex. Nearly anyone can call themselves a financial advisor, financial planner, or financial coach, with minimum qualifications required. Consequently, it's important to be careful and thoughtful when selecting a professional to help you save, grow, and protect your savings.
Here are five things to consider when shopping for a financial advisor.
Education and Experience
Review your prospective advisor's educational background and experience to learn why that particular person may be uniquely positioned to help you with your financial situation. In particular, seek advisors who have demonstrated they can actually apply their knowledge to develop an optimal strategy for you.
An advisor's website and articles could be a good starting point to learn about their qualifications, planning practice, and thought process. You can get detailed information on independent advisors registered with their states or the U.S. Securities and Exchange Commission (SEC), as well as advisors associated with a brokerage firm, at Broker Check, a free tool from FINRA.
Try to glean what steps an advisor has taken to continue to increase their knowledge base in personal finance. One way to gauge this is through the various certifications they may hold. Specifically, take the time to learn about both the upfront requirements needed to attain a certification and the ongoing requirements for maintaining the designation.
For example, the Certified Financial Planner designation (CFP®) is considered the gold standard in financial planning circles. To get the CFP® designation, planners must take extensive, specialized coursework, pass a six-hour exam, and accrue three years of relevant experience. Every two years, certificants must complete at least 30 hours of continuing education.
Other common designations include Certified Public Accountant (CPA) and Enrolled Agent (EA), for planners that may specialize in accounting and taxes, Chartered Financial Analyst (CFA), for advisors that specialize in portfolio management and investing, and the Accredited Financial Counselor (AFC®), for advisors who may focus on financial coaching and counseling.
Fees and Conflicts of Interest
Identify how an advisor is compensated to gain a better understanding of their potential incentives and conflicts of interest. Typically, advisors are paid through: 1) client fees ("fee-only"), 2) commissions, or 3) a combination of both ("fee-based").
Julie Ford, CFP® and financial planner at Ford Financial Solutions, says, "Anytime you interact with someone calling themselves a financial advisor, make sure you understand how they are being compensated for the service they are providing. More conflicts of interest arise when commissions are involved. It becomes harder for the advisor to stay independent and put your interests ahead of their own."
"Even if they claim the contrary, advisors are always influenced by their compensation method - if not intentionally, then even inadvertently or subconsciously," adds Justin Chidester, AFC® and financial planner at Wealth Mode Financial Planning.
Advisors typically use one or more of the following pricing models:
1. Hourly Fee: Based on the amount of time they spend with you.
2. Fixed/Flat Fee: Based on an agreed upon flat fee.
3. Assets Under Management Fee: Based on a percentage of assets they manage for you.
Across these fee models, Lori Dietzler, CFP® and financial planner at Zero Gravity Financial, recommends consumers find a financial planner that charges a flat fee.
"Over the past decade, the industry has shifted away from commission compensation to asset-based fees. This change has removed the financial incentive to actively trade client portfolios and/or invest in funds that charge high front- or back-end expenses," Dietzler says. "In addition, financial advisors know from experience that it does not cost a firm more to manage a portfolio of $5 million than a portfolio of $1 million. Therefore, why should clients pay more in fees to receive the same services? Flat fees align services with a fair price model used by other professionals, such as accountants, lawyers, and doctors."
Be sure to also identify and consider any fees that are associated with the underlying investments recommended.
"Focus not only on how the advisor is getting paid, but also the all-in costs associated with their strategy, such as fund expense ratios, trading costs, and taxes," recommends David Oransky, CFP® and financial planner at Laminar Wealth.
According to a study done by Personal Capital, while the average Merrill Lynch advisory fee is 1.30%, the all-in fee is nearly 2.00% because of approximately 0.70% of additional fees from the underlying investments.
Standard of Care
Registered investment advisory firms (RIA) are required to be fiduciaries, which means they must look out for the best interest of their clients, at all times, above all else.
Advisors that work at banks and brokerages, on the other hand, may only be held to a suitability standard for now. A suitability standard means that a particular recommendation they make doesn't necessarily need to be the best for you - just suitable for you.
However, Oransky points out that, "with the impending DOL fiduciary regulations, many advisors will suddenly be claiming fiduciary status. While this will thankfully be true in certain aspects of client relationships, it still will not be universal, so buyer beware. The highest standard of care, and what every client should demand, is an advisor who acts as a fiduciary in all aspects of the client relationship, at all times, and on all accounts."
Chidester recommends asking advisors, "With what topics, decisions, or areas of your advice are you not held to a fiduciary standard?"
Before you sign on, be sure to understand how often and with whom you will be interacting. Some advisors have an initial upfront meeting and then check-in with clients once a year, while other advisors provide ongoing support throughout the year to help with the implementation of a plan and coordination with other service providers, such as insurance agents, mortgage brokers, and accountants.
Beyond meeting cadence and service level, transparency matters as well. "Ask yourself: 'Does the advisor make it seem as if my circumstances are so complex I could never do it myself or do they suggest that everything can be simplified in an understandable manner?,'" recommends Jamie Menges, CFP®, who is a principal and client advisor at PDS Planning. "I want an advisor who suggests that at some point, I may be able to take my planning needs back over. The majority of clients do not have such involved circumstances that they would not be able to do it on their own if they chose to."
Diligence Pays Off
In the end, not all financial advisors are created equal. A bad advisor could cost you higher fees and taxes, or lose your money all together. Take the time to research potential advisors who can help you efficiently and effectively plan and reach your financial goals.