How do you choose a financial advisor? Do you select one because they showed up on the 1st page of a Google search? Do you take the recommendations of friends or sites like NextDoor? Maybe an advertisement has caught your attention. These are all fine ways to begin your search, but make sure you do your due diligence.
Compensation Method
One of the easiest ways to start narrowing down your search is to consider whether you prefer to pay directly for advice or if you’re comfortable with your advisor receiving commissions.
Commission-Based: An agent or broker/dealer representative who is compensated mainly by selling products and earning commissions. They may also earn bonuses and incentive vacations by meeting quotas on certain products.
Commission-based reps and agents may have a thorough knowledge of the products they are selling, but they may have a narrow view of the overall financial picture and a limited set of products. They may offer a free financial plan as an incentive to work with them.
Commissions do create an inherit conflict of interest. That does not mean commission-based agents are unethical. It just means that you should be aware of the conflicts and perhaps do more research before committing to a product.
Insurance agents, old-school reps, and those representing specialty investments are really the only true commission-based financial service reps these days.
Fee-Only: An advisor whose compensation is 100% from his/her clients in the form of financial planning and investment management fees. They do not receive commissions or other kickbacks for recommending certain investments or products.
Fee-Only advisors are usually Registered Investment Advisors (registered by either the state or Financial Industry Regulatory Authority [FINRA]), and are not associated with a broker/dealer or insurance company.
Compensation is more closely aligned with client goals, as there is an incentive to continue to provide good service and advice to continue the relationship. This method of compensation typically has the fewest conflicts of interest.
Fee-Based: An advisor who is compensated in the form of fees for financial planning and investment management, and commissions for investments and insurance they sell.
Fee-based advisors are usually also considered Registered Investment Advisors, but have ties to a broker/dealer or insurance company for support and product sales. This relationship is often mentioned on their marketing materials and website.
There are more conflicts of interest because of the ambiguous nature of the business model. A fee-based advisor may charge a fee for financial planning but earn commissions for recommended investment products.
Most financial advisors are fee-based. Although they sound alike, fee-based is not the same as fee-only.
Fiduciary vs. Suitability Standard
Fiduciary Standard: An advisor who works under a fiduciary standard must always act in the best interest of their clients. They make recommendations as if they were the client, or the client were a family member. It requires a duty of loyalty and care and to put clients’ interests ahead of their own. An advisor must also disclose any conflicts of interest, disclose all of their fees and strive for reasonable investment costs.
Suitability Standard: A broker/dealer rep who works under the suitability standard only has to reasonably believe that any recommendations made are suitable for their clients, in terms of their financial needs, objectives and unique circumstances. They do not have to place their own interests below that of the client. For instance, they can sell a higher commission-based investment as long as it’s deemed suitable. The rep’s loyalty is often to the broker/dealer he or she works for, and not necessarily the client served. For example, a broker/dealer rep may sell their own products ahead of competing lower-cost products.
The fiduciary standard is usually associated with advisors who charge fees, while the suitability standard is often associated with commission-based reps. Fee-based advisors operate under both standards and may not disclose which mode they’re in, or when they’ve switched from one to the other. A fee-based advisor could prepare a financial plan under the fiduciary standard and then drop to a suitability standard when discussing investment recommendations. Or they might handle investment management as a fiduciary, but then pitch a higher-cost annuity for part of the portfolio under the suitability standard. Again, it doesn’t mean fee-based advisors are unethical. It just means you should be aware of the differences.
Professional Designations
The financial services industry has way too many designations. Some of them are tough to earn and respected in the industry, while others are the equivalent of a one-day correspondence course. At best, these diploma-mill type designations confuse the public. At worst, they are used to mislead consumers.
Respected, professional designations won’t guarantee a “good” advisor, but they do indicate a certain commitment to the field. Here are some of the more common ones:
Certified Financial PlannerTM (CFP): This is the most common and one of the most stringent certifications for financial planners. Those with the designation have demonstrated competency in all areas of financial planning, passed a rigorous certification exam, have at least 3 years of industry experience, adhere to the CFP Board’s Code of Ethics, and complete ongoing continued education credits.
Chartered Financial Consultant® (ChFC): Similar to the CFP® designation in that it is a broad-based financial planning designation requiring at least 3 years of industry experience, compliance to a Code of Ethics, and ongoing continued education credits. However, it does not require a final comprehensive certification exam. It is administered by the American College. Designees tend to be a little more insurance-oriented.
Chartered Life Underwriter® (CLU): This designation is for agents and advisors who specialize in life insurance. It is also administered by the American College and since many of the courses overlap with the ChFC, you will usually see advisors with both designations.
Certified Public Accountant (CPA): This is the official license for a practicing accountant. Those holding the CPA designation have passed challenging examinations in accounting and tax preparation, but it does not cover the broader areas of financial planning.
Experience
Age can be a significant factor in experience. That’s not to say that there aren’t some younger advisors with more experience. A 32-year old advisor could already have 10 years of experience if they started right after college. Financial planning may be a second career for an older advisor. They may have a lot of life experience, but not a lot of financial advising experience. Age, whether we like to admit it or not, does come into consideration.
Young: Younger advisors usually have less experience. Most work for brokerage firms that can provide training and pay a salary and benefits. It is a difficult road for young advisors, particularly because they may have to cover their salary with commissions on products they sell.
According to research firm Cerulli Associates, “In 2016, there were about 36,000 new advisor “trainees” (those with less than 3 years of experience) in the financial advice industry. But more than 29,600 advisors who’d entered the field in the previous 5 years washed out in 2015. Washouts are considered those who do not succeed in the advisor role and either attempt another position in the field, or leave the industry altogether.”
Mid-Career: Mid-career advisors usually have 10-25 years of experience. They’ve survived the early years, and many have navigated the tech bubble in the early 2000s and the financial crisis of 2008. While some are happy to work at larger
brokerage firms, most have made the step towards independence, and some have opened their own practice. They generally offer experience and stability over young advisors, and longevity over older advisors.
Older: Older advisors have a vast amount of experience. The good ones continue to improve their knowledge and keep their technology up-to-date. However, it’s reasonable to wonder who’s going to retire first – you or your financial advisor? Will the advisor still be around in 5 years? These are questions that should be addressed in an initial interview.
“Nearly one-third of advisors fall into the 55 – 64 age range,” according to recent research by Cerulli Associates.
Other
Be wary of any advisor who touts an award. There are no legitimate industry awards for “best financial advisor.” There are many pay-to-play type awards, like the ones found in airline magazines, i.e. “best steakhouses” and “best plastic surgeons.” Research an advisor’s background at the following sites:
FINRA – https://brokercheck.finra.org/
Investment Advisor / SEC – https://www.adviserinfo.sec.gov/IAPD/Default.aspx
CFP Board – https://www.cfp.net/utility/verify-an-individual-s-cfp-certification-and-background
When you interview them, make sure the advisor can clearly explain their firm’s financial planning services, their investment philosophy, what to expect from the engagement including all costs, and a general breakdown of who they serve. Finally, make sure you review the advisor’s “Form ADV.” This is a disclosure document that every advisor is required to provide to you.
Terry Green, CFP® is the owner of Blue Water Capital Management, LLC, a financial advisory firm in Apex, NC.
