Hiring a “financial advisor” can be difficult. Here are some tips for you to use when evaluating an investment advisor or financial planner.
Know what type of financial professional you are speaking with
The financial services industry unfortunately suffers from hopelessly obscure and arbitrary titles. But you should know what type of financial professional you are speaking with because that will give you insight into their expertise and incentives.
If you are speaking with someone whose title is Investment Advisor Representative(IAR), you are speaking with an investment advisor. These people typically (but not always) charge a percentage of the client’s assets they manage (usually about 1% /yr.).
Investment Advisor Representatives have a fiduciary obligation to their clients. This is a legal standard that obligates the advisor to disclose and mitigate all conflicts of interest and strictly place the client’s interests ahead of their own.
If you are speaking with a “Registered Representative”, you are speaking with a broker employed by a broker-dealer. Historically, brokers charge commissions generated from the investment or insurance products they sell to their clients.
Brokers hold a lesser legal standard than the fiduciary standard but there are ongoing attempts to change this and it should be noted that this doesn’t imply that all brokers are “bad” or taking advantage of their clients.
Over the last 10-15 years, many brokers and also become Investment Advisor Representatives which makes things confusing. The legal standards these dually registered folks hold depends on the capacity they are acting in at a given moment. Basically, when they are making trades or selling investment products they are brokers; when the client is asking for advice or they are offering advice, they are Investment Advisors.
Before you hire a “financial advisor” know whether they are an Investment Advisor Representative or a broker.
Pay close attention to fees
A common way to charge for investment advice in the financial services industry is via a percentage of assets under management. Here’s typically how it works; if you have $1000 in your account, you may pay $10 a year for the investment advice you receive (1% per year is common).
There are also custodian fees, commissions, and other fees that mutual charge. Many of these fees are expressed as a percentage of your investment. For example, a commission on a mutual fund might be 5% of your investment. In addition, many types of funds also have other fees expressed as an “expense ratio” that typically ranges from .2% – 1%.
You might think to yourself, what’s the difference between a percentage point or two, but that is a dangerous game to play. If you ever plan to have a substantial portfolio those small percentage differences will become huge in actual dollar terms; especially over years.
Instead of merely knowing what your advisor charges for advice (usually 1% per year) you should add up the “all-in cost” of working with a given advisor. The average “all-in cost” for working with an advisor is 1.65%. That means if the market returns it’s average 7% this year; the typical client at a typical advisory firm is only receiving 5.35%!
To sum up, before you hire a “financial advisor” make sure your advisor tells you 1) what fee he(she) charges for advice 2) whether there are any commissions involved in the investments he(she) recommends 3) the average expense ratio of the funds recommended. Add these percentages together so you know exactly what you are paying.
Know what services are being offered
The financial planning industry is nascent when compared to other industries. Regulations are still emerging and shifting and the industry is constantly adapting to new technologies.
When I was doing some market research for my own firm, I conducted many interviews with people so I could hone in on the services they wanted. One of the questions I asked was “What comes to mind when you think of “financial planning?”. The answers I got were all over the place; it was quickly apparent that financial planning is a super vague service.
Very broadly speaking there are 3 general services offered by “financial advisors”; Investment advice and management, insurance sales, and financial planning. It’s uncommon for “financial advisors” to offer tax filing services or legal services surrounding LLCs or S Corporations.
Investment advice and management services help clients identify and implement portfolios to meet their stated goals. Insurance sales are usually life insurance and annuity sales. Finally, financial planning generally involves bringing together the areas of tax planning, retirement planning, education planning, estate planning, investment planning, and insurance planning all together under one roof.
It’s not uncommon to see these 3 different services mixed together. For example, many Financial Planners also offer investment advice and management, as do insurance salesmen.
The bottom line here is to know what is being offered when hiring a “financial advisor.”
Most “financial advisors” that I know are good people and some have excellent service offerings. But that doesn’t mean they are perfect for everyone who walks through the door. The three considerations above are not exhaustive but they will help you do your due diligence when hiring a financial advisor.
Erik Goodge is a CERTIFIED FINANCIAL PLANNER™ and the President of uVest Advisory Group. He holds a B.S. in Economics and Cognitive Science from the University of Evansville. Erik is a Marine Corps veteran of the Afghanistan campaign and Purple Heart recipient. He is from Evansville, Indiana, and currently lives in near-by Newburgh with his wife and daughter.