Types of Financial Advisors (and which ones you should avoid)
Types of Advisors
Before beginning your search, it is essential to understand the difference between financial professionals, many of which may be called “financial advisors.” We’ve all gone to the doctor’s office, but just because they are in the business of medically healing patients, not all doctors are the same. For example, if you have a heart problem, you will seek a cardiologist, not a dermatologist. In the same way, financial advisors aren’t all the same – far from it. As the profession has evolved, different types of advisors have emerged with varying practice specialties. Other compensation methods for those advisors have emerged, too. Just like choosing the right doctor, it is vital to understand these subtle and not-so-subtle differences before selecting a financial advisor. The outline below should help you determine how to select a financial advisor that is best for you.
- Registered Investment Advisor (RIA). A financial advisor that has a legal duty to act as a fiduciary, acting in the best interests of their clients. These advisors may market their services as “fee-only” or “fee-based.“
- Independent Registered Investment Advisor (RIA). Like other RIAs, this type of advisor is legally bound to the fiduciary standard. However, they typically go one step further in removing conflicts of interest by being fully independent. In other words, an independent advisor is not beholden to any particular family of mutual funds, insurance products, bank, or brokerage firm. Independent RIAs will often promote their services as “fee-only.”
- Broker. These financial advisors sell insurance or investment-related products for commissions. These products only need to be “suitable” for clients, known as the suitability standard. This standard is one step below the fiduciary standard and gives the advisor wiggle room in making recommendations. For example, a broker may have two suitable and similar investment products to sell. One product may provide a higher commission to the broker. Which product do you think the broker will recommend to their client? Brokers often work at banks, brokerage firms, or insurance companies and do not have a legal obligation to put your interests first. 1
- Dually-Registered. This type of financial advisor acts as both a broker and an investment advisor. Due to being dually registered, the investment advisor is not independent of the broker, creating significant conflicts of interest between the advisor and the client. This dual registration allows them to wear two distinctly different hats; the investment advisor hat and the broker hat. When the advisor wears the broker hat, they are not required to act as a fiduciary.
- Financial Planner. This financial advisor creates financial plans to help achieve long-term financial goals. A Certified Financial Planner (CFP) is a formal certification acknowledging expertise in financial planning, taxes, insurance, estate planning, and retirement and also carries a fiduciary duty. Financial planners can be brokers, RIAs, or both. When interviewing planners, you should first ask them how they get paid. If they tell you that they receive commissions, you know you are speaking with a broker. Additionally, brokers will often use financial plans to sell you investment-related or insurance products. These types of “plans” are not financial plans. Instead, they are sales proposals, and you should avoid them.
How Do Your Goals Align With The Advisor’s Objectives:
Now that you understand the differences between the types of financial advisors. You should now focus on narrowing down your search to advisors whose services align with your goals. Ask yourself the following questions to find the right fit for your objectives more quickly. If you’re unsure of your objectives, go through the questions anyway. These questions will help you identify your goals and ultimately help you get more value from whichever advisor you choose.
- Do I need ongoing financial advice, or are my needs more immediate and infrequent? Of course, there is no substitute for ongoing financial planning services provided by a competent and objective financial professional. However, some people like to manage their financial plans on their own. A one-time financial plan to help validate (or invalidate) your outcomes may be more appropriate for the do-it-your-self planner. For example, suppose you are looking for a one-time financial plan to help make sure you’re on pace for retirement. In that case, you should contact a Certified Financial Planner (CFP), who offers planning services for an hourly or per-project fee. Remember that financial plans need to be updated frequently, and a one-time plan may only be valid for a year.
- Do I prefer to make my own investment decisions or rely on an expert? Suppose you enjoy day trading or actively participate in selecting investments independently. In that case, you may benefit more from an investment advisor who offers a consultative service for an hourly fee. These services may include advice about selecting securities and can help you validate (or invalidate) your plans or portfolio allocation. While these types of advisors may be more difficult to find, a self-directed investor may benefit more from these services than a financial advisor who manages investments for clients.
- Do I need help with finding more ways to save more money? For example, suppose one of your objectives is to save more, but you’re unsure of the best way forward. In that case, you may want to look for a financial advisor that offers comprehensive wealth management and financial planning – long-range planning with tax and risk planning designed to help you build and preserve retirement savings. In addition, these advisors can help you maximize your tax-advantaged savings plans and ensure that your overall portfolio is under one unified strategy.
- Are you primarily interested in portfolio performance? You may want an advisor who offers active money management that continually fine-tunes portfolios in light of valuation and economic factors, intending to exploit the better-performing parts of the market. However, this type of money management can be riskier and cost more. These types of advisors may not help you with overall planning as their focus is more on investing. Additionally, they may be blind to other areas of your investment portfolio and subject you to unnecessary risks.
- Do I need help with income or estate taxes? You may want a financial advisor well versed in a) accounting, b) estate planning, c) insurance, and d) law. Some advisors have additional skill sets, such as being a CPA or licensed to practice law, or team with partners that do. While convenient, it is important to note that conflicts of interest arise when your financial advisor also serves as your legal counsel or tax advisor. If possible, you should hire tax and legal professionals independent of your financial advisor. Even if they’re separate from each other, they can still work together to find an outcome that serves your best interests. Additionally, you are less likely to pay for services you don’t need.
How to Pay an Advisor:
Now that you have hopefully uncovered your objectives, you should focus on the fee structure and align fees with your goals and best interests. Unfortunately, advisor compensation is a critical area that most investors overlook when determining how to select a financial advisor. Failure to align advisor compensation with your plans will ultimately lead to sub-par results. Below are the most common compensation models for advisors.
- Fee-Only: In working on a fee-only basis, a financial advisor is telling you that their business is built on advice and objectivity, not product sales. A fee-only financial professional collects may collect a flat fee (generally a set retainer or hourly rate) or be paid a percentage of the assets they manage. Flat and hourly fees are more appropriate for people looking for one-time planning engagements or advice. The percentage of assets under management(AUM) fee structure is more suitable for ongoing management and comprehensive services. A fee-only advisor is only paid by you, not by fees or commissions from products.
- Fee-Based. Commonly confused with “fee-only,” this fee structure allows advisors to receive commissions and charge a percentage of assets under management. While the advisor may have an incentive to grow your portfolio, there are more potential conflicts of interest when commissions are involved.
- Commission-Sales Based: When an advisor’s primary income comes from commissions driven through product-driven sales, they are considered commission or sales-based advisors. While many commission-based advisors are knowledgeable and competent, they are subjected to pressure from their employer to sell products, not act in your best interest. These advisors most often work for banks, banks’ wealth management arms, or insurance companies.
How To Select A Financial Advisor: Key Takeaways
- Take your time to understand how an advisor is compensated and how their compensation may influence their advice. If you’re unsure how they are paid, download their ADV. The ADV should be available on their website, typically in the footer.
- Make sure the advisor you’re interviewing has knowledge and expertise specific to your unique goals.
- Perform a background check on the advisor. If they have a long history of disclosures or infractions, move on. To run a free background check on an advisor, go to BrokerCheck – Find a broker, investment or financial advisor (finra.org)
If you have a financial advisor already and are looking to make a change, the steps above should help you make a better decision moving forward. However, choosing an advisor can be a difficult choice. Fortunately, you don’t have to do it alone. We can help you get to the right financial advisor more quickly. We have developed several tools and resources to help investors more quickly identify their needs, saving time and energy in selecting the right fit. Serving clients for over 25 years, we’ve learned that we’re not the best fit for everyone, and that’s okay. However, we want to make sure everyone gets to the right fit. If we can help you determine if our services are right for you or you need help in determining how to select a financial advisor, please let us know.