Picking which financial advisor or planner to work with is an important decision and one that should not be taken lightly. Below are five important questions that you should ask any prospective financial advisor.
1.Are you a fiduciary?
Most advisors would tell you that their advice and recommendations are made in the best interest of the clients that they serve, but a mere fraction of these advisors have an actual legal obligation to act in the client’s best interest. The majority of financial advisors today are held to a Suitability Standard, which means that they only have to prove that a recommended product or service was, to their knowledge, an acceptable recommendation for the client based on their age and level of investment pedigree. This can lead to conflicts of interest where an advisor might steer a client towards a product that (unbeknownst to the client) pays the advisor the most commission, versus suggesting the product that best accomplishes what the client is trying to do. A great example of this is if an advisor, in order to get a much larger commission, steers a young couple (mid 30’s) towards rolling their old 401(k)s over into a variable annuity with really high expenses, instead of investing in much lower cost mutual funds or ETFs. They both MIGHT be theoretically suitable (and there are other instances where a variable annuity might actually make sense), but in this particular case it’s probably in the long-term best interest of the client to put those funds in the lower cost investment vehicle.
Financial planners and advisors who are fiduciaries, on the other hand, have a sworn legal responsibility to put the interests of the client above their own. Instead of providing solutions that are suitable, they must provide recommendations and advice that are in the BEST INTEREST of their clients. Ensuring that your financial advisor is a fiduciary should be a mandatory requirement when looking for a financial advisor.
2.What are your credentials?
There are many people in our industry who call themselves “financial advisors”, but not all advice is of the same merit. Everyone from insurance brokers who only sell insurance-based products to someone who may not even be registered with the government to give financial advice might describe themselves as financial advisors. So how can you tell if someone is truly qualified to provide quality financial planning and advice? I would suggest asking potential advisors what their credentials and qualifications are.
When it comes to being qualified to give comprehensive financial planning advice, the CERTIFIED FINANCIAL PLANNER™ (CFP®) designation is the gold standard and is what you should look for when working with a financial advisor. In order for someone to receive the CFP® designation, they must satisfy all of the following requirements:
- Must have an undergraduate degree
- Must have three years of client experience in financial planning, or two years of client experience while working with another CFP®
- Completed extensive financial planning education program including courses on General Principals of Financial Planning, Insurance Planning, Investment Planning, Income Tax Planning, Retirement Planning, and Estate Planning
- Complete a capstone course that utilizes all of the above material
- Pass a rigorous seven-hour comprehensive exam of all the above material with a historical pass rate of 55-60%
- Agree to adhere to the standards of ethics and practice outlined in the CFP Board’s Standards of Professional Conduct
- Maintain 30 hours of continuing education on a bi-annual basis
Of all advisors who claim to do financial planning, only 25% hold the CFP® designation. I would consider the CFP® designation an essential requirement when looking for a financial advisor or financial planner. You can find out more information about the CFP® designation and the certification process here.
3. How are you compensated?
The majority of financial advisors are commission-based, meaning that they are paid a commission by the various mutual fund, annuity, and insurance companies when they sell one of the company’s products to their clients. Most times, the client is unaware of how much the advisor is being compensated by the company to recommend a particular product or service to the client.
This commission-based structure is rife with potential conflicts of interest and many times leaves the client wondering if the particular products and services being recommended were made in the best interest of the client or the advisor. Did the advisor recommend this variable annuity to me because this is the best vehicle to accomplish what I’m trying to accomplish, or did he recommend me this product because he gets a 7% commission on the sale of this product and helps him qualify for a free cruise to the Bahamas? While there are many great advisors with good intentions that are truly trying to do what’s best for their clients in this service model, it is not an optimal compensation structure for a client/advisor relationship as it is too easy for recommendations to have ulterior motives.
Fee-only financial planners, on the other hand, do not receive commissions or any other form of compensation from any third-party company. They are solely compensated by their clients. Unlike a commission-based relationship where it’s hard to figure out how much your advisor is being paid for services rendered, a fee-only advisory relationship has a transparent fee structure that allows the client to easily see how much he/she is paying for the services being provided. This fee structure helps to substantially reduce the conflicts of interest in the client/advisor relationship, while also building more trust between the two parties.
*Note: While the terms “fee-based” and “fee-only” sound like they’re synonyms, they are not! Fee-based advisors can still receive commission and other forms of compensation from third parties, while fee-only advisors cannot. *
4.Do you use a third-party custodian?
In investment terms, a custodian is a person or institution that holds client monies and investments in order to protect them from theft or loss. Most custodians are large, reputable companies that are responsible for large sums of client money (generally in the billions of dollars). Most advisors use these third-party custodians to safeguard client assets. For instance, our firm uses TD Ameritrade as our custodian. This means that even though we manage our clients’ investments, we are not in physical possession of our clients’ assets. Rather, they are safely held in the custody of TD Ameritrade. Fidelity, Pershing, Schwab, Interactive Brokers, and Scottrade are all other examples of reputable third-party custodians. If an advisor tells you that he, personally, is his own custodian, run! This doesn’t necessarily mean that he’s a crook or dishonest, but having a custodian adds an additional layer of protection and helps to prevent investors from getting suckered into ponzi schemes (see Bernie Maddoff) or other various forms of fraud.
5. What services do you provide?
Some financial advisors are solely investment or insurance focused, while others are more comprehensive in scope. If you’re looking for someone to just help you with your investments, then its fine to go with an investment-centric advisor. If, however, you’re looking for an advisor that will not only help you with your investments, but also make sure that you have adequate insurance coverage in place, are maximizing your employer benefits through work, are on course to pay for your children’s college education, will help you figure out a plan to pay down your student loan debt, and help ensure that you are on course for retirement; then I’d suggest looking for someone who does comprehensive financial planning. Identify what you’re needing help with and pick an advisor that aligns with your needs.
Conclusion
Not all advisors are created equal, but by asking these five questions you'll most likely end up with a much more qualified financial advisor.
If you have any questions, feel free to email me at daniel@sweetgrassfp.com or schedule a free introductory consultation.
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Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Daniel Patterson, and all rights are reserved. Read the full disclaimer here.
