The purpose of this post is to aid those who are looking for a financial advisor by outlining five important questions to find answers to before entrusting a firm/individual to manage your assets and help you plan for your future. It can also provide helpful prompts to those who are happy with their current advisor, but want to better understand the advisor's practice. Any advisor worth hiring will be happy to field these questions and will have clear, straightforward answers.
1. Are you obligated to act in my best interest?
The term fiduciary is thrown around often in the world of financial planning. It is used to describe an advisor who is obligated to act in the best interest of his/her clients. It might sound crazy (because it is), but there are some jobs in financial planning that don’t obligate the advisor to act in the client’s best interest. Below is an overly-simplistic breakdown of who is obligated to act in your best interest and who is not.
Advisors who work under a firm organized as a Registered Investment Advisor[i] (RIA) are classified as Investment Advisor Representatives (confusing, I know). RIAs and their advisors (IARs), are obligated to act in the best interest of their clients.
Registered Representatives affiliated with/operating under Broker Dealers[ii], on the other hand, do not have a fiduciary standard, but instead, operate under a suitability standard, which simply means that their recommendations/actions must be suitable for their client and the client’s situation.
To make things more confusing, there are certain designations that can impose a fiduciary standard on an advisor – being a Certified Financial Planner, for example, necessitates a fiduciary standard. So, if you are working with a CFP professional, that person is required to do what is in your best interest, regardless of whether he/she works at an RIA, Broker-dealer, bank, or anywhere else.
Just because someone technically has the obligation to do right by you, doesn’t mean he or she will. The best qualities to have in an advisor are honesty and integrity… past that, it is generally a good idea to look for advisors who have designations like CFP and work under the structure of an with RIA.
2. How do you get paid?
There are several different ways advisors get paid… Some are better than others for specific situations, but none are perfect.
AUM (Assets Under Management): This is the most common of the various pricing models. In an AUM fee arrangement, the annual fee will be the total assets under management multiplied by the AUM fee. The industry average for AUM fee is around 1% but can be much lower or much higher and can cover many different services such as insurance planning, estate planning, tax planning, financial planning, etc., or it could only cover the portfolio management of that one account. Clients should weigh their fee against the services being offered. A client who is paying 1.25% AUM fee and receiving comprehensive financial planning is potentially getting a lot more bang for their buck than a client paying 0.75% but only receiving asset management. As an example, an AUM fee for an advisor charging a 1% AUM fee and is billing monthly would have a fee of $833 ($1M*.01/12) debited from their account monthly (assuming the account balance was exactly $1M every billing cycle). The fee will go up and down with the value of the account.
What are the potential drawbacks to the AUM fee model?
It’s easier for advisors to potentially overcharge. Especially if they are not doing the planning that would justify a high fee.
Makes the client think they are paying for asset management and getting the other services as an add on - typically the other services are much more important and difficult to execute than asset management.
What are the benefits of the AUM fee model?
It’s easy to understand for the client and easy to execute for the advisor as the fee is debited right out of the account.
It aligns the interest of the client and the advisor. The advisor is incentivized to do right by the client and keep the AUM fee coming in the door for years to come.
Flat Fee: The most straightforward of all the pricing models - the advisor quotes a flat fee and the client receives the agreed upon services. Pretty simple. It is especially suitable for those advisors/clients who are looking for a one-time or shorter-term engagement.
What are the potential drawbacks to the flat fee model?
Because the fee is paid out of pocket (versus debited directly from the accounts under management), it could make for a hassle for both client and advisor come billing time.
The advisor is less incentivized to keep the client happy indefinitely. Once he/she gets paid, the outcome of the client is less relevant to the advisor than with a longer-term AUM structure (from a monetary perspective).
What are the benefits of the flat fee model?
The upside to a flat fee is you know exactly what services you’re getting and the price associated with them.
This fee structure is ideal for a client who wants a one-time deep dive to get a plan for the next chapter of life or wants to know if they are on track to achieving their goals.
Hourly: There are advisors who are willing to track the time they spend working for you and charge you just like an attorney or a CPA would.
What are the potential drawbacks of the hourly fee model?
It is less objective than some of the other fee models and is harder to track
It discourages clients from engaging with the advisor because doing so would incur an expense
What are the benefits of the hourly fee model?
Could be more cost effective if you don’t need in depth planning or ongoing advice
You only pay for the time you need - no more, no less
Commissions: This is the common fee model for advisors who are also representatives of broker dealers and/or insurance agents. The advisor/broker/agent gets paid to sell a product of some sort, be it an investment, annuity, or insurance policy.
What are the potential drawbacks of the commissions fee model?
It incentivizes the advisor (broker/agent) to sell a suitable product to a client and then move onto finding the next buyer.
The products being sold in this environment tend to be expensive and complex
There is rarely, if ever, true financial planning taking place in this model
What are the benefits of the commissions fee model?
If a client is just looking for help finding a specific product to fill a specific need, this is typically the cheapest and best way to purchase said product - a good example of this might be an annuity to solve a retirement income need or an insurance product to hedge against a specific risk.
Regardless of the pricing model, consumers should understand the fee model as well as what they are receiving in return for their fee. Some advisors charge separate fees for separate services, so it is possible to have some combination of the models listed above. None of them are inherently bad, but there are definitely some that are more appropriate for certain situations than others.
3.What services are you actually offering me and why should I care?
Not long ago, the majority of advisors were either managed investments or sold insurance; some did both. You can still find many advisors operating this way today. Our firm’s broad definition of financial planning is the coordination and planning within the areas of insurance, estate, cashflows, goals (retirement, education, life event, etc), investments, and taxes. To successfully execute deep and personalized planning necessitates a lot of effort from the client and will never come cheaply. As a result, full planning might not be a great fit for every client.
Additionally, some clients have very specific needs that necessitate an advisor who has specialized expertise in a given field. Getting ready to sell a business? There are financial advisors who specialize in advising clients through exit plans. Did you just get hired at a tech startup? There are financial advisors who specialize in navigating warrants, RSUs, stock options, and the like. No matter your unique circumstances, there is an advisor who is an expert in what you are needing.
4. What are your qualifications?
There are plenty of advisors out there who don’t have designations but do a wonderful job for their clients. Conversely, there are also advisors with impressive designations and degrees who I wouldn’t trust to watch my dog. Designations are not sole determinant as to whether an advisor is qualified to give you advice or manage your assets, instead they are a marker of a baseline level of knowledge that the advisor has obtained. More than any objective qualification, you must be confident that your advisor cares about you and your family. You must also be confident that he or she is competent and capable enough to help you solve the financial puzzles that arise in your life. Past those two subjective qualifications, designations are great for differentiating advisors. Below are a few of the common designations to look out for if you’re shopping for an advisor:
Certified Financial Planner (CFP)[iii]: The gold standard of designations for financial planners. This designation is for advisors who have a bachelor’s degree, have taken the required CFP coursework, and have passed the six hour, 170 question CFP exam. It shows the advisor has a baseline knowledge in all the areas of comprehensive planning (financial planning, taxes, insurance, estate planning, and retirement saving). For more info, check out this Investopedia article on Why Your Financial Advisor Should Be a CFP[iv].
Certified Public Accountant (CPA)[v]: Most are familiar with the CPA - it is a designation that shows the advisor is highly educated (150 hours of higher education hours) and has passed the rigorous four-part CPA exam. This professional is likely to be highly skilled and knowledgeable when it comes to taxes.
Chartered Financial Analyst (CFA)[vi]: Passing the three-part CFA exam is incredibly difficult. Anyone who is able to accomplish this grueling feat knows their stuff when it comes to investments. However, it can be argued that investments are the least valuable area of financial planning as investors are typically better off employing a simple, cheap, efficient hands-off approach to their portfolio.
Chartered Life Underwriter (CLU)[vii]: An advisor with a CLU mark behind their name is who you want advising you if you are in need of complex life insurance and/or estate planning solutions.
Bachelors and/or Masters degrees in Financial Planning: As financial planning is becoming a burgeoning profession, financial planning programs in higher education are becoming more popular, as well. Most of these programs are CFP-registered, meaning a student can satisfy their CFP coursework through their bachelors or masters program and sit for the test right out of college.
There are many, many more designations advisors can attain… some designations demonstrate an impressive expertise possessed by the holder… some do not. Check out this link[viii] to learn more about the many designations advisors can earn.
5. Do you eat your own cooking?
Everyone’s situation is different - I should probably not manage a 90-year-old client's account the same way I manage my own. However, if we both have a need for a domestic equity fund, would I be willing to invest in the same fund that I place my client in? In my opinion, the answer should be yes. It is very confidence-invoking to hear your advisor tell you that he or she invests in the same investments that you are invested in. Or that he or she is using the same insurance product. Again, everyone’s situation is different, but if your advisor were in your situation, he/she should be doing for you what they would want done for them.
If you are looking for an advisor or want to have a conversation about the material in this post, send us an email at hello@genwd.com
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
Foster Capital Management Inc. dba Generations Wealth Design (“Generations Wealth Design”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Generations Wealth Design and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at www.genwd.com.
References:
[i] Adam Hayes, “Registered Investment Advisor (RIA) Definition”, Investopedia, June 10, 2023, https://www.investopedia.com/terms/r/ria.asp
[ii] Adam Hayes, “What is a Broker-Dealer (B-D), and How Does it Work?”, Investopedia, May 19, 2021, https://www.investopedia.com/terms/b/broker-dealer.asp
[iii] Julia Kagan, “Certified Financial Planner (CFP), What it is and How to Become One”, August 3, 2023, https://www.investopedia.com/terms/c/cfp.asp
[iv] Zina Kumok, “Why Your Advisor Should Be a CFP”, Investopedia, October 21, 2021, https://www.investopedia.com/articles/investing/100115/why-your-financial-advisor-should-be-cfp.asp
[v] Adam Hayes, “Certified Public Accountant, What the CPA Credential Means”, Investopedia, July 21, 2023, https://www.investopedia.com/terms/c/cpa.asp
[vi] Adam Hayes, “Chartered Financial Analyst (CFA) Definition and Exams”, Investopedia, September 28, 2023, https://www.investopedia.com/terms/c/cfa.asp
[vii] Julia Kagan, “Chartered Life Underwriter (CLU): Meaning, Qualifications”, Investopedia, November 29, 2021, https://www.investopedia.com/terms/c/clu.asp
[viii] The Investopedia Team, “The Alphabet Soup of Financial Designations”, Investopedia, November 25, 2023, https://www.investopedia.com/articles/01/101001.asp
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