Selecting a financial adviser is not easy, and consumers often do not know what to ask.
So, let’s tackle some of the important questions.
I recommend you interview several potential financial advisers, so have your questions ready!
First, titles are deceptive. You may find titles like financial planner, investment adviser, financial adviser, wealth adviser, stockbroker, financial counselor, investment representative, and insurance salesperson.
Question 1: What services will you provide? Traditionally, a stockbroker or an investment adviser only provided advice on investments. This has changed, and some will now prepare retirement projections for you, and they may provide other services. For example, they may discuss college funding (for a child or grandchild), and they should be able to explain the pros and cons of converting a traditional IRA to a Roth IRA. However, they will likely not provide tax planning (which is a critical component for a Roth conversion).
Typically, a financial planner will offer broader services, including investment advice or management, retirement planning, tax planning, cash flow, insurance advice (although they may or may not sell insurance), college funding, social security planning, legacy planning, and estate planning (although they will not prepare legal documents).
In my view, all the advice should be customized to your goals and situation. Cookie-cutter retirement plans (where the firm chooses the assumptions and you have little input) are not worthwhile.
Question 2: How much service will you provide? Financial planners and financial advisers often work on a retainer, which continues for at least a year, and for many years if the client chooses. This is best for clients who want their investments managed on an ongoing basis, along with regular meetings to discuss many topics. Clients will have access to the financial planner whenever questions arise throughout the year.
However, some financial planners work on a project basis, and the size of the project is determined based on what you are trying to accomplish. Services end when the project is completed. A project may be a few hours of work, or it can be more extensive. This arrangement is often good for do-it-yourselfers, and it is much less expensive than ongoing service. However, the downside is that once the project is over, you must contact the financial planner when you want to ask a question, and potentially start another project or pay an hourly fee.
Question 3: What are your fees? Historically, stockbrokers were paid by commissions on the products (stocks and bonds) they sold. This has changed significantly during the past 20 years. The fee structure that is now common is termed “Assets Under Management,” or AUM. The fee is a percentage of the investment assets the financial planner or adviser manages. Although fees vary considerably, 1% on $1 million dollars is common, which equates to a $10,000 fee if $1 million is managed. The percentage is often higher for assets less than $1 million, and it typically declines significantly for amounts over $1 million. An investment advisory firm that often advertises on TV states “We do better when our clients do better.” This is referring to an AUM fee structure. As the assets increase, the fee increases. If the assets decrease, the fee decreases.
Another fee structure that is not widely used (but clients seem to like) is called a “flat fee.” An example is $7,500 per year, regardless of the amount of assets a client may have.
Advisers who work on a project basis are calculating their fee based upon an hourly rate for the number of hours they estimate will be needed to complete the project.
Fortunately, many new “robo” advisers have become available in recent years, and most brokerage firms offer online services to people with fewer assets who cannot afford a financial adviser on a retainer model. These services are less customized, but are much more affordable.
There are also various categories of financial planners. A “fee-only” planner is one who can only receive money (fees) from a client. In other words, they will not accept commissions or money from a mutual fund company, an insurance representative, or any source other than the client. This eliminates most potential conflicts of interest, but not all.
A “fee-based” financial planner or stockbroker can charge a fee to the client, but they can also accept income from other sources, such as commissions from selling the client an annuity or from a “revenue sharing” arrangement with an insurance agent who sells the client an insurance policy. There are also mutual fund families that will pay financial planners or stockbrokers a portion of the expense ratio when the client owns that mutual fund. This is allowed for fee-based planners.
Some financial advisers and stockbrokers may be paid a salary by their parent company, and they may also be paid based on new assets they bring to the firm. In addition, they may participate in bonus programs designed by the parent firm. This qualifies as a fee-based structure but not as fee-only.
You should also ask, “What other fees will I be paying?” Regardless if you are working with a fee-only or a fee-based financial adviser, another fee is called an “expense ratio,” which is paid to the mutual funds or exchange traded funds you own in your investment accounts. This fee is deducted directly from your mutual funds or exchange traded funds. It does not go to the adviser. By using mostly index funds, this fee should be very low, preferably less than 0.25 of 1 percent. There may also be transaction fees when a mutual fund, ETF, stock, or bond is purchased. These should be minimal, and they go directly to the brokerage firm and not to the financial adviser.
For fee-based or commission-based planners, there may be many fees that are hidden and are not disclosed. These are typically in addition to the fee the adviser discusses with you. These fees include commissions, referral fees, annual account fees, and investment manager fees (sometimes called “separate account manager” or “wrap” fees) if the adviser outsources the investment management function. The adviser may also earn “trails” from insurance products sold to the client in prior years. Trails are usually paid to the adviser for as long as the client owns the insurance policy.
Prior to the 2008 financial crisis, a well-known large brokerage firm was charging 1.5% for their advisory fee plus another 1.5% for the “separate account manager” fee. Fees of 3% are excessive. Unfortunately, there is not a “full disclosure” law in the financial industry. If there were, the fees would have to be disclosed clearly to the client, which would be a huge step forward toward transparency.
Question 4: Do you specialize in a certain type of client? Some financial advisers work primarily with retirees, millennials, doctors, entrepreneurs, or small-business owners. Some work mainly with couples, women, or the LGBTQ community. Some work with middle-income clients, and others focus on high net-worth clients. Finding an adviser who will provide extensive value to you requires that you select the adviser carefully.
Question 5: Are you a fiduciary? A fiduciary is a legal term that means the financial adviser is required by law to put the needs of their clients first. In addition, according to compliance attorney Thomas Giachetti, a fiduciary is required to make “full and fair disclosure of all material facts, especially when the adviser’s interests may conflict with those of his clients.”
If you are working with a financial adviser who is a “Registered Investment Advisor” (RIA), they are required to be a fiduciary. RIAs are independent financial advisers registered with the Securities and Exchange Commission (SEC) or state securities regulators. They know they are fiduciaries, and they take the responsibility seriously.
However, for financial advisers who are not RIAs, the word fiduciary is used loosely, and no one seems to be policing the usage. Several years ago, roughly 80% of financial professionals who described themselves as financial advisers, investment advisers, brokers, and insurance agents were not fiduciaries. In recent years, passing new requirements that would require financial advisers to have a “fiduciary duty” to their clients has been debated by the SEC and regulatory agencies. It was never resolved, so there is not a fiduciary standard in the financial industry. As stated earlier, buyer beware.
If you want your financial adviser to serve you as a fiduciary, consider asking them to sign the fiduciary pledge. This appeared in a New York Times article by Tara Siegel Bernard in 2010:
Fiduciary pledge
I, the undersigned, pledge to exercise my best efforts to always act in good faith and in the best interests of my client, __________________________, and will act as a fiduciary. I will provide written disclosure, in advance, of any conflicts of interest, which could reasonably compromise the impartiality of my advice. Moreover, in advance, I will disclose any and all fees I will receive as a result of this transaction to me. This pledge covers all services provided.
Question 6: What is your investment philosophy? Many financial planners and financial advisers follow different investment strategies. Some use only index funds (funds managed by a computer and designed to match an index such as the S&P 500). Others use a “core and explore” strategy (mostly index funds but a few actively managed funds). Some use mutual funds and others use exchange traded funds (ETFs). Some prefer individual stocks and bonds.
I recommend you have a discussion on this topic and ask whether the financial adviser will ask for your permission before trades are placed in your account. Most do not. This is because they want to rebalance their clients’ accounts and make changes on a global basis (for all clients at once), which is more efficient for them.
Thankfully, “churning accounts” (frequent trading) happens much less often than 20 years ago. However, some advisers outsource the investment management for their clients, and these “managed” accounts or “subadvisers” may do more churning if they are trying to beat the stock market. If the investments are in a taxable account this can trigger higher taxes.
What’s the bottom line? The financial industry has plenty of people who are eager to make money off you. You must be careful. Conversely, there are some excellent financial planners and financial advisers who provide great value and can help you achieve your goals. Financial planners and financial advisers should all offer you a free initial appointment to discuss your goals and answer all your questions. I recommend you interview several, until you find one you trust. Remember, you are the customer, and they should be serving you.
Donna Skeels Cygan, CFP, MBA, is the author of “The Joy of Financial Security.” She was a fee-only financial planner in Albuquerque for more than 20 years before retiring in 2021.