There are big differences between an advisor who's firm is solely an RIA and others who work for a broker dealer. Here are the 10 things you need to know before hiring a financial advisor:
1. What Do You Need: Depending on the complexity of your finances, you may need a one time review or ongoing support. Do you need help with one specific area of your finances like investment management? A one time review of your retirement plan or budget? Or someone who will tie your taxes, investments, insurance, estate, and retirement parts together? Make sure they offer all the services you need.
2. Your Best Interests, ALL THE TIME: Only some financial professionals have pledged to act in the client's best interests at all times. These types of advisors are called "fiduciaries." Advisors working for Registered Investment Advisor firms have a fiduciary standard all the time.
Brokers have a lessor, more vague, standard where they are able to sell "suitable" products for your situation. Advisors that work for companies like Merrill Lynch, Morgan Stanley, and Edward Jones can go back and forth between the two standards to benefit their bottom line and not you the client.
To me it comes down to loyalty. A fiduciary advisor is loyal to clients where a broker is loyal to the company and its shareholders.
3. Background Check: Do your due diligence to avoid the "bad eggs" in the financial services industry. There are resources to see if disciplinary action has been taken against an advisor or broker. If you are considering a Registered Investment Advisor they must provide a brochure (Form ADV Part 2 A&B) disclosing information about the company and its representatives. Brokers registered with FINRA do not have to disclose all conflicts or how they are paid.
Registered Investment Advisors: SEC Advisor Search
Brokers: FINRA Broker Check
4. Some Are Pros, Some are Amateurs: Unlike other professions like a doctor or lawyer, anyone can say they are a financial planner. But, that doesn't mean they have any experience or credentials to provide you with quality financial planning.
Again, check the person and or company at the SEC or FINRA websites. Credentials like the Certified Financial Planner (CFP®) are not easy to attain and show further expertise. Certified Financial Planners have years of experience; extensive knowledge and skill in all areas of financial planning; completed a background check; ongoing continuing education; and they adhere to ethical standards set by the Certified Financial Planning Board governing body.
CFP Lookup: CFP Certification
I attained my Certified Financial Planner designation after three years of working as an advisor, studied and passed six pre-tests and then passed a two-day, 10 hour comprehensive exam. This rigorous testing prepared me and sharpened my knowledge to advise client's appropriately for many financial situations.
5. Avoid Fraud: To protect your money you should only work with someone who uses a Third Party Custodian. Companies like Charles Schwab, Scottrade, and Fidelity are examples of Third Party Custodians. They act as a check and balance for clients by keeping your money separate from the advisor and they provide independent statements to verify account balances.
6. A Financial Planner is NOT a Broker: This repeats some of the information above but it is important to emphasize the difference between the two. A true financial planner will provide unbiased advice that is in your best interest. They will look at all of your financial matters, understand what your goals are, work with you to create a plan to accomplish them and be by your side every step of the way. They will not sell you products or move you in and out of investments every month.
Brokers are all about selling, selling, selling. They have corporate sales quotas, focus on gathering assets, earn big commissions on insurance products and other investments, don't disclose their compensation, and are not required to work in the clients best interests at all times.
7. How Are They Paid: There are three standard ways financial professionals are paid:
Fee-Only: The only composition earned is directly from the client. It can be a flat dollar amount or a percentage of assets/net worth, or on an hourly basis. A Registered Investment Advisor firm has to disclose how they are paid, the amount or percentage and any conflicts up front. They can not receive commissions or kickbacks. This eliminates any incentive to sell products that are unnecessary or inappropriate for the client. Fee-only is the easiest to monitor and understand how much you are paying for the services you are receiving. Fee-only advisors adhere to the fiduciary standard.
Commissions: This is a percentage charged on the amount of product sold. They more you sell the more you make. Variable annuities are notorious for high fees with up front commissions of 6% -7% and trailing annual fees of 3%. Load mutual funds like American Funds sold at Edward Jones can charge 5.75% commissions up front plus fees to the manager. That means you have to earn 7% or more to get back to even. And you don't receive any advice on other financial matters. They do not have to disclose any kick backs or revenue sharing agreements which provide incentive to sell one product over the other.
Fee-Based: The term was deliberately created to seem better than the reality and it has become a great money maker for brokers. In truth, "fee-based" means brokers can charge you commissions and fees at the same time. They hide behind both broker and registered investment advisor labels and use them to benefit themselves. Brokers are able to sell a product with an upfront commission and then place it in an account that charges an annual fee on that same asset. Again, they do not have to disclose any kick backs or revenue sharing agreements that provide incentive to sell one product over the other.
8. What Tools Do They Use: Is the advisor able to use the best industry tools or are they tied to only what their company allows? Are they technologically savvy so you can communicate or get information when and where you want? Because I am an independent financial planner I am able to evaluate and implement the technology tools I believe provide high value, are easy to use and relevant to my clients. Are they set up for video conferencing, sharing documents remotely, computer sharing, financial planning software with client login?
9. How Do They Invest: History, research and studies show it is almost impossible to consistently beat the market. So why pay an actively managed fund more for something that doesn't perform better? Instead, look for an advisor that uses index funds. They are more tax efficient, have transparent investment holdings and have very low costs. It is also important that the advisor is focused on long-term investing (5 or more years), uses a diversified asset allocation strategy and rebalances.
10. What Advice Can They Give: Brokers can not give advice, only general "guidance", on investments inside 401(k) and other employee benefit plans. They won't give advice on these plans because they have to take on a fiduciary responsibility and that limits how and what brokers sell.
RIA firms and their advisors can and will provide advice on all of your accounts and assets regardless of where they are. This gives clients a cohesive strategy across all their accounts so they are working to achieve their goals.