To find a financial advisor, we begin by assuming that you have determined that you need a financial advisor. The next step will be to gather a small group of qualified candidates and to meet with them, in person if possible, to discuss both your needs and their qualifications to meet those needs.
Remember, in most cases the relationship with a financial advisor will last a lifetime. Taking extra time up front to find the best one for you and your family will be worth the time invested.
Where to Begin?
There are around one million people in the U.S. alone referring to themselves as either a financial advisor or financial planner, and they vary greatly in qualifications and experience from one to the next. We discussed this in greater detail in our article, “What is a Financial Advisor?“.
Financial advisors can be found at banks, at large brokerage firms, or at independent financial advisory firms. You might find candidates through online searches, referrals from trusted friends and business associates, or from offline sources, such as local newspapers and the Yellow Pages.
What’s most important is to make sure you find more than one qualified candidate and that you have an idea of what you’re looking for and what questions you’ll ask in your search of an advisor.
The Shortest Path to a Truly Independent Financial Advisor – the RIA
If you ask any advisor if they offer truly independent financial advice, they will all certainly answer, “yes, of course!”. Yet we know this isn’t always true. So, is there a way that you can know for certain, without having to ask? There is.
You can filter out 99% of all financial advisors and planners in the country who have no fiduciary responsibility to act in your best interest by choosing, from the start, to only work with an Independent Registered Investment Advisor (RIA). An RIA has met the most stringent standards in the industry and is the only type of advisor under a legal obligation to act as a fiduciary in service of their clients. This means that, at all times, the must act in the best interest of their clients. Non-RIAs are not held to this standard. When we say, “independent”, we mean an RIA that is not part of a large brokerage firm or bank, as potential conflicts of interest will still exist in those situations.
See our discussion below on “fiduciary or suitability” as well as our article discussing why RIAs make the best financial advisors for more information.
Taking Measure of Their Character
Apart from professional credentials, forms of compensation, investment philosophies and the like, you will want to take good measure of the character of the advisors you meet with. What qualities are you looking for in an advisor? Does the advisor strike you as intelligent, trustworthy, knowledgeable, experienced and caring? Will they be accessible once the relationship begins? Was rapport established easily?
What Professional Credentials do they Have?
As mentioned above, a Registered Investment Advisor (RIA) is the most important credential for those seeking a truly independent, fee-only financial advisor. Beyond this there are other credentials to consider, some directly related to financial planning and investment management services, and some indirectly.
Financial planning is an integral part of financial advisory services. There are a number of professional designations for financial planners and we will discuss two of them here.
CP/PFS (Certified Public Accountant and Personal Financial Specialist)
With a CPA/PFS you get two professional designations rolled into one. A CPA will have a college degree and will have passed a rigorous, three-day exam. Further, they are required to have at least two years of supervised experience working for a CPA. The PFS designation requires its own detailed exam as well as significant proven financial planning experience.
It is important to note that the core of a comprehensive financial plan consists of a number of financial statements (balance sheet, income statements, cash flow statements, etc.), all of which are standard fare to the experienced CPA. Further, a CPA will have substantial education and experience in tax matters, even if they aren’t practicing as a tax accountant or preparer.
CFP (Certified Financial Planner)
A CFP will have passed a course in financial planning and successfully completed a 10-hour exam. A college degree is not required. Though there are many competent CFPs in the marketplace, there is a reason this credential is the most commonly found,- it is simply the easiest of the two to obtain.
Which Standard – Fiduciary or Suitability?
It may not be fun to learn the difference between such technical terms as “fiduciary” and “suitability”, but it is certainly critical to know the difference when choosing your financial advisor.
Over 650,000 people in the U.S. have passed at least one securities exam and hold the designation, Registered Representative. When they work, they most likely refer to themselves as financial advisors or financial planners, because the previously used designation, “stock broker”, has fallen out of favor. Further, there a many more who are not registered representatives who also refer to themselves as financial advisors and planners. At best, these professionals are held to a standard referred to as “suitability”.
The Standard of Suitability
We are most concerned here with the motivations that drive the investment decisions that an advisor will make on your behalf. The standard of “suitability” requires that the investment decision be “suitable” to the client’s needs AT THE TIME OF PURCHASE ONLY. It does not require that the investment chosen be in the best interest of the client. Confusing?
Let’s use a simple example. Let’s say a client needs to hold a mutual fund in the energy sector. The advisor has found two funds, Fund A and Fund B, that are both deemed “suitable” to the client’s needs. However, Fund A is clearly the better fund for the client, and Fund B will pay the advisor a much higher commission. The advisor under a standard of suitability is able to purchased Fund B on behalf of the client, serving their own best interest at the expense of what’s best for the client. This is an example of conflict of interest.
The Standard of Fiduciary
An RIA, held to the standard of fiduciary, must at all times act in the best interest of the client. They are very carefully regulated, as well.
Considering the above “suitability” example, an RIA held to a standard of fiduciary would be required to recommend Fund A, because it was determined to be the better fund for the client. Further, an RIA would never have been put into this predicament because they, under most circumstances, are forbidden from earning commissions from investment decisions. When an RIA is compensated as a percentage of assets under management, they earn the same in either case. In fact, they will earn more over time if the assets under management grow in value, which encourages them to make the best decisions on behalf of the client.
To further illustrate the difference, let’s say the client currently holds Fund C, and that Fund C also meets the suitability standard. Let’s further say that, after analysis, remaining in Fund C is the best decision for the client. A stock broker may still sell Fund A or B to generate a nice commission for himself at the expense of the client and yet still meet the suitability standard. An RIA-licensed financial advisor would be obligated as a fiduciary to advise the client to stay in Fund C. Additionally, the RIA under an assets-under-management fee agreement would neither gain nor lose income personally by recommending this course of action. There is no conflict of interest present.
Depth and Breadth of Professional and Personal Experience
In addition to financial planning and investment management experience, consider what other professional and life experience the advisor may have. Do they have any post-graduate degrees, such as an MBA? Have they worked outside of the financial advisory profession and, if so, does this experience make them even more qualified to do their job? Do they have a family? Have they built significant wealth? Are they involved in the community? Consider what experience might be important to you and don’t be afraid to ask if your advisor has this experience.
Fee-Only (Fee-based) Versus Commission-based Compensation
Clients with substantial wealth are deeply concerned with the performance of their investment portfolio under the advisor’s management. Conflicts of interest have existed for a century that pit the advisor’s need to earn as much money as possible with the clients need to yield the most from their investments.
The primary conflict of interest over the years has been a result of commission-based compensation for financial advisors, stock brokers and other types of investment managers and salespersons. When commissions are at stake, there exists the temptation to the advisor to create buy and sell transactions when none are necessary (a practice known as “churning”). Or, it encourages the broker/advisor to choose investments for their clients that pay the highest commissions or earn the firm a higher profit, regardless of what’s in the best interest of the client.
More recently, the fee-only (sometimes called fee-based) compensation structure entered the marketplace. As it pertains to investment services, this refers to the practice of charging a fixed percentage (typically 1% to 2%) annually of assets under management. With fee-only compensation, the advisor has no incentive to make unnecessary trades or to choose investments that pay higher commissions (because they don’t earn commissions). The financial incentive to the advisor is simply to grow the value of the investment portfolio, which is perfectly inline with the goals of the client.
Of all the criteria you’re looking for in an advisor, consider placing a fee-only advisor at the top of your list.
Compatible Investment Philosophies
Each advisor you interview should be able to clearly articulate their investment philosophy. It is important to clear this up early, and to make sure it is compatible with your desires, before engaging an advisor. If you seek an advisor who buys and sells individual stocks daily like playing the ponies, then you’ll tire quickly of one who takes a more tempered approach.
What Technologies and Tools Does the Advisor Employ?
A financial advisor’s use of software and other technologies in the planning and investment process is rarely considered by those in search of a financial advisor. Some may use off the shelf planning software that cost them a few hundred dollars. Some may have to manually make all investment transactions and have little in the way of tools to help them quickly analyze investment data across all clients, all accounts and all portfolios.
At the other end of the spectrum are advisors who have invested thousands or even tens of thousands of dollars in the most sophisticated tools available for financial planning and investment management. With these tools they can be more precise and more productive than an advisor who lacks these tools and their clients stand to benefit as a result.
Be sure to ask the advisors to explain the tools they use to assist them in the planning and investment processes.