Not all advisors fall under the real fiduciary rule
What qualities should you look for when hiring a great financial advisor?
There are a few terms you should always be on the lookout for when hiring a financial advisor. ‘Fiduciary’ is one. ‘Fee-only’ is another. Let’s go over what those actually mean, along with a few other qualities to look for.
Fiduciary: This means putting a client’s interests ahead of your own. The advisor’s thought process should be: how does this help my client, rather than how does this help me. An example is choosing the best technology fund rather than the technology fund that gives a kickback to the advisor.
Fee-only: A fee-only advisor will have clear and transparent fees that you know upfront. This could be a flat percentage of assets under management. The advisor could charge 1% of assets for ongoing management. You know you will pay $10,000 a year to manage your $1,000,000 portfolio. They don’t charge commissions every time they enter a trade for you. They don’t receive fees for selling you products. Also, don’t confuse fee-only with fee-based. A fee-based advisor will charge fees in addition to commissions. You want fee-only.
No conflicts of interest: A conflict of interest occurs when a financial advisor’s goals aren’t aligned with your own. An advisor could receive a fee from certain fund families by picking XYZ fund instead of ABC fund. They could receive a high commission selling you an annuity. They may put you into a non-liquid fund that ties up your principle for multiple years. These conflicts have to be disclosed but it still doesn’t take away that lingering thought – is this really in your best interest or is the advisor just trying to make money. There are advisors that purposefully don’t enter any of those agreements and those are the ones you want advising you.
Interestingly, it’s nearly impossible to avoid all conflicts of interest. The SEC even considers a percentage of assets fee as a conflict of interest. The SEC claims its a conflict because the advisor benefits if the client’s account balance rises. For the most part, that goal aligns with the client trying to increase their holdings. The conflict would arise if the client asked about paying off their mortgage versus keeping the money invested. The advisor benefits if the money stays in the account so there could be a conflict.
Brokercheck profile: Most investors don’t realize this but there’s a site that allows you to perform a ‘background check’ on the advisor: brokercheck. Most advisors don’t have any bad marks. Some have quite a few complaints and fines but new clients keep signing up with them! Just avoid that mess. This is your life savings so only accept the best.
Investment management: This one is more a personal opinion of my own, but I like to look at how an advisor handles your investments. A lot of them will outsource the management of your investments to a third party. If so, I would question why you feel the need to sign up with them. You’ll most likely be put into a cookie-cutter portfolio based on a questionnaire you filled out. You can pick a few low-cost funds on your own without paying that advisor so look for actual in-house management customized for you.
Investment advisor vs stock broker
Everything I described above generally falls under the bounds of a fiduciary investment advisor. Don’t confuse investment advisors with stockbrokers. Stockbrokers suck. Stockbrokers may call themselves financial advisors, investment advisors, financial consultants, or wealth managers among a long list of titles, but the bottom line is they work for broker-dealers (BD) rather than registered investment advisors (RIA). Some big firms are both BDs and RIAs. In that case, the advisor is supposed to change hats and let you know if they are working in the capacity of BD or RIA. The hat will change based on the transaction and advice being given; good luck trying to keep up with that! Here’s what happens: they give advice that you think falls under the fiduciary rule (RIA umbrella) only to find out later that the advice was given while under the BD umbrella.
Why is that distinction important? Because there are two different fiduciary rules. I know, it’s crazy but true. Investment advisors (working for RIAs) follow the actual fiduciary rule where they have to do what’s in your best interest. The other “fiduciary” rule that broker-dealer employees have to follow only makes it sound like they’re working in your best interest. In reality, as long as their conflicts are in the fine print they are safe from liability.
Merrill Lynch, Morgan Stanley, and Raymond James are examples of broker-dealers. Any advisor working for them could muddy those fiduciary waters. Don’t even bother trying to figure it out; just avoid BDs or BD/RIAs altogether. Stick with pure RIAs and know exactly what fiduciary rule they are following (the legal, unambiguous one).
One distinction to make, though – there’s a difference between using a firm as custodian to hold the assets and actually working for the firm. A fully independent advisor could use Charles Schwab as custodian; that’s perfectly fine. On the other hand, you could have an advisor that actually works for Charles Schwab; that’s the one you want to be careful of. If they work for the firm they are protected under the BD umbrella.
You have to ask yourself: why is it so hard for these broker-dealer advisors to put their clients’ best interests ahead of their own? If an advisor is fighting that, what is their motive? And why would you trust them with your life savings?
How to hire a financial advisor
Hopefully, we’re on the same page at this point. Hiring a pure investment advisor is the way to go and you’ve identified a few good ones based on the terms at the beginning of the article. It’s time to reach out to each of them and set up meetings. Don’t worry, you’re not committing to anything at this point. It’s more of an interview to see how they operate.
With the meetings set up, start thinking about what you want a financial advisor to do for you. What’s their role in your financial life? Do you want them to completely manage your investments or do you just want them to review what you’re doing? Do you want them to run a complete financial plan of your future or just bounce a question off of them every once in a while? Maybe you want them to explain what they are doing so you can slowly take over control as you learn. That’s fine too. Having this conversation upfront will save you and the advisor a lot of stress. You’ll start on the same page with what your goals are and it will help reveal the best fee structure. Remember, you don’t have to know all the answers beforehand; that’s the point of the meeting.
You’ll probably notice one advisor made you feel at ease during the meeting. They listened to you, they explained things clearly, and you left feeling good about them. That’s probably the advisor you want to go with. That comfortable feeling will help your overall financial life. You’ll be more open to discuss items that you are embarrassed or ashamed to discuss with friends and family.
Alright, so you’ve picked your top advisor and went over the parameters of the relationship. The final step is to agree on the fee structure and sign the new client paperwork!
Fee structures
As stated earlier, you can pay your advisor as a percentage of assets under management. This will cover investment management, periodic meetings & updates, and whatever questions you have from time to time. It usually also covers financial planning, which will give you an idea of what your retirement income will look like if you stick to the plan. Typical advisors charge anywhere from 1% up to 1.5%, but there are lower-cost investment advisors charging 0.80%, 0.60%, and sometimes even 0.50%. From what I’ve seen, the amount charged has nothing to do with the service received so don’t think you’ll be missing out on anything by going with an advisor charging lower fees.
Many advisors will also offer a service for a flat fee. You would meet with the advisor on a quarterly basis. They would review all of your accounts and holdings and let you know what changes you should make. It’s up to you, though, to actually make the changes since your accounts will still be held at outside companies.
Finally, you can even pay an hourly fee, something like $300, to sit down with a certified financial planner and put a plan together for one hour. You still manage your own investments, and you’re not committing any more money other than the initial $300 fee. For a $100,000 portfolio, $300 is a 0.30% fee, and you’ll get multiple years of use from the CFP’s plan. The trade-off is you have to stay on top of the plan since the advisor won’t be there day-to-day to remind you.
It should become obvious which fee structure is right for you as you define what role your financial advisor will have.
One final note: Don’t just take your friend’s word for it when they say their advisor is the best. They probably have no idea if ‘their guy’ is a fiduciary or a stockbroker. Most people can’t even tell you how much their advisor charges them.