Most people need help with their finances at some point. A financial advisor can help; but to get the right kind of help, you need to understand what type of advisor to look for, how they operate, and how to find the right advisor for your needs.
This article can help you explore topics to understand the basics, including:
- What is a financial advisor?
- What financial advisors do
- Can I trust a financial advisor?
- How to find a financial advisor?
What is a Financial Advisor, and What Does a Financial Advisor Do?
"Financial advisor" is a very broad term. It generally refers to a professional qualified to provide some form of expertise related to handling your money. This may involve investing, retirement planning, budgeting or managing tax liabilities.
In a sense, a financial advisor is like an architect, helping you create a blueprint or plan for how to reach your financial goals. Many financial advisors can also help you execute on your plan, bringing relevant, current information and knowledge about financial products and choices that you can use to inform your decisions.
Though the specific form of advice may vary, perhaps what most distinguishes financial advisors from automated programs such as robo-advisors is their ability to give personalized financial advice based on your needs.
Since those needs can vary depending on your financial status and what you are trying to accomplish, you should pick a financial advisor whose area of expertise matches up with your needs.
Also, financial advisors can come from a variety of different backgrounds and hold different regulatory licenses. You should check that a financial advisor's qualifications and licenses are appropriate for the job you want them to do.
Types of Financial Advisors
The following are examples of different types of financial advisors:
If you don't want to pick stocks and other investments for yourself, you may want to turn the job over to an investment manager.
There are different degrees of professional help you can get with your investments. Mutual funds allow you to buy shares of professionally managed portfolios, but those portfolios are managed uniformly according to general guidelines. They are not tailored to your specifications.
A stock broker can make investment recommendations to you, but you still have the ultimate responsibility for which recommendations you choose to follow. This form of advice is known as "non-discretionary." That means the broker does not have the final say-so, or discretion, as to whether a recommendation is implemented.
If you want someone to take full responsibility for managing a portfolio according to your needs and goals, you should choose a discretionary investment manager. This is a person or an organization that will take operational and legal responsibility for your investments.
Discretionary investment managers are usually Registered Investment Advisors (RIA) regulated by the Securities and Exchange Commission (SEC). You can check whether a firm is an RIA, as well as find out details on its background, by using the search tool at the SEC's www.investor.gov website.
Financial planning involves taking a broad view of your long-term financial needs. This might include investments, but may also take into account budgeting, education or retirement saving, and estate planning.
Financial planners come in many different forms. Some are called "personal financial advisors," some may be insurance agents, some may be accountants, and some may be attorneys.
Those different professions show just how complex long-term financial needs can be. At various times you might need investment advice, life insurance expertise, tax services or legal counseling. Since it is difficult for any one person to be proficient in all those fields, one solution might be to work with a firm that has specialists in a variety of areas.
Since financial planning encompasses so many specialties, a good qualification to look for is the Certified Financial Planner (CFP) designation. This requires a combination of experience in the field with either completion of a program administered by the Certified Financial Planner Board of Standards or earning a professional designation such as Certified Public Accountant (CPA), Chartered Financial Analyst (CFA), Chartered Life Underwriter (CLU) or a license to practice law.
Many people get help with tax preparation; but as your financial situation gets more complex, you might also want to engage in some tax planning.
Tax planning involves strategies for managing your long-term tax liabilities. This can include setting up tax-advantaged accounts, pursuing tax-friendly investment strategies, timing distributions from retirement plans and a variety of other tactics.
Tax planners may have a variety of titles and qualifications, but a CPA might be best positioned to make the link between your long-term tax strategy and your year-to-year tax returns.
As you can see, these different types of financial advisors provide very different services. That's why the first step in choosing a financial advisor should be to clearly define what you need them to do.
What is a Fiduciary?
A key concept in some types of financial advice is fiduciary responsibility.
This means that a service provider has a legal obligation to handle your business in your best interest. This is a higher standard of legal responsibility than simply having to make reasonable representations when selling you a financial or investment product.
Some financial professionals are fiduciaries, and some are not. For example, a registered investment advisor generally has a fiduciary relationship with clients, while a broker does not. If you expect a financial professional to act as a fiduciary toward your account, you should confirm that in writing.
Not every financial professional you deal with has to be a fiduciary. However, it is important that you understand who is a fiduciary and who is not so you know how to scrutinize any advice they give.
How to Spot Conflicts of Interest
A fiduciary is supposed to act in your best interest regardless of their own interests. However, when dealing with non-fiduciaries, it is particularly important to understand any financial incentives they may have that differ from yours.
Two types of business arrangements can help you determine whether potential conflicts exist:
- Whether the professional is paid by a flat fee or a variable commission
- Whether the professional operates independently or represents an organization with proprietary financial products.
Fee vs. commission
Some financial professionals charge a flat fee covering the services they provide. For investment services, this fee is often a percentage of the amount of your money that they manage.
Other professionals get paid a commission based on what they sell you. This can create an incentive to sell you certain products that pay a higher commission and/or to sell you products more frequently to generate more commissions.
Generally speaking, fee-based advisors are considered more objective than commission-based advisors, because their compensation doesn't depend on which products they sell you.
That doesn't mean you should never deal with commission-based financial professionals. It just means you should be aware of the potential for a conflict of interest.
Independent vs. proprietary
Some financial professionals operate independently and can recommend products from a variety of different firms. Others operate on behalf of a specific financial firm and can only offer that firm's proprietary products.
Generally speaking, an independent professional can offer a broader range of products and operate more objectively. However, it is possible that someone representing proprietary products only can meet your needs, depending on the scope of the firm's products and the nature of your needs.
How to Find a Financial Advisor
Based on the above background about what financial advisors are and how they work, the following are some steps you should take when looking for one:
- Define the job you need done
Don't just ask yourself "Do I need a financial advisor?" For most people, the answer to that at some point is "yes." The real issue is what services you need. Is it investment management, tax planning or something else? The qualifications for each type of job differ, so define the job first so you can look for the right qualifications.
- Check the qualifications
Once you've defined which qualifications you're looking for, check whether any advisor you are considering has the right expertise. Be careful, because professional designations are like an alphabet soup of initials that stand for different things.
Make sure any professional you deal with has a recognized credential, and check who issued it. Often professional associations or regulatory agencies have directories that allow you to look up information on practitioners.
- Pay attention to the cost
This is a very important factor because, if you pay too much for financial services, the cost can negate the benefit of those services.
Ask for a written disclosure of all fees and expenses. Consider not just the amount of those costs, but whether the way they are assessed creates any potential conflict of interest.
- Determine the product range
Consider what relevant products the advisor has to offer and whether the advisor can offer products from multiple firms or is limited to its own product line.
- Look into the history
Consider how long the firm has been helping clients like you. For investment services, look at how well the advisor has done in both up and down markets. Also research whether the firm has a history of legal/regulatory problems.
- Depth of resources
Consider how much the firm has to offer in terms of personnel and technology. A small mom-and-pop outfit might be great for personal attention, but you have to ask whether they depend too much on one person or lack the resources to provide the latest tools.
A financial advisor can be a terrific resource for making financial decisions. Just don't forget that choosing the right advisor in the first place is a crucial decision that you have to make for yourself.