Choosing a Financial Advisor

Full disclosure: I am a financial advisor. I’m also the owner of a firm whose business success is predicated on consumers choosing to pay us for advice. What follows will not be an unbiased opinion.

However, after 21 years in the advice business, I’ve been fortunate enough to land in a position that allows me to choose the business model I work under. Given enough experience, all financial advisors eventually learn which business model they prefer to work under. These preferences are motivated by compensation structure, access to research, lifestyle, and of course, conflicts of interest (or lack thereof).

As unfortunate as it may be for consumers seeking our services, the financial advice (and financial sales) industry has evolved into several confusing platforms with different engagement dynamics. Each platform comes with advantages and disadvantages that can be hard for clients and prospective clients to identify.

Financial Planning Roots

In the U.S., modern financial services have slowly evolved since the 1970s and 1980s. It was then that IRAs and 401(k) plans first became available and an added layer of complexity around tax and investment decisions left individuals pining for guidance. However, “Investment Advisors” and their representatives have actually been around since the Securities and Exchange Commission was formed in the 1930s.

Initially, the SEC’s aim was to ensure uniform licensing procedures for professionals advising the public on investment decisions. Their main priority was to prevent fraudulent activities and scams. Shortly after the Great Depression, the everyday investor often found themselves taking advice from wolves in sheep’s clothing. Regulators have come a long way since the 1930s, but sadly, the public is far from insulated from bad actors.

Stockbrokers and the Wolves of Wall Street

Anyone who saw the movie “Wall Street” (or the more contemporary “The Wolf of Wall Street”) understands that stockbrokers in the 1980s were not generally on the side of the retail investor. Their objective was to offload their firm’s inventory of securities, whether they were quality investments or total junk.

Brokers, or the people “selling” securities, were eventually joined by true advisors who charged a flat fee for their advice. In the 1980s, these folks were rare and hard to come by. By 2000, the tables began to turn.

Instead of charging commissions for each security purchase or sale, industry professionals began charging an ongoing asset management fee. That allowed them to make changes to client portfolios with little to no impact on their own compensation. This more closely aligned the interests of advisors with those of their clients.

At the same time, securities licenses became a regulatory necessity, if not necessarily the badge of honor they once were. Licensing exams that took weeks or months to study for were now supplemented with professional designations such as CFP^®, CFA^®, or CPA. These took years to prepare for and prevented over half of the test takers from succeeding. This barrier to entry provided the public with an additional screen when it came to choosing a trusted advisor.

Who’s Left Today?

Today, stockbrokers have essentially been removed from the playing field. You no longer need a human to buy or sell a stock. Online custodial platforms such as Schwab, Fidelity, TD Ameritrade, and others have disintermediated the classic stockbroker. And more recently, they’ve made trading stocks virtually free.

Human involvement increasingly exists to advise clients on what to buy or sell or to analyze the tax strategy behind buying and selling. Human advisors can also help with strategies around estate planning, savvy withdrawal techniques, and other complexities related to financial plans.

Given this backdrop, who are the current players in the “financial advisor” space? There are primarily three types of financial professionals advising consumers today. It behooves everyone to understand their roles and the differences between their business models:

1. • Insurance agents – These are the original financial advisors. Insurance agents can sell life, disability, health, long-term care, or other types of insurance policies and act as either a “captive agent” (State Farm, Allstate, Northwestern Mutual) or an “independent agent” or agency.

A captive agent is employed by the insurance company and is generally incentivized to sell policies manufactured by their parent company. They give more true advice than they used to, but their roots are in product distribution.

An independent agent can “shop” for the best deal for their client and is not tied to just one insurance company’s products.

In either role, the players are compensated through commissions for distributing products.

• • Fee-only financial advisors – These are the newest kids on the block. The term “fee-only” means that commissions cannot be charged under any circumstances. These advisors have to act as fiduciaries to their clients at all times.

They may charge an asset-based percentage on the investments they manage but cannot receive fees or “kickbacks” from any investment product provider. The client is the only person that may pay them. They may also charge a flat or hourly fee for their services.

• • Hybrid advisors – These advisors have usually held on to their insurance licenses because they want the ability to sell insurance policies when the need arises. They can also manage investment portfolios by receiving compensation from the investment product providers in the portfolio rather than directly from the client.

Because they sometimes manage investments on a fee-based platform, they can be hard to differentiate from fee-only advisors who may only work on a fee basis. Annuity commissions are often a high percentage of their compensation, but not always.

The list above covers the primary methods of engagement, but there may be “degrees” to which advisors act in one role vs. another. To find out what this breakdown or business model looks like for a prospective advisor — just ask! An honest advisor will not hesitate to share this information.

The most important thing to keep in mind is that there is a spectrum between advice and sales. Some advisors sit so far toward the sales side of the spectrum that using the term “advisor” is overly generous. Some sit so far toward the advice side that they will expect you to implement all the recommendations. Be prepared, and don’t be surprised in either case.

It’s also important to recognize that there are great people and horrible people in all three segments.

To decrease the odds of ending up with a bad actor, follow these steps:

1. Get a referral. Get the low-down from someone you know and trust. Confirm that they’ve found the firm or individual to be responsive, knowledgeable, and someone who does what they say they will do.
2. Confirm how they are paid. Are they paid a fee for advice, a commission for products, or both?
3. Do they have a clean regulatory record? Have clients made complaints? Check out their regulatory record here: BrokerCheck by FINRA Some advisors who are registered as investment advisor representatives will have regulatory records here: SEC’s Investment Adviser Public Disclosure.
4. If they were referred to you by another professional or organization, ask if that referee will share revenue from the fees you pay the firm. There’s nothing wrong or illegal about revenue sharing (as long as it’s disclosed), but you should know everyone’s motivations and potential conflicts.
5. Ask about their credentials. Are they a CFP^®? Do they have other letters after their name? Ask what was required to receive their designations. Are they impressive or not so much?
6. Remember that only licenses and credentials matter, not titles. There is no such thing as a license to become a “financial advisor” or “wealth manager.” These are titles given to licensed advisors by their firm, not the regulators, based on internal firm structure.
7. Keep in mind that the CERTIFIED FINANCIAL PLANNER™ designation may be the most important and relevant designation to look for, but it doesn’t guarantee a good experience. You wouldn’t visit a doctor who didn’t graduate from med school, but you also can’t guarantee that you’re getting both a great bedside manner and great medicine from one who did.

Unfortunately, there is no such thing as zero conflict when working with a professional. Doctors, CPAs, attorneys, and therapists — all have motivations, no matter how small, that could potentially conflict with your interests. The goal isn’t zero conflict. The goal is to know what the conflicts are upfront and to confirm none of them are too significant to expect reasonably unconflicted guidance.

The National Association of Professional Financial Advisors (NAPFA) also has a great webpage that may help you compile a list of due diligence questions when interviewing a potential advice partner.

If you’d like to ask the same questions of any of our advisors, we’d welcome the opportunity to provide the answers. Click here to learn more about our advisor team or to schedule a time to get acquainted.