Do I Need A Financial Advisor?
Plus, How To Find One
As a former financial planner my experience comes from the world of traditional finance, where working with a financial planner requires that you have complexity in your financial life, a certain amount of wealth, and the commitment to sign up for year-long engagements. Thankfully, there are more accessible financial planning options for everyone.
You can hire a planner to create your financial plan, review a plan you created or to consult with at various times in your life. For example, if you’re newly divorced, received an inheritance, got a big fat raise, are close to retiring, have gone through some other major financial milestone, or think you need to hire an actual professional to get your crap together, you can get someone to be your temporary guide as you move through these different circumstances in your life.
Whether you decide you want to hire a financial planner or advisor (or any other kind of financial professional), here are the things you should consider and the questions you need answered to help you decide which person is right for you.
What Is A Financial Advisor?
Let’s define some key terms.
A financial planner is generally trained to help you come up with a comprehensive plan to help navigate your entire financial life, whereas financial advisors might be more limited to giving you advice on investments. Whoever you hire must be an independent fiduciary that never recommends products under the “Suitability Standard.”
A fiduciary is a person or organization that acts on behalf of another person to manage assets. A fiduciary is legally and ethically required to put their client’s best interest before their own. But here’s the kicker: not all financial advisors are fiduciaries! How could this even be a possibility? Because of something called the Suitability Standard.
The Suitability Standard is a regulation that says a broker must make “reasonable efforts to obtain information” on a client’s financial life when determining whether a financial product is deemed “suitable” for a client. Suitability doesn’t sound sketchy, but it can be. For example, if you hired a dietician whose food recommendations only needed to meet a suitability standard, they could argue that it’s suitable for you to only eat vitamin-infused pop tarts. What is suitable for you is not what is in your best interest. That’s the trick with this language.
When advisors are independent, this means they are free to recommend financial products from different companies. Someone who is not independent would be a “wealth manager” who works at Wells Fargo; they are usually only allowed to sell you Wells Fargo products, which might not be the best product for you, but it’s the only product they can sell.
Products are types of investments, securities and financial instruments like annuities or life insurance policies.
Let’s look at an example. Let’s say, Jesse, the financial advisor, has two product options for his client, Julian. The first product is an investment that is the best option for Julian that happens to be less costly for her, but it only pays Jake a 3 percent commission. The second investment is not the best option for Julian and it happens to be more expensive, it meets the suitability standard, and pays Jesse a 10 percent commission. The problem with the suitability standard, and with commission-based fees in general, is that it can create a conflict of interest between the advisor and the client.
How Do Financial Advisors Get Paid?
There are generally two ways financial professionals get paid. There are client fees and commissions on selling financial products. Client fees can be structured in a variety of ways. There are asset management fees, hourly fees, retainers, quarterly fees or flat-rate fees.
When hiring someone to help you with your money, it’s important to know how they make theirs because it comes at your expense—literally. There is nothing inherently wrong with people getting compensated for their work, but that doesn’t mean we shouldn’t be critical about potential conflicts of interest or critical of the value you receive compared to the price you’re paying.
If you interview a financial planner, ask them to tell you all the ways they get paid. If their response is that they are a fee-only practice, this means their compensation comes directly from the clients they serve. Fee-only planners and advisors are almost always fiduciaries that act in the best interest of their clients.
Since their pay comes directly from their clients and not from third parties like mutual funds or insurance companies, these planners and advisors can keep their focus on their clients’ needs and best interests. When a fee-only advisor or planner recommends financial investments products, you can feel confident knowing that they are truly recommending the best product for you since the recommendations are not in competition with commissions.
The fee paid to advisors and planners can be structured in a number of different ways. There are annual retainers, monthly subscriptions, a fee to deliver a comprehensive financial plan and different service packages with different options. There are planners that charge an hourly rate or a fee per session. An asset management fee has been a popular fee structure in the industry, but it can end up being a lot costlier for the clients in the long run.
ASSETS UNDER MANAGEMENT
An assets under management (AUM) fee can be fee-only, but it can also be a part of a fee-based compensation if the advisor also gets paid commissions. It’s tricky, which is why it’s important to get these questions answered when considering hiring someone.
At my first week working at the financial planning firm, my new boss sat me down and explained to me how the industry worked. He explained how our firm can charge an annual financial planning fee and a 1 percent asset management fee. This means that 1 percent of the client’s investment account balance is paid as a fee. So, a client with a million dollars invested with us would pay us $10,000 per year and a client with $10 million would pay us $100,000 a year. At first, this seemed totally fine and a 1 percent fee may not sound like much, but it ends up being very expensive in the long run. It could cost investors 25 percent of their returns over forty years—or nearly half a million dollars! Ouch.
For some people, paying this fee is worth it because they use their financial planner to help them analyze all sorts of investment options or financial opportunities, from businesses they might invest in to publishing and licensing deals they’re considering. But for a lot of folks, this fee is not worth it because they aren’t getting services to justify the fee. Most people don’t need to be giving away that much of the returns that they could be generating themselves by investing in index funds and ETFs.
COMMISSIONS ON PRODUCTS
If you ask a financial advisor how they get paid and their answer is that their compensation is fee-based, this means that they can get paid both from fees paid by clients and from commission on the financial products they sell. Some of these products may include insurance or a particular investment like a fund.
Why do they call it fee-based when it sounds misleading and so similar to fee-only? To confuse you, maybe? I don’t know if that’s the answer, but it probably is because it would be way more straightforward to call this payment structure “fees and commission.”
Where to Find Fee-Only Advisors and Planners
The XY Planning Network is a wonderful database to find fee-only advisors. The database is extensive, so you can search for the things you’re looking for in a planner. If you want to find someone who is local, charges a flat rate for creating a plan and specializes in socially responsible investments, you can do a search to find all the advisors within the network that meet that criteria. Once you find the advisors and planners that meet your criteria, you should set up informational interviews to figure out which person is the right fit for you.
Beyond the fee-structure and ensuring that who you hire is a fiduciary, it’s also important to make sure the person you hire takes their time to listen to your needs, desires and fears. And it’s imperative that you hire someone you feel like you can confide in and seek counsel from.
From FINANCE FOR THE PEOPLE: Getting a Grip on Your Finances, published by Penguin Books, an imprint of Penguin Publishing Group, a division of Penguin Random House LLC. Copyright © 2022 by One Jelly Bean, Co.
Paco de Leon is an author, illustrator, musician and the founder of The Hell Yeah Group, a financial firm dedicated to inspiring creatives to engage with their personal and business finances. Her career experiences in banking, business consulting, financial planning, and wealth management have informed her financial philosophies. She is a TED speaker and her work has been published or featured in The New York Times, NPR, Bloomberg, Vice, and others. She lives in Los Angeles with her wife.