Choosing the right option for managing your money, such as retirement accounts and other investments, is critical. Choosing a bad financial advisor can have a lasting impact on your future net worth, ultimately leading to additional years you need to work to meet your retirement goals. A difference between a .05% fee and a 1% fee can mean a retirement date that is 3+ years later, not to mention the impact from the quality of investments made by the advisor.
Did I get your attention? The good news is that there are many options out there, and the information contained in this article can help you avoid making costly mistakes when choosing a financial advisor.
You have many options when it comes to managing your money and investments
- You can do it yourself. I have been managing my family’s portfolio for over 20 years; from the time I had my first 401k right out of college. I have not always been savvy in personal finance topics. The key to my success? I read a lot of books, articles and other things which empower me to understand what’s needed. I personally trust myself more than anyone else to manage my own money. And really, its not all that difficult if you make simple choices, such as investing in low-cost index funds. Much of it is as simple as saving a good portion of your income, making sure you have a good mix of investments for risk and checking in on things at least once a year. You do not need to be in the “stock picking” business. In fact, a dead person’s portfolio has been shown to outperform one that is actively managed. Meaning, the more you buy, sell (aka mess with things), the lower your rate of return could be overall. Make a plan and stay the course.
- You can go with a robo-advisor. Robo-advisor services have grown in popularity over the past several years. These services often use a series of questions to learn about you as an investor. They then use algorithms and other tools to build suitable portfolios for their clients based on that up-front questionnaire. And they provide these services at a fraction of the cost of a traditional financial advisor. Check out NerdWallet’s list of 11 best robo-advisors to see some options for highly-rated robo-advisor services. I have personally used WealthFront, but in full transparency, not as an advisor. I have been using their free app for over two years to track all of my accounts in one place. It basically aggregates all of your retirement, savings, mortgage, credit card and other accounts in one view so that you can track your net worth over time. The app also lets you plug in goals, including retirement age, major purchase goals, sending kids to college, etc. and will tell you if you’re on track or what you might need to do to make some adjustments. Also, it gives you your “F.U. number,” the amount of money you need today in order to put in your two week’s notice. Overall, it is informative and has actionable information.
- You can choose a financial advisor. Financial advisors are another option for managing your portfolio. However, the term “financial advisor” is used very loosely in the industry. The most important decision you can make in choosing the right advisor is choosing one that has your interests and needs at the forefront. For this reason, shy away from commissioned advisors. Also, be cautious of taking financial advice from advisors who focus on one brokerage or offer a large amount of their own firm’s products, as they will always be in a position of recommending their own products and services. Instead, seek out an independent authentic Certified Financial “Planner” who is not merely packing your portfolio with what makes them the most money.
Things to look for when choosing the right financial advisor
- Check the financial advisor’s credentials. One of the best credentials you can look for in a financial advisor is the Certified Financial Planner (CFP) designation. Advisors earn this designation by taking a series of exams and also need to complete continuing education to maintain it. Note, however, that just because someone is a CFP does not automatically qualify them as a “good” advisor. Some commission-oriented firms out there hire CFPs as a way to boost their reputation while still employing their same “sales” tactics.
- Know how they get paid so that you know they have your best interests at heart. This is extremely important. This is the thing that can make or break your portfolio and cost you years of earnings (meaning a later retirement). When an advisor is commission-oriented, they are incented to buy and sell often in your portfolio, which leads to what is called high turn-over. High turn-over is very costly. It causes high transaction fees and commissions. Instead of commissions, other advisors charge a percentage of assets under management (AUM). For example, the average AUM fee is 1.02%. This means, with $500,000 invested with this firm, they get a $5,000 cut each and every year. And this is on top of the fees that you may already be paying for the underlying investments they are putting you in, such as mutual funds.The advisor gets a percentage of your account balance, whether that balance increase is due to the returns or because you are saving more. So, in essence, the more money you save, the more you’re paying in fees for someone else to manage.
- Consider an hourly fee advisor. Some financial advisors are wolves in sheep’s clothing. They wave the title “advisor” out in front of you, but in actuality, they are commissioned salespeople. Would you hire a salesperson to represent you in the court room or do your taxes ? It is important to make sure that your advisor has your best interests in mind. A big part of this is ensuring that their incentives (what they make off of you) are aligned to doing what’s best for YOU and not what simply lines their pockets. Choosing an hourly-fee financial planner or one on a retainer, like you would any other service profession, ensures you are paying for what you get vs. how much you are worth.
- Does the financial advisor treat you with equal respect? There’s nothing that irritates my wife and I more than when a person we’re doing business with directs all of their attention to me, the male breadwinner. It is the instant deal killer with us. If you have a partner, how an advisor addresses the two of you says a lot about the respect they’ll have for your money. Just because a person earns their wages in hugs from their kids vs. in cash doesn’t make their opinion any less important.
- Compare them to the indexes. One quick way to do a check up on a financial advisor is to compare the annual returns you’re getting to an index such as the S&P 500. The S&P has climbed 26% so far in 2021 (thru Dec). If you tend to have a very conservative portfolio, your returns may be lower. The broad indexes, however, are good benchmarks to how the broader market is performing without an advisor. Has your return for 2021 been higher or lower?
3 Types of Payment Models with Financial Advisors and What To Look Out For When Choosing An Advisor
| Commission-driven | Assets-under-management | Hourly fee or subscription-based RECOMMENDED | |
| How they get paid | Advisor gets paid a percentage of each of the products and services they “sell” you. | The financial advisor or the firm gets paid a certain percentage of the balance of your portfolio being managed by them, typically paid quarterly. | You pay an hourly fee or subscription/retainer for their services, like you would a lawyer, an accountant or a plumber. |
| Effect this has on you and your money | The advisor can put you into products that better serve them financially versus those that serve your goals. For example, with whole life insurance, advisors are paid significantly on the front end which is why many commission-paid advisors recommend these policies. Life insurance is not an investment. If you need it, buy term life. | The more you save and invest, the more money you pay to manage it. As your portfolio grows (regardless of whether it is more that you’re saving or earnings you are getting on the money), the firm’s fees grow with it. Also, if you do not have as high of a net worth as other clients, you will likely not get equal attention. | You choose when you want to meet with someone and drive how much you pay based on what you’re asking for. Most of the time, the hourly-fee advisor is giving you instructions and you are making any necessary transactions yourself with your accounts. |
| What to keep an eye out for | Watch out for the “churn” inside your account. Review your transaction history. How often are investments getting bought and sold? Every time a transaction occurs, the cash register rings for the commission-based advisor. | Assets Under Management fees are not always “all inclusive” fees. Watch out for underlying investment fees, commissions, wealth management service and other fees. | Ask for estimates on how long things will take. Typically, hourly fee advisors know exactly how much time goes into building your annual plan and other tools you need. Some feel that hourly advisors have no “skin in the game,” but I disagree. They have an incentive to retain clients just like any other professional service firm. |
If you already have a financial advisor today, ask them these 4 questions ASAP. If you don’t feel good about the responses, it might be time to seek out a new option.
- How do you get paid? What are all of the ways you make money from my business? You want your advisor to be very transparent with fees, and you want to see the detailed breakdown.
- Are you a fiduciary and who is your custodian? Fiduciaries work in the best interest of their clients vs. the products and services they sell. By having a separate custodian for your actual investments, it helps ensure you don’t get trapped in a ponzi scheme (remember Bernie Madoff?).
- What’s your investment philosophy? You want to make sure that you and your financial advisor are aligned and have a plan suitable for you. Good financial advisors will use that plan to ensure you stay on course even when there are turbulent times and don’t “panic sell.”
- How do you know if what you’re doing is good? What benchmarks do you use to measure your performance for me? For instance, do they measure their success against the S&P or other indexes?
How to find a new financial advisor if you need one
The National Association of Personal Financial Advisors is a non-profit organization that supports fee-only advising. Visit their site where they have a national directory of fee-only financial planners. Note, some of the advisors listed offer different payment models, including “assets under management” that I also listed above. You can filter down to “hourly” or “retainer-based” if that is the route you want to go.