shark-infested waters: hiring a financial advisor, part 1

Last week’s post notwithstanding, everyone’s financial situation is different; sooner or later you’re probably going to want to consult a financial planner. However, the financial services industry has such a bad rap that a lot of people I know have opted for doing the research themselves, with varying degrees of success. (I can’t tell you how many engineers I know invested in a “sure thing” — Dutch auctions, municipal bonds, a bevy of stocks picked by a program they wrote — that promptly collapsed in 2008.) If you don’t have the time, inclination, or trust in your own financial wizardry, you’re going to want to hire a planner. But how to find one that won’t take a huge bite (as it were) out of your investments?

To answer that question, first let’s take a quick look at the two designations: RIA/IAR and CFP.

Registered Investment Advisor/Investment Advisor Representative:

The terminology here is a little bit confusing. A “Registered Investment Advisor” can refer to either a company or an individual in business for themselves; in either case, it means that they have registered with the SEC or state securities board and are licensed to give investment advice. (“Investment Advisor Representative” is the term used for a licensed individual working for an RIA.) Important things to note about an RIA(or IAR — from now on, when I say “RIA” assume I mean “RIA or IAR”, unless I explicitly state otherwise):

• You don’t necessarily have to be an RIA to give investment advice. I won’t bore you with the details, but your accountant, broker, or lawyer can legally give you “incidental” investment advice without being an RIA. So if they do, don’t assume anything about their investment credentials.

• They have passed one or more tests regarding their investing and legal knowledge. Exactly which test varies depending on whether they also intend to act as a broker — it could be a Series 7, 63, 65, 66, or some other. Not only does it cover investing, but it also ensures that an RIA knows exactly where their legal boundaries are.

• They are held to a fiduciary standard. This means that every recommendation they make must be in the client’s best interest; their ultimate loyalty is explicitly to the client. Any potential conflicts of interest must be made clear through their brochure (see the next bullet point). Contrast this with the “suitability” standard, to which brokers are held, which states that recommendations must not be “unsuitable” for the client; however, their ultimate loyalty is to the broker-dealer company they work for. As you might imagine, this subtle distinction can make quite a bit of difference.

• You can look up their information online in a centralized database. The online search tool is called IAPD, and it’s a great way to check up on an RIA or IAR and see if they’ve committed any past indiscretions. If you look up an RIA, you’ll get a “Form ADV”, which outlines everything you ever wanted to know about their practice (and a lot you probably didn’t). The bit of awesomeness, however, is that RIA’s are required to create what’s called a “brochure” for part 2 of the Form ADV, which must be in layman’s terms and must contain certain information, including details on any possible conflicts of interest. If you’re wondering about commissions your RIA might be getting for certain investment products, this will lay it out.

Certified Financial Planner

Whereas RIA/IAR is a legal designation for dealing with government bodies such as the SEC or state securities boards, CFP is a private, professional certification.

• CFP’s must meet certain education requirements. This includes having a bachelor’s degree, taking a very specific set of coursework on various financial planning topics, from insurance planning to estate planning, and a prescribed amount of continuing education each year.

• CFP’s must have three years of financial planning experience.

• CFP’s are also RIA’s/IAR’s. So you can look up their information in the IAPD database, and they’re held to the same fiduciary standard, in addition to a Code of Conduct enforced by the CFP Board.

Now you know a bit about the designations financial planners use. There’s more to a planner than their designation, however — next time, we’re going to talk about how different types of planners make their money. It’s more important to you than you might think!