shark-infested waters: hiring a financial advisor, part 2
So now you know all about the difference between and RIA and a CFP (and that you should choose an advisor who is one if not both of the above) thanks to last week’s post. But almost as important as their certification level is how exactly they get paid. Yes, both RIA’s and CFP’s have a fiduciary obligation to you — which is definitely a step up from, say, a stockbroker — but financial advisors have developed a reputation for coinciding their best interests with yours, while following the strict definitions of the law. As they say: follow the money. Financial advisers are generally paid in one of three ways: hourly/flat fees, retainer fees, and fees plus commissions.
Hourly/flate-fee: Like lawyers, CPA’s, and many other professionals, some financial advisors charge an hourly rate for their services, or a flat rate for a financial plan. That’s it. They have no vested interest in selling you a particular product, nor do they care whether you have a thousand socked away or a million — their only interest is in doing right by you, so as to get your referrals and repeat business. That said, if you only have a thousand dollars to your name, paying five hundred dollars or more for a plan — a not-unlikely scenario — might not make sense.
Retainer fee: While retainer fee advisors also have no vested interest in selling you a particular product, they do care how much you have in your investment accounts — quite a bit, as they charge a percentage of your assets on a yearly basis (and will generally have a required minimum of several hundred thousand dollars). Generally, it amounts to 1%, with the percentage becoming lower as your account balance goes higher. In return for this fee, they manage your assets for you, leaving you to focus on other things. There are two potential issues with this: for one thing, 1% is a deceptively low number, but when compounded over time can really eat at your total returns. The other problem is more insidious: by handing over the keys to your wealth, the temptation is to just “let them handle it” and disengage from how your wealth is handled. Not only is it not the most responsible thing to do, but as 2008 showed us, it can be downright dangerous.
Commision-and-fee: Another term for this is “fee-based”, which can be somewhat misleading. These advisors generally charge an annual fee — one much lower than that of a retainer-based advisor — but on top of that, they are also paid commissions by mutual fund and insurance companies to sell their products. Most advisors associated with big brand names, like Ameriprise (formerly American Express Financial Advisors), Wells Fargo Advisors (formerly A.G. Edwards), and Edward Jones, follow this model. The potential for conflict of interest is clear, and while some shops steer the straight and narrow, others have developed a reputation for heavily incentivizing their advisors to push high-margin products (e.g. Variable Universal Life insurance policies) onto customers that would be better served through other vehicles. Translation: beware, here there be dragons!
So: from my descriptions, you might think that I’m a big fan of hourly-fee advisors — and that’s not untrue. But while it’s easy for someone to paint all advisors who fall under a certain category with broad strokes, it really all comes down to the individual. You could get an incompetent or unscrupulous hourly-fee advisor, or the world’s best commission-based advisor. And to be honest, a good commission-based advisor could be the most cost-effective, if they point you towards low-cost, no-load mutual funds. But if you’re looking to avoid conflict of interest and remain engaged with your assets, I strongly recommend hourly/flat-rate advisors.
(Full disclosure: as part of my financial coaching services, I myself serve as an hourly-rate RIA. However, I’m not recommending them because I am one; rather, it’s the other way around. I chose to go this route specifically because this was the only way I would feel comfortable charging for investment advice.)
So how exactly do you find a good advisor? If you don’t already know one, there are two fee-only networks I recommend: NAPFA — the National Association of Personal Financial Advisors — and the Garrett Planning Network. Pick out several in your area — not necessarily in your neighborhood, you won’t be visiting them that often — and look up their Form ADV’s. You’ll be able to get a lot of information there (like how long they’ve been in business, their cost structure, and how many clients they have) that you can use to narrow down the list. Don’t make a final choice until you’ve at least talked to them on the phone. Ask them to explain their investment strategy to you, and how they generally handle cases such as yours (due to confidentiality, they won’t be able to give you specifics). See if they listen as much as they talk.