Choosing a Financial Advisor, Part 1

“You don’t need 99.9 percent of what Wall Street is selling. It’s expensive, unsuitable, or stupid. Most investments are designed to profit the brokers, banks, and insurance companies, not you.” – Jane Bryant Quinn.

The quality of the financial advice that you get is dependent upon many things, including the training and academic background of your financial advisor. It also depends, in large measure, on how your advisor is compensated. Researching this issue and understanding what best serves your particular interests is a task well worth pursuing. Reading books on financial planning is one way to arm yourself because, in my opinion, it is nothing short of a war. I hope to do my part by providing you with a series of articles on the subject.

If you take the “easy way out” and merely go with the investment firm that has the best (i.e. most expensive) commercials on TV and the glitziest print ads in the local newspapers, consider this. You may be lining the pockets of your advisor, with your gold.

For one purely objective view on the subject, consider the Consumer Federation of America, an advocacy, research, education, and service organization. In an article on choosing a financial advisor, they argue that using a “fee-only” advisor may be your best choice.

Financial Planners

The way in which a financial planner is compensated can directly affect the advice he or she gives clients. A relatively small percentage of the individuals offering financial advice actually get paid exclusively for giving such advice. The majority earn some or all of their income selling mutual funds, annuities, insurance, and other financial products to implement their recommendations. “Advisers” who are also salespeople, however, inevitably face a conflict of interest and will almost certainly be tempted to steer clients into products in which they have a financial interest. The greater the adviser’s dependence on commission income, the greater the conflict. In the end, that conflict could cost you both in out-of-pocket expenses and in the quality of advice you receive.

Long-Term Cost

One of the chief attractions of commission-based financial planning is that it appears affordable. Typically, commission-based planners charge a relatively low fee or no fee, for the “advice,” expecting to earn the real money on the back end, when they sell the products to implement their recommendations. When you buy a product to implement that plan, however, a percentage of the money you spend goes to pay a commission to the planner. Ultimately, the price you pay includes not just the commission itself, but the money it would have earned over time had it been invested. In assessing the costs of financial planning, therefore, you have to include the cost of implementation.

Quality of Advice

The increase in implementation costs is not the only price you pay for commission-based planning. You may also pay in the form of poor advice. After all, when a financial “adviser” earns most of his or her money as a financial salesperson, the product sales tend to drive the process. In the worst case scenario, the planning becomes nothing more than window dressing to attract clients for the real money-making business of selling products. Clients are offered one-size-fits-all plans that inevitably lead to the purchase of a handful of high-commission products.

Even those commission-based advisers who attempt to offer comprehensive financial advice still can find themselves biased by compensation considerations when it comes time to implement their recommendations. After all, the more the adviser lowers the initial fees to attract business, and the more time he or she spends on the planning process, the more he or she must earn in the implementation phase to make that investment of time pay off.

Under such circumstances, even the best of commission-based planners is unlikely to recommend no-load or low-load products, for example. Other less scrupulous planners may recommend an investment, such as a particular mutual fund or annuity, simply because of the special incentives or higher commissions they receive.

The temptation for planners to recommend higher commission products carries another risk for clients. Product sponsors tend to offer higher commissions on those products that are more difficult to sell, because they are riskier. Thus, in pushing higher commission products, the planner may encourage you to take unnecessary risks with your money.

“Fee-Only” May Be Your Best Choice

So, if you are looking for objective financial advice, a fee-only financial planner is probably your best bet. Fee-only financial planners are compensated solely by fees paid by their clients. They can be paid in a variety of ways—a flat fee or retainer, an hourly fee, a percentage of assets under management, or a percentage of income from investments. The key is that they do not accept commissions or compensation from any other source.

Fee-only financial planning does not necessarily eliminate every conceivable form of conflict-of-interest. When fee-only planners “sell” portfolio management services, for example, they may have a financial incentive to recommend those services to clients. The fee-only approach is, however, subject to fewer conflicts than any other form of financial advice. Furthermore, because fee-only planners are compensated solely by the client, there are no hidden third parties in the relationship and thus, no divided loyalties.

Conclusion

I work strictly on a fee-only basis. That was my choice in setting up my practice, as it is the kind of arrangement I would want if I were the client.

Since everyone’s circumstances are different, you may be the rare individual who can best be served by a financial advisor who is compensated by commission. But, you won’t know that unless you get a second opinion. As Jane Bryant Quinn said, “If you don’t know much about investing yourself, it’s hard to tell good advice from bad.”

The majority of fee-only financial planners are members of the National Association of Personal Financial Advisors (NAPFA), an organization started in 1983. To find a fee-only advisor in your area, call NAPFA at 1-800-FEE-ONLYor visit their homepage at www.feeonly.org

To be continued.

photo credit: Office Now