Inquire about areas of expertise, compensation arrangements, and credentials before signing on for financial help.
By Christine Benz | 08-06-17 | 05:00 AM | Email Article

Investment guru Bill Bernstein once quipped that by the time you know enough to select a high-quality financial advisor, you could probably manage your assets on your own.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

Sadly, that's not all that far from the truth. As I discussed last week, the financial-advice industry features a bewildering array of titles, designations, and compensation schemes. Some advisors are fiduciaries, some aren't. And even though advisors must obtain licenses if they're selling securities, and pass tests and log work experience if they want to earn certain credentials (such as the certified financial planner designation), there aren't any minimum standards in place for calling yourself a financial advisor. You could work your whole life selling cars and no one would stop you from hanging out a shingle as a financial advisor tomorrow; you'd be competing head-to-head with advisors with years of experience and prospective clients wouldn't necessarily know the difference.

It's no wonder so many investors shortcut the process, opting for recommendations from friends and family members with limited financial backgrounds. Nor should it come as a surprise that lesser advisors who happen to be strong salespeople can rake in clients, while skilled but less slick financial professionals toil in obscurity.

People skills are important when it comes to getting financial help; financial matters are highly personal, so you need to have a basic comfort level with any individual you're entrusting to help you out. But you also need to conduct due diligence before signing on with an advisor. The process can be broken down into two, rather manageable, steps. The first, which I addressed last week, involves taking stock of your needs in the realm of advice consumption. The second step, which I’ll focus on today, is to take what you just learned about your own needs and goals to identify an advisor who can help you meet them.

Here are the key questions to ask of prospective advisors.

1. Are you primarily a financial planner or an investment advisor?
This is one of the first forks in the road that investors will encounter when surveying the universe of financial advisors: There are wealth managers/investment advisors, and there are financial planners.

The former type of advisor has a narrower purview--investments--than do financial planners, who consider all major aspects of a financial plan, not just investments: insurance, estate planning, and household budgeting, to name a few. However, it's worth noting that the best investment advisors think holistically about their clients' plans, while many financial planners possess topnotch investing acumen. So there's not necessarily a bright line.

If you're seeking a financial planner: Ask prospective planners about their areas of special expertise, and the demographic they typically serve. If you've identified specific areas you need to work on--for example, figuring out how your small-business ownership impacts the rest of your personal financial plan--ask the planner if he's had experience with situations like yours. Also look for someone who has earned the certified financial planner or chartered financial consultant designation, discussed below.

If you're seeking an investment advisor: Ask about investment strategy: Does it jibe with your own philosophy? Does the advisor use basic portfolio building blocks like low-cost mutual funds, or dabble in more arcane investments like futures and options? Is the strategy readily understandable? (If not, ask every question you can think of until it is. If the advisor gets exasperated, you're not a match.) The gold-standard designation for this type of advisor is the chartered financial analyst.

Softer, but no less important, does the advisor approach his or her job with a healthy dose of humility? You can get at that by asking about what he or she expects a balanced portfolio to return over the next decade. Any advisor who’s promising portfolio returns higher than the midsingle-digits over the next decade isnt being realistic and/or may be taking excessive risks.

2. Are you a fiduciary?
The Department of Labor's "fiduciary rule" has been one hot topic among financial advisors over the past few years. Simply put, the rule would require all financial advisors to put their clients' interests ahead of their own when consulting on retirement portfolios. Some portions of the rule went into effect earlier this year, but it has been contentious.

The good news is that many financial advisors already adhere to a fiduciary standard. Investment advisors who are registered investment advisors--or work for firms organized as registered investment advisors--are already fiduciaries. Certified financial planners are required to act as fiduciaries when offering planning advice, but they may not be when they're selling securities. (I know, too confusing.) Your job is to ask the question outright: Are you a fiduciary, and will you be one in every context in which you'll serve me?

That's not to suggest that financial professionals who aren't fiduciaries are automatically unethical hacks, by the way; many non-fiduciaries uphold high ethical standards and treat clients with every bit as much care as their fiduciary counterparts. But investors who work with a fiduciary have a higher level of legal protections than if they work with an advisor who’s held to the lower "suitability standard." The latter type of advisors need to be able to defend their recommendations as being appropriate/suitable for you, versus fiduciaries, who are legally obligated to recommend the "best" products for you given your situation.

3. How do you charge for your services?
Advisor compensation can get messy. One of the first questions to ask is whether the advisor is fee-only, fee-based, or commission-based. Fee-only means that the advisor is compensated by charging fees for various services and is never compensated with commissions. Commission-based advisors obviously accept commissions for recommending products. Fee-based advisors may charge primarily fees for services they provide, but may also accept commissions. 

As with the fiduciary discussion above, advisors who accept commissions shouldn't automatically be marked with a skull and crossbones. But receiving commissions for products can introduce conflicts of interest, incentivizing advisors to recommend products that aren't necessarily in clients' best interests. The fee-only model is cleaner. And while the commission model is often touted as a way for investors with smaller portfolios to gain investment advice, that's a straw-man argument, as I discussed in this video.

If you've decided to go with a fee-only advisor, you still need to ask about the specific business model, as well as a dollar estimate of what you'll pay for the advisor's services in a given year. (Ask for an estimate that includes underlying investment fees, too.) Here's an overview of the key ways in which advisors charge for their services.

Hourly: Financial planners, rather than investment advisors, may charge on an hourly basis. This business model is highly transparent and most directly aligns the advisor's work with the client's outlay. A typical hourly rate is $150 to $300; investment-related expenses, such as mutual fund fees, would be on top of the hourly rate. Before signing on with an hourly advisor, ask for an estimate of how many hours it will take to complete your job, given the tasks you've discussed with the advisor.

Best for: The hourly model is a good fit for individuals whose financial planning needs are focused rather than broad-ranging and ongoing. Clients paying hourly should also be prepared to do some of the heavy lifting for their plans; the model won't be cost-effective for "do-it-for-me" types. Because you may only need to see the advisor once every few years, and because you'll carry out some of the work yourself, paying hourly will often be more cost-effective than paying a retainer or a percentage of your assets under management.

Per Project: Under this model, the advisor charges a flat fee to complete a given project, such as a pre-retirement review and plan. Much like the hourly model, this is a highly transparent way for advisors to charge you for their services. This model is less common than the hourly model, but most hourly advisors should be able to "back into" a fee for your project before getting started. As with the hourly model, any underlying investment-related fees are separate.

Best for: Like the hourly model, this model is best for investors who have a focused need rather than an ongoing need for advice.

Percent of Your Assets: Many investment advisors charge in this fashion (often called the assets under management model), taking a percentage of the client's assets under management on an ongoing basis. The average rate is 1% for a $1 million portfolio, though clients with larger portfolios will generally pay a lower percentage. (After all, managing a $2 million portfolio isn't necessarily double the work of a $1 million portfolio.) Such fees are usually on top of whatever the investment fees are; for example, if an advisor charges 1% and puts the client in a portfolio with average fees of 0.35%, the client's fees are 1.35%. Advisors who employ the AUM model often have minimum portfolio thresholds; $1 million is a common level.

Best for: The AUM model is best for delegators who expect to need a fair amount of ongoing help and would also like to be able to be able to contact their advisors with questions or concerns on a regular basis. These consultations are baked into the ongoing fees you're paying, so you should be the type to take advantage of them.

Retainer: Under this model, which is picking up traction in the marketplace, you pay a flat monthly or annual fee for advice, much as you would for a gym membership or cable TV. Such fees are on top of any investment-specific expenses.

Best for: This model can make sense for investors who need ongoing advice on various aspects of their financial plans but don't yet have portfolios that are sufficiently large to qualify for advice under the AUM model.

4. What designations/credentials do you have?
In addition to getting clear on how you're compensating the advisor, it's also worth asking about designations the person has earned. Don't be blinded by a long list of letters after the advisor's name; some designations, such as the following, carry more heft and have heavier requirements than others. (Note: There are other several other worthy designations for advisors, such as chartered life underwriter [CLU], but they're not as broadly applicable as the following.)

If you're seeking a financial planner, look for the following:

Certified Financial Planner (CFP): A certified financial planner is a financial planning expert accredited by the Certified Financial Planner Board of Standards. In order to use the CFP designation, planners must complete an educational program, pass a comprehensive exam, and log extensive financial planning-related work experience.

Chartered Financial Consultant (ChFC): Much like the better-known CFP, this is a broad financial-planning designation. Chartered financial consultants must complete an educational program and a series of exams, while also logging related work experience.

If you're seeking investment advice, first and foremost, look for the following:

Chartered Financial Analyst (CFA): Individuals with this designation qualify as financial experts accredited by the CFA Institute. In order to use the CFA designation, advisors must log substantial work experience involving investment decision-making and take courses on subjects such as economics; financial reporting and analysis; ethical standards; equity and fixed-income investments; and portfolio management. They also must pass a series of rigorous exams requiring substantial study time.

5. What's your backup plan?
Even if your advisor is young, it's still worth asking about backup planning. Who would step in and offer assistance if the advisor could not do so for a period of time, due to death, illness, or even a long vacation? Especially if you're hiring an advisor on an AUM or retainer basis--but even if you're not--there should be individuals in place to serve as backups if your primary advisor isn't available.

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