How to Choose a Financial Advisor
“When do I need to hire a financial advisor?” Despite a deluge of information free online tools and apps that abound, this remains one of the more frequent questions that I field. Before delving into the nuance of the response, we need to delineate between people who sell products, like life insurance or investments, and those who engage in a process of providing guidance based on your objectives. A planner is like a financial navigator, someone who helps you articulate where you would like to go on your financial journey and provides various routes to get you there, kind of like Waze for your financial life.
Next, we need to drop an F-Bomb: FIDUCIARY. Anyone you engage in such an important relationship must be held to the fiduciary standard, a duty that requires that the person providing advice or guidance acts in your best interest, even if doing so is not in their own or their company’s best interest. In financial services, this means that they must recommend a product or service that is better for you, regardless of whether it results in lower compensation for them. They must also avoid conflicts of interest or fully disclose them to you (and then obtain your informed consent) and they must be transparent about all fees and how they’re compensated.
About half of the so-called financial professionals out there do NOT have to put your best interest first. They are held to a lesser standard, called “suitability,” meaning that anything they sell you has to be appropriate for you, though not necessarily the best option. To ensure that you are working with a fiduciary, seek out those who hold one of these designations: CFP® certification from the Certified Financial Planner Board of Standards, CPA Personal Financial Specialist, Chartered Financial Analyst, and members of the National Association of Personal Financial Advisors.
OK, before you start the process of working with a financial planner, here are three questions to consider:
1. Have I covered my “Big 3”?
You can probably hold off on engaging an advisor until you pay down your consumer and student loan debt; have accumulated an emergency reserve fund of 6 to 12 months of living expenses; and have maxed out your retirement plan (aka “Jills Big 3”). If someone relies on your income, (lower earning spouse, kids) you may want to seek guidance before these tasks are complete for estate and life insurance advice. As a side note, the most important part of addressing the Big 3 is identical to one of the key requirements to working with an advisor: you need to understand how much you spend, and unfortunately, only you can do this dreaded task.
2. Do I trust myself?
If you have the time, energy, know-how and emotional discipline to do so, managing your own financial life and creating, updating and executing your plan can be rewarding. As a bonus, the price is right! But as I wrote in my book, The Dumb Things Smart People Do with Their Money, “sometimes you need financial advice because you’re your own worst enemy: You think you know more than you do, and you have to come clean with yourself. Sometimes you need financial advice because you manage your money in a way that your romantic partner finds abhorrent, and the two of you need to get on the same page. Sometimes you need a financial advisor because you just don’t want to do the work of managing your affairs.” According to the CFP Board of Standards’ 10-year Financial Planning Longitudinal Study (FPLS24), people using financial professionals tend to have lower levels of general and financial anxiety.
3. Do I need a pro to help my uninvolved spouse in the future?
In most relationships, there is a division of labor, which often leaves one person responsible for “money stuff”. If that’s you, remember that you will not be around forever and establishing a relationship with a financial planner before something bad happens can help the surviving spouse better manage the rest of the journey.
If you determine that you are ready to proceed, here are 5 questions to ask a potential financial professional during the interview process:
1. Are you held to the fiduciary standard at all times? Double check, just in case!
2. How do you get paid? Follow up: Do you receive commissions from any products you might recommend to me?
Financial planners typically charge in one of three ways: fee-only, fee-based, or commission-based. Fee-only planners charge you directly, either an hourly rate, a flat fee for specific services, or a percentage of your assets under management. Some planners can earn commissions from products they sell you, which is not inherently bad, but understand that their incentives might not always align perfectly with yours.
3. Tell me about your experience and the types of people you work with.
Working with someone who is new to the business is not necessarily a deal breaker, but make sure that a more experienced colleague is mentoring the newbie. Most advisors have a broad-based clientele, but you want to make sure that they have experience working with people whose situations are similar to yours. If you're a small business owner, you want someone who understands the unique challenges you face. If you're dealing with a recent divorce or inheritance, find someone who's been down that road before. If you were not referred to this person, ask for names of current clients that would be willing to talk to you. You may get some interesting feedback from someone whose goals and finances match your own.
4. What is your investment philosophy?
If you are going to have the planner manage your money, you need to understand their approach to investing. Most will highlight long-term, diversified strategies, but ask what investments they use to do so. Are they believers in passive or low-cost index or exchange-traded funds or do they think active managers are preferable? (Note: I am a big believer in the former!) Be wary of those who say they can beat the market or suggest complicated products.
5. How will we communicate and how often will we meet?
Working with a financial planner is an intimate relationship that will hopefully last a long time, so make sure you're comfortable with how they communicate. Ask about the frequency of communication, and also, who will be the primary contact about service issues. Ultimately, you want expertise, trustworthiness, and someone who listens to your concerns.