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How to Choose a Financial Advisor

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Unless you are both knowledgeable and disciplined when it comes to money, you will probably have more chance of reaching your financial goals if you hire a financial advisor. However, just as important as deciding to hire an advisor, is making sure you choose the right advisor. In this post, we break down the important factors to consider when finding and hiring an advisor.

Why Hire a Financial Advisor?

The vast array of financial products available, as well as a range of psychological factors, can make financial decision making a challenge. Financial advisors are there to educate you on products, help you plan toward goals, and often to make sure you don’t make decisions that sabotage your finances.

If you don’t have much in the way of savings, you may not be ready for a full-service advisor – but there are other options. When your savings start approaching $50,000 you may want to begin looking for an advisor, but there is certainly no rush. By the time your savings reach $100,000 you should be well on your way to choosing someone to help you – this is when mistakes might begin to cost a lot of money.

If you find yourself with a large windfall like an inheritance, a bonus, or even a lottery win, you should definitely hire an advisor. You will be entering new territory in terms of financial psychology and expensive mistakes will be inevitable without help.

What Advisory Services are Needed?

Your first step is to consider the services you will need. Financial advisors provide a wide range of services. Some of these services are offered by almost every advisor, while others will require specialists.

Most people are going to need help figuring out how much they will need to save and how to invest that money in order to enjoy the retirement lifestyle they aspire too. This may also require managing expectations, being realistic about goals, and some motivation to stick to the savings plan. A plan may also have some intermediate goals, like saving for a child’s tertiary education or a vacation home.

A basic plan also needs to be tax-efficient and include life insurance and a will.

These are the basic services most people will be looking for. But, depending on your situation you may also need help in some of the following areas:

Tax

For the average investor, tax is not actually that complicated and almost all advisors will have the necessary expertise. Tax begins to get complicated when you introduce new revenue streams, offshore investments, trusts, family businesses, and other factors. If any of these considerations apply to you, you will need to ensure that your advisor has access to the necessary expertise regarding tax.

Insurance

Insurance is there in case the events no one likes to talk about occur – so it’s all too easy to overlook this important topic. But insurance is an essential element of any financial plan. Regardless of how much you manage to save, and how well that money is invested, unfortunate events can ruin your finances. Financial plans revolve around an expected income stream, and the loss of that income stream derails the entire plan.

The most important types of insurance cover the death of the primary income earner in a family and the loss of income earning ability due to accident or disease. Life insurance can be complemented with other types of insurance to cover assets like houses, vehicles, and belongings.

Most advisors will be able to help you with life insurance and other types of basic insurance. But if your needs are more complex – for example, if you need business insurance – you will want to check that prospective advisors have the necessary expertise.

Estate Planning

Most of the larger financial advisory and planning firms have departments dedicated to estate planning. Independent advisors can also bring in expertise where necessary, which is absolutely fine if your needs are relatively simple.

Estate planning may require more expertise if your situation is complicated, or is likely to change over time. This is particularly important when there are family businesses or trusts involved.

Business owners

If you own a business, you may want to look for an advisor that specializes in small businesses. For many small business owners, most of their wealth is tied up in the business – but at the same time, the business’s most valuable asset is the owner. So, if anything happens to the business or the owner, there are significant consequences.

For small business owners, insurance is the most important financial planning tool. Succession planning and an exit strategy are essential. Fortunately, there are advisors who specialize in these areas.

But not every small business owner needs a specialist advisor. If for example you are self-employed, but your business doesn’t have value beyond the income you earn, then a regular advisor is fine. In this case, your ability to save and invest is most important.

Fiduciary vs Suitability Standards

Before considering the type of advisor that best suits your needs, you should understand the standards they comply with. First of all, the financial intermediary (i.e. financial advisors, planners, and brokers) you deal with should be licensed in some way. Intermediaries who are licensed and regulated are obliged to comply with one of two standards when providing services to clients.

Those who are held to the fiduciary standard are obliged to put the interests of their client before their own or their firm’s interests. They are obliged to make sure the advice they give is as complete as possible and to avoid conflicts of interest.

The suitability standard is less stringent. An intermediary who is held to the suitability standard only needs to ensure that recommendations and products are suitable for the client. So they cannot advise you to buy a product that is not suitable for you, but they don’t necessarily need to ensure that it is the best product for you.

Typically, advisors are held to the fiduciary standard, while broker-dealers are held to the suitability standard.

What Type of Advisor do I Need?

Once you have an idea of the services you will require, you can start working out which type of advisor you will need. At this stage, it’s worth mentioning that the labels various types of financial advisors give themselves are not always uniform. Two people might provide exactly the same services, with one describing themselves as a financial advisor, while the other describes themselves as a wealth planner or a financial planner. So, you really need to consider the services they provide, and the way they charge their clients, to determine if they are right for you.

Robo advisors

Robo advisors are web-based platforms that help their users save and invest. Typically, you will start out by filling out a detailed questionnaire which will include your current savings, income, expenses, and your financial goals. The platform then works out how much you will need to save and takes care of the investing part for you.

The advantage of a robo advisor is that the fees are very low, and you can start with a very small amount of capital. Human advisors typically have a minimum account size, or charge a minimum fee, before they can take you on as a client. So, if you don’t have a substantial savings account, a robo advisor may be your only option.

Robo advisors are a great way to give some structure to your saving and to begin investing. But they do have limitations, so at some point, you will probably need to look to a human advisor.

Financial advisors

Typically, those who describe themselves as financial advisors offer holistic advisory service. They help you with every aspect of your financial portfolio from planning to implementation. The services they provide range from financial planning, to investments, estate planning, and insurance. Financial advisors in most countries fall into two categories.

The first category is RIAs or registered investment advisors. RIAs either work on their own or as part of a small firm. Because RIAs are independent, they are free to choose the services and products they offer. Most RIAs work on a fee-based model and do not charge commission. RIAs are a good option if your needs are fairly straightforward and often allow you to establish a long term relationship.

The second category is large advisory firms, which are often subsidiaries of larger financial institutions. Some are regional, some are national, and some operate globally. These firms which were historically called ‘wirehouses’ have evolved from full-service brokerage firms.

If you are a client at a wirehouse, you will have a dedicated advisor, but the advisor will be an employee of the firm, and you will be a client of the firm, not the advisor. The advantage of wirehouses is the extensive resources and expertise they offer. The disadvantages of wirehouses are that advisors are often incentivized to cross-sell the firm’s products, and you may be passed from one advisor to the next if there is high turnover at the firm.  Nevertheless, wirehouses are a good option if you will need access to a wide range of services

Financial planner

Financial planners develop comprehensive plans for their plans. Those who hold the CFP (chartered financial planner) designation have a very thorough understanding of investment products and strategies. Financial planners often provide ongoing advisory services, but many will also draw up a financial plan for a flat fee.

You may be in a position where you don’t have a lot of capital saved up yet, but you have a decent income, and you are managing to save a substantial amount. At this stage, you may not need the ongoing services of a financial advisor- but a financial plan will give some structure to your investments. The fee you pay may seem like a lot compared to your current savings but could save you a lot more in the long run. To give the fee some context you can consider the savings you are likely to accumulate over the next 10 to 20 years rather than your current account value.

Stockbrokers

Stockbrokers help you buy stocks, ETFs, mutual funds, and other financial products. They can offer advice and provide investment ideas and research. In most cases, stockbrokers can also provide wealth management and financial advisory services.

Importantly, brokers are generally held to the suitability standard and earn a commission when you buy a product. This means their incentives are not entirely aligned with yours.

There are really three scenarios when you would use a stockbroker. Firstly, if you are very knowledgeable about investing and financial products, and you are making your own decisions. Secondly, if you already have a financial plan from an advisor or wealth planner, and you know exactly when and what to invest in. Finally, you may have an advisor helping you with your investments, but you may want to also learn more about investing. In this case, you could set a small part of your savings aside to invest on your own.

Wealth managers

Some advisors only deal with investments. Wealth managers usually work with HNIs (high net worth individuals) to help them manage their wealth rather than working toward a specific goal. The wealth manager and client will agree on the portfolio’s objectives, and then the wealth manager will allocate capital to investments that according to a mandate. The objective may be capital growth, capital preservation, income generation, or a combination of the three.

If you have a substantial portfolio and are not working toward a specific goal, a wealth manager will be able to help you. In this case, you may work with a number of professionals, each handling a different aspect of your finances.

Hybrid advisors

The financial advice industry is constantly evolving, and new business models are emerging all the time. Several discount stockbrokers have launched robo advisor platforms to complement their existing offerings. Some platforms offer a combination of automated and human advice – an alternative with lower fees for basic services and access to bespoke advice when necessary.

There is no reason not to choose one of these hybrid platforms, but it’s still important to compare the services they offer to those you need now and will need in the future.

What Types of Fees do Advisors Charge?

Financial advisors charge their clients in several ways. Broadly speaking broker-dealers charge commission, advisors, and wealth managers charge a fee based on the total value of your assets, and financial planners charge an hourly fee. But, in reality, you are likely to end up being charged a combination of the above.

Fees vary according to several factors, but the following will give you a rough idea of what you are likely to pay different types of advisors:

  • Robo advisors typically charge 0.2 to 0.6% of your account value each year, though there may also be a minimum fee.
  • Online/hybrid advisors charge 0.5 to 1%, with a minimum fee of around $1000 a year. For additional services, you would pay a flat fee.
  • Traditional advisors typically charge anywhere from 0.5% and 2%, depending on the size of an account.
  • If a financial planner is not charging you an annual fee, they will probably be charging you $1000 to $3000 for a financial plan, or $200 to $500 per hour.

Remember that financial products may incur additional management fees, and you might pay a commission when you buy them.

Very often the types of fees that initially appear very high are not actually the most expensive. For example, someone might charge $2,000 to draw up a financial plan which seems like a lot. In reality, commissions and hourly fees might quickly add up to that.

Performing Due Diligence on Advisor

Once you have identified an advisor or a shortlist of advisors, you will need to do some due diligence. Ultimately, an advisor’s integrity is more important than anything else.

Before you even speak to an advisor, you should do as much research as possible. If your advisor is based in the US, you can check their Form ADV at the following website: adviserinfo.sec.gov. This form will show you how the advisor charges their clients, the history of their firm, as well as any misconduct they have been charged with. Some states also have a local regulatory authority that provides similar information.

You can also view the advisor’s social media pages to see if their services have been reviewed or commented on by other clients. Obviously, personal references are helpful too, but you shouldn’t limit yourself to references within your network.

Your first meeting with a prospective advisor will also be part of your due diligence process. Ask them as many questions as you can and take note of the questions, they ask you. It’s important that you get along and are able to communicate easily. Equally important is that an advisor is genuinely interested in your current situation and your aspirations and not merely ‘ticking boxes.’

Conclusion

Choosing an advisor is one of the most important decisions you will make. Ultimately you want to create a long-term relationship with someone who can educate and advise you at various stages of your life.  It’s something you should take your time over and follow a deliberate process. Speak to a few different advisors and give it some thought before making a final decision.

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Richard Bowman is a writer, analyst and investor based in Cape Town, South Africa. He has over 18 years’ experience in asset management, stockbroking, financial media and systematic trading. Richard combines fundamental, quantitative and technical analysis with a dash of common sense.

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