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Financial advisors have a large number of roles and responsibilities, and these roles go far beyond deciding where a client should invest their money. The best way to explain what a financial advisor does is to outline the various roles they fulfill and their responsibilities
Understanding the client’s financial situation
The first responsibility of any financial advisor is to get a complete picture of their client’s financial situation. This information is often gathered by going through a questionnaire with the client.
Important information that needs to be gathered includes:
- The age of the primary client as well as of their spouse and any dependents. Any mandatory retirement ages are also useful.
- Current and expected future income of the client and spouse.
- Any other sources or potential sources of income.
- A full list of assets including properties, vehicles, saving accounts, investment products, and retirement plans.
- All debts including mortgages, loans, and credit card debts.
- Current living expenses.
- Expected future living expenses.
- Potential future liabilities and expenses like children’s education or planned holidays.
- Life, health, and other insurance policies or plans.
- Any known or potential health issues.
This very comprehensive list includes objective data. The advisor will also need to assess subjective topics like the client’s risk tolerance.
There is far more to financial planning than investments. The wealth that you accumulate depends on the length of time capital is saved and invested, the amount earned, the amount saved, fees and taxes and the investment returns that can be achieved. While investment returns tend to get the most attention, it is actually the age that you begin saving and investing that has the biggest impact on the wealth you can accumulate.
The second responsibility for an advisor is drawing up a long-term financial plan for the client. The objective of the plan is to achieve realistic investment goals. The plan will indicate how much needs to be saved, and what type of investment plan needs to be followed to achieve the plan’s objectives.
The primary objective of a financial plan will usually be to ensure that a client can save enough capital to retire comfortably. But the plan will often also have a few other goals to be achieved sooner. These may include saving for children’s tertiary education, weddings, or extended holidays.
Besides a plan to save and invest a certain amount, the plan also needs to include contingency plans for unexpected events. This includes health insurance and life insurance to cover expenses if the primary income earner dies or is unable to continue working.
Finally, a financial plan must consider debts and whether they should be consolidated or paid off.
A core component of a financial plan is an investment strategy. In many cases, a client will already have an employer-sponsored retirement plan, so the advisor will need to work around this and compliment it as best as possible.
In order to draw up an effective investment plan, the advisor needs to have a thorough knowledge of all available investment products. This includes exchange-traded funds (ETFs), mutual funds, annuities, 401(k)s, IRAs, and Roth IRAs. An IRA is a deferred tax individual retirement account, while a ROTH IRA is an account in which contributions are paid after tax, while withdrawals are tax-free.
Every investment product available has inherent strengths and weaknesses. A major responsibility of any financial advisor is staying up to date with the types of products available. Advisors often attend seminars and training courses to ensure their knowledge is current.
Long term investment strategies are designed to achieve financial goals with the minimum required risk. Typically, an investor will need to own some riskier assets like small-cap and growth stocks to achieve capital growth, but the risk can be reduced by also holding assets with lower volatility like bonds.
The risk profile of the portfolio will also change over time. In the early years, capital growth will be the primary objective, and risk tolerance will be higher as there will be more time for the portfolio to recover from volatility. As a client approaches retirement age, the objective will shift to generating income and preserving capital. The portfolio will gradually be shifted to blue-chip stocks, bonds, and other assets with low price volatility.
Typically, investments will not be made directly into stocks or bonds, but into investment products like ETFs or retirement accounts that hold those instruments as this is more cost-effective. In the case of HNIs (high net worth individuals), direct investments are more common.
An investment plan will include a range of projections for the amount the client is likely to have saved up when they retire, and the amount they will be able to withdraw each month. These projections are based on historical returns for various asset classes and inflation data. The projections will range from worst-case to best-case scenario.
Educator and coach
An overlooked but important role for advisors is that of financial educators and coaches. At the outset, the advisor will need to explain the different investment products and the role budgeting, saving, fees, and taxes will play in determining how much capital a client will be able to accumulate. Product education is likely to also extend to life insurance and health cover too.
As mentioned, one of the most important factors in determining an investor’s ultimate nest egg is how early they begin investing, and how much they save. In this regard, financial advisors can make a big difference by encouraging clients to save as much as possible and delay major expenses.
Over time, an advisor becomes more like a financial coach. One of the most important responsibilities is preventing clients from making poor decisions with their money. Good examples of this occurred in 2008 and in 2020 when the stock market crashed. Most retail investors sold stocks close to the lows – which was actually a great time to buy. This is not unusual and occurs whenever there is a sharp decline in the market.
Certain biases affect decision making for most people. The effect is more acute when it comes to making decisions about money, and even more acute people are stressed or under pressure. These biases very often result in poor decision making when it comes to people’s finances. A good financial advisor knows this and is able to convince their clients to remain invested when market volatility increases.
This part of the job has become so highly regarded that it has become a standalone occupation. Financial coaches educate and coach people, without actually making decisions on their behalf.
Ongoing monitoring, reporting, and advice
Once a financial plan is in place, an advisor must still monitor their client portfolios at regular intervals and report back to clients whenever necessary. Face to face review may only take place once a year, but statements will be sent out monthly.
Besides the regularly scheduled reports and reviews, there are also times when ad hoc communication is necessary. Typically, whenever market volatility increases an advisor will need to continuously communicate with clients. Often this will entail convincing clients to stick to the long-term plan and not act impulsively.
Advisors will also need to update clients whenever there are changes to the tax code or legislation regarding investments. Major changes to interest rates or inflation may also require action on the advisor’s part.
Other roles and responsibilities
Every advisor’s practice is slightly different. Some cover related areas like insurance, health cover, and estate planning, while others may refer clients to third parties.
Increasingly, investment products and some life insurance products are designed with estate planning in mind. For this reason, estate planning is often something financial advisors need to understand.
Some financial advisors specialize in providing services to entrepreneurs and business owners. If you own a small business, a significant amount of your net worth will probably be your equity in the business. In this case, a holistic approach is needed to manage personal finances and those of the business.
For small business owners, two of the most important topics are insurance and an exit strategy. Business owners need comprehensive insurance to protect themselves if something unforeseen affects the value of their business. They will also need to be able to sell or realize the value of the business at some point.
Another area that some advisors specialize in is managing multigenerational wealth. People with substantial wealth are often concerned with preserving that wealth for several generations. Advisors working in this area need to understand estate planning and trusts, and often business succession too.
Technology is playing a growing role in the world of personal finance. Robo advisors are digital platforms that help customers save and invest toward specific goals. The process begins with a questionnaire similar to the ones used by financial advisors to assess their client’s financial situation.
The platform then draws on a series of investment and planning models to formulate a plan to save and invest toward the goal. In most cases, debit orders are set up to fund the plan, and the platform automatically invests and rebalances the capital. Typically, the bulk of savings are invested in ETFs.
The major advantage of robo advisors is that they make the basics of financial planning affordable for clients with small accounts. Financial advisors can only serve a limited number of clients, and it simply isn’t feasible to provide services to clients with less than a few hundred thousand dollars.
Robo advisors do have some limitations. Firstly, they use a one size fits all approach which isn’t suitable for clients with specific needs. And secondly, and perhaps more importantly, they fall short when it comes to the coaching role of financial advisors.
The best of both worlds appears to be a combination of technology and personal interaction. Advisors can leverage technology to service more clients, while still providing individual attention when necessary.
Similar and related roles
Historically advisors sold products and earned commission. Increasingly, advisors provide advice and services, for which they charge a fee. The fee is often calculated as a percentage of the assets under management or administration.
There isn’t a precise definition of financial advisors, and there are several similar and overlapping job titles. Even financial advisors operate with two quite different business models.
The first are those that work as broker-dealers and earn a commission when they sell investment products. Broker-dealers in the US are registered with the Financial Industry Regulatory Authority (FINRA). Broker-dealers are held to a ‘suitability standard’ which means the products they sell or recommend need to be suitable for the client’s needs at a precise time.
The second type of financial advisor are RIAs (registered investment advisors) who do not earn a commission but charge an annual management fee. RIAs in the US must pass the Series 65 exam and register with state authorities. Similar requirements exist for RIAs in other countries. RIAs are held to a more stringent ‘fiduciary standard’ and must put the client’s interests ahead of their own or their firms.
Financial planners perform a role that is sometimes similar, and sometimes identical to that of a financial advisor. Financial planners specialize in developing plans to help their clients achieve financial goals, usually be saving and investing. By contrast, financial advisors often offer more services than planners. RIAs are often also qualified as financial planners, and sometimes use that title rather than the RIA title.
Financial planners usually hold the CFP designation from the Certified Financial Planner Board of Standards. This is a highly regarded qualification, and planners need to demonstrate a thorough understanding of planning and investment products to pass the exam.
While advisors calculate annual fees as a percentage of the client’s assets, planners may charge a flat fee for developing a plan.
A wealth manager is solely responsible for managing investments on behalf of a client. Wealth managers tend to work with wealthier clients to maximize a portfolio’s return for a given level of risk. Similar roles are performed by portfolio managers and investment advisors.
Do you need an advisor, a planner, a broker, a wealth manager, or a financial coach?
Deciding on the right type of professional to help you with your finances will depend on the following:
- How much capital you have already saved?
You will probably need savings of at least $100,000 to justify the fees charged by a full-service RIA. If you have less than that you could combine the services of a robo advisor and a financial coach until your assets exceed $100,000.
- How disciplined you are with money.
Some people are just naturally good at budgeting and saving, while others are not. If you are disciplined, a wealth planner could help you with an investment plan which you can manage yourself. If you struggle with budgeting, your first step should be to speak to a financial coach.
- How much knowledge you have about investments and financial products?
If you have very little knowledge about financial products and can afford it, it’s worth speaking to an RIA. They will be able to advise you on investing as well as other topics like insurance and health cover. If you are very knowledgeable and comfortable managing your own affairs you may only need a broker to buy and sell the products you need.
- How complicated your financial situation is.
If you have a complicated list of assets and liabilities, things like tax, insurance, and estate planning may be important topics. In this case, an RIA firm with a team of specialists that is worth considering.
As you can see, financial advisors perform a wide range of services for their clients. Besides the tangible services they offer, there is a lot to be said for having an impartial third party advising on major decisions too.
There was a time in the past when advisors were badly incentivized when it came to looking after their client’s interests. This has changed to a large extent and the industry is now well regulated, and incentives are aligned. Each advisor’s practice is slightly different, so it’s now easy to find one with the right capabilities to help you reach your financial goals.
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.