How to Select a Financial Advisor–Step 1: Find Out Who They’re Working For [Infographic 2]
Infographic 1 explored the pros and cons of some of the most common financial advisor compensation arrangements.
Even armed with all that information, the decision can prove complicated and overwhelming. I created a flowchart to assist your selection process (find it at the bottom of this post!).
Readers ask me to just tell them what to do.
My goal has always been to be impartial, fact-based, and logic-driven; to lay everything out in the open to help you make your decision.
Since you asked, however, I’ll share my opinions. If you aren’t interested, please skip down to the infographic below--I think you will still find it helpful!
I see no reason to justify the inherent uncertainty and stress of dealing with a rep who can profit from the recommendations he presents. More bluntly, I see no reason or circumstance to engage with a commission- or fee-based financial rep (advisor, planner, et al)--ever.
I see no reason or circumstance to engage with a commission- or fee-based financial rep, ever!
That means fee-only is the only way to go. That’s not the end of the selection process, however. You still have to ensure the goals of the individual and the (fee-only) compensation structure are aligned with yours.
I believe most people would realize a net gain over their lives by engaging in a long-term financial planning relationship with a trustworthy, competent fee-only advisor. The retainer model supports such a relationship.
A competent fee-only advisor can give you peace of mind and a net financial gain long-term.
The retainer fee in such models is often calculated as a percentage of a predetermined variable: assets, income, net worth, etc. As that variable grows--your assets, your income, your net worth--so grows the advisor’s compensation. Interest alignment!
That being said, the variable by which the retainer is determined can make all the difference. For example, a retainer based on assets could be dangerous (as it creates an incentive to over-leverage), as could be a retainer based on Adjusted Gross Income (as it disincentivizes your rep to help with tax planning).
Net worth-based or AUM model
I think most people would benefit from cultivating a relationship with an advisor whose retainer is linked to their total net worth. This positions the advisor on the same side of the table as you. The only way they can get a raise is by increasing your net worth!
Some people just want or need help managing their (non-real-estate) investment portfolio. They would be best served by an advisor compensated based on the total value of assets under management (AUM).
The are some concerns, however, with having an advisor’s compensation exclusively linked to the investable assets he manages. For example, he would be incentivized to recommend that all new liquid funds pour into those investment accounts (increasing his compensation), as opposed to making a real estate purchase, paying down debts, building an emergency fund, and so on.
Ultra-high-net-worth individuals (UHNWIs), for example, often engage multiple advisors. They should have one looking out for their total picture (net worth-based retainer) and the others tied only to the value of the assets they are managing (AUM).
There you have it
I believe most people would be best served by a fee-only advisor paid through a retainer tied to the value of their total net worth.
Most people would be best served by a fee-only advisor paid through a net worth-based retainer
Unwilling to Pay?
Financial planning for free (or at least on the cheap)
Many people feel they do not have enough money to commit to that level of engagement. That does not mean you should settle for the “free” plans of the commissioned reps. That could end up costing you much more! (See point #2 in the linked article.)
There are plenty of free or inexpensive resources online (at this very moment, I am in the process of creating a course to help investors and savers understand and overcome the potentially ruinous flaws in their investment portfolio).
Sure, that will require a little work on your part, but that’s preferable to constantly worrying about what you’re being sold.
For your investment portfolio, there are plenty of inexpensive robo-advisors (computer-run portfolios) out there. I don’t like working with a robot quite as much as working with a human, but again, low fees are better than “free” sales pressure.
Unfortunately, they all share investment philosophies rooted in the traditional investment paradigms. Investing with them (like most other options today) would still leave you exposed to the potentially ruinous flaws of Modern Portfolio Theory. (I explore these concepts in greater detail in other posts and in my book.)
For this reason, I built Siltty, a robo-advisor that can help you to Stop Investing Like They Tell You. It's built around the adaptive strategies we implement for our clients and the concerns about which I blog.
Aligning your advisor’s compensation with your goals is merely the first step. It is not the end of the selection process. Not all fee-only advisors are created equal.
Once you have screened for the compensation model you prefer, begin evaluating prospective reps based on what they know and their desire to learn more. This is a subject about which I am extremely passionate; as such, I will dive into it ad nauseam in future posts.
Enjoy the Infographic Flowchart to Help You with Your Decision