Financial advice is something many need, but few want to pay for. It’s not all that surprising that financial advisors tend to join the ranks of lawyers or used car salesman – the line between advice and salesmanship is often blurred.
Financial Advice Dividing Lines
By far the biggest differentiator in financial advice is how the advisor is paid. Here are the typical compensation methods:
- Commissions – The most common fee schedule is based on commissions on sales. A commissioned advisor charges nothing for advice. However, he or she is compensated on any sale. Generally, commissions come in the form of sales loads on mutual funds. Also, 12b-1 fees are charged on assets each year which is paid directly to the advisor. Sales loads can go as high as 8% on the purchase or sale and 12b-1 fees are capped at .75% per year. Remember, loads and 12b-1 fees are purely fees for the advisor and firm.
- Fee-only – Fee-only advisors charge a fee to their clients in the form of an annual fee as a percentage of assets, or a flat fee on an hourly or per-service basis. For example, you might pay .50% of assets each year for an advisor to regularly look over your investment portfolio, recommend new products, or help with other services like estate planning or will writing. Alternatively, fee-only advisors can be hired on an hourly basis.
By law, advisors have fiduciary duty to give advice that favors the client rather than the advisor. Frankly, I find this to be something found only in the ideal scenario. Commissioned representatives obviously have their own conflicts of interest with clients – you wouldn’t ask a car salesman if you need a new car, would you?
Consider that finance should be one of the most transparent industries in the world. For commissioned representatives to be paid, money has to come from the client. In a fee-only transaction, the advisor is paid either an hourly rate or a flat percentage charge of assets for continuous advice.
RIA, CFP, CFA – What the Letters Mean
Fee-only advisors usually set up their practice as a Registered Investment Advisor, where the individual giving advice is an Investment Advisor Representative. You do not need a financial certification – CFP or CFA – to be an RIA. Many hold a CFP or CFA, however.
CFPs are Certified Financial Advisors, which is probably the most practical certification for financial advice. It covers topical issues as they relate to individual financial planning including topics like tax law, and estate and retirement planning. The CFA certification – Certified Financial Analyst – is arguably more academic, a certification that focuses on asset management for institutions more so than individual issues.
Of course, a financial advisor does not need any particular certifications. Most commissioned representatives have a series 7 or 63, a license that gives them the right to be compensated for the sale of securities and insurance products.
I’ll never forget a phone call from a friend who was pitched whole life insurance as an investment product. Nevermind that he does not have insurable interest – the investment would not break even under the best case scenario until year 19 or 20. In effect, he’d lose money until the 20th year. The advisor was obviously paid on commissions.
The best choice in finance, in my opinion, is always the most transparent choice. Most people would be best to visit a fee-only advisor for financial advice. Ideally, a fee-only advisor would have a common credential like a CFP or CFA, and also access to a lawyer and CPA for tax and legal advice. In my area, you can hire a CFA or CFP plus a CPA and lawyer for planning purposes for $250 per hour. This varies, of course, but a good team should be able to look over your full financial plan, build a low-cost portfolio, examine legal concerns and leave no stone unturned in only a few billable hours.
Of course, the majority of the costs are on the front-end. Annual rebalancing or updates to a will should not take much more than an hour.
The rate for fee-only help sounds steep, but commissioned advisors will cost even more. The simple purchase of a mutual fund from a commissioned advisor will cost you as much as $1,250 on a $25,000 investment. And purchasing a mutual fund doesn’t even begin to cover more important tax and legal issues.
The simple fact is that your advisor is going to make money somehow. If you’re willing to bite the bullet and pay out of pocket for advice, you’ll save far more and, in my opinion, get much better advice than you would from a representative compensated by commissions.