It is important to note that every individual’s financial situation is different.  This means that everyone’s financial needs are going to vary.  While some individuals will have a more complex financial picture and may need a more focused approach, others may only need minimal guidance and in many cases a more hands off approach.  It is important to know what you are looking for in a financial advisor.

UNDERSTAND COMPENSATION STRUCTURES

An important place to start is to understand your advisor’s compensation structure.  All advisors can be grouped into one of three compensation structures: fee-only advisor, fee-based advisor or commission-based advisor.

1. Fee-only advisors are compensated only on the advice they give and are not paid on products they may sell.  Fee-only advisors can be paid by the hour, on a retainer/flat fee basis, or based on the amount of assets they manage.  It is important to remember that these advisors are not commissioned on what they sell, so there is no motivation to sell you something you don’t need.  They are incentivized to maintain and grow your assets.  Paying an advisor by the hour might make sense if you need only limited help or you are more of a do-it-yourselfer.
2. Fee-based advisors get compensated on both the advice they give and the products they sell.  Broker-dealers are the best example of fee-based advisors.   They charge a management fee as well as making a commission on products they sell.  Some of the more common securities they receive commission on include load mutual funds, annuities and individual bonds.   Many brokers at some of the larger banks will also cross-sell mortgages, checking accounts and credit cards.
3. Commission-only advisors are paid on products they sell to their clients.  While there are many good commission-only advisors, caution is warranted in working with a commission based advisor because there have been multiple examples of product sales that are not appropriate for the investor.  Being paid to sell a product does not necessarily put the advisor in the position of looking out for the client’s best interests.  In fact, many commission-only advisors need to meet a monthly quota and are incentivized with giveaways like vacation trips.  Mortgages, insurance policies and annuities are some of the more common products sold by commission-only advisors.  For example, life insurance policies pay out 30-120% commission upfront and 1-5% annually.

WHO’S INTERESTS COME FIRST

One common distinction between registered investment advisors (“RIA’s”) and broker-dealers is the standard under which each must operate.  Under the Investment Advisors Act of 1940, RIA’s are bound to a fiduciary standard.  The act is pretty specific in defining what a fiduciary means and it stipulates that an advisor must place his/her interests below that of the client.  It consists of a duty of loyalty and care, and simply means that the advisor must act in the best interest of his client.  Broker-dealers, on the other hand, are regulated by FINRA and are bound to a “suitability” obligation.  The suitability standard only details that a broker-dealer has to reasonably believe that any recommendations made are suitable for clients, in terms of the client’s financial needs, objectives and unique circumstances, instead of having to place their interests below the client’s.  A broker-dealer’s duty is to the broker-dealer he works for, not necessarily for the client served.  A portfolio with excessive turnover may be a telltale sign of your advisor putting their interests first.

DO YOUR HOMEWORK & AND EXPECT YOUR ADVISOR TO DO THE SAME

It is important to understand your advisors background, experience and education.  You are using their service because you have something to gain from their expertise.  Anybody can call themselves a financial advisor, but does your advisor’s background reflect experience and expertise in the area.  Some important things to look at include education, including well recognized industry designations such as CFA, CFP or CPA, and experience.

As important as it is for your advisor to have financial expertise and education, it is as important for them to understand the individual.  An advisor must have patience and guidance when working with you.  The best financial advisors will take the time to help educate you about their overall process, your financial situation and your investments.  Face to face meetings is one of the best ways to judge a person on what type of fit they will be for you as an advisor.  Trust is an integral part of your relationship with your advisor and is built by years of communication and understanding the values of your advisor.