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The Most Important Question To Ask Your Financial Advisor

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Whether you already have a financial advisor or are now looking to hire one, you want someone who has your best financial interest at heart. That means that when she is helping you direct your money and advising you on financial goals, she’s not just selling you products that she will be making money on, while you shell out more than need be.

But other than asking an advisor to look directly into your eyes and pinky swear that he’ll always do what’s best for you, how can you find the best person to help you achieve your financial goals?

What makes the evaluation process especially difficult is that financial advisors use a bevy of terms to describe what they do and how they do it, and that even within these definitions there are gray areas. In fact, many financial professionals who are more in the business of selling purposely use titles that give the opposite impression — that they are giving you the best advice for your situation.

Here’s a primer on all the terms you need to know, the slippery terms that sound like one thing but mean another, and the most important request to make of your current and any potential advisor.

 The Main Types Of Providers

1. Investment Advisors

These people will give you advice on your securities, which include stocks, bonds and mutual funds, and oversee and manage them for you. They typically have authority to make investment decisions on your behalf. They may also go by terms like “investment manager,” “wealth advisor, “asset manager, “wealth manager” or “portfolio manager.”

Registered investment advisors (RIAs) are firms registered with the SEC. RIAs are held to the highest ethical standard, which is called fiduciary. That means they are required to always act in your best interest and give advice and recommend investments that are the best for you. Their employees are called Investment Advisor Representatives (IARs) who are also fiduciaries. With an exception outlined below, they are generally not in the business of selling.

2. Brokers

Brokers are in the business of buying and selling on behalf of customers. “Stockbrokers are not fiduciaries and are held to a much lower ethical standard called suitability,” says Jack Waymire, founder of Paladin Research and Registry, a service that matches investors with financial advisors. “They are supposed to make suitable recommendations based on his or her knowledge of the investors, but basically, suitability varies by client and is difficult to enforce.”

Brokers make money by commission, which means they have an incentive to sell you products — and while the products have to be considered “suitable” for your situation, they do not have to be in your best financial interest.

They can also be called stockbrokers, financial consultants, financial advisors, wealth managers and investment consultants.

3. Financial Planners

Financial planners will look at your whole financial picture, including estate, retirement and tax planning, plus insurance needs and debt management, and help you come up with a plan to achieve your long-term financial goals. (Find out here why financial plans aren't just for the 1%.) They may also provide investment advice as an RIA, subjecting them to a fiduciary duty, or they could also be a broker who sells products.

While a certified financial planner is often considered the gold standard among these types of planners, the CFP Board’s rules of conduct aren’t foolproof. One rule states, “A certificant shall at all times place the interest of the client ahead of his or her own. When the certificant provides financial planning or material elements of financial planning, the certificant owes to the client the duty of care of a fiduciary as defined by CFP Board.”

The second sentence leaves open the possibility for CFPs to occasionally not act as a fiduciary — such as, for instance, when they’re not doing financial planning but instead doing commission sales. 

The Misleading Category: Hybrids

Thus, whether you’re looking for a money manager or someone who can give you an overall financial plan that also looks at your estate, taxes, insurance, etc., you’d want someone who is a fiduciary at all times, not someone who makes money from commission either some or all of the time.

But some fiduciaries are also broker-dealers who aren’t held to the fiduciary standard 100% of the time. Sometimes when they advise you, they’ll act as a fiduciary, but at the times they act as a broker with you, they will sell you suitable products, not what’s best for you.

Calling these hybrids “the worst of the worst,” Knut Rostad, President of the Institute for the Fiduciary Standard says, “They can operate at 10 o’clock in the morning as a registered investment advisor and provide investment advice to the Joneses family, and at 12 o’clock, can operate as a broker to the Smith family and sell them whatever he wants to sell them.”

This type of advisor will prey on the ignorance of investors, says Waymire: “That is one more source of confusion for investors. If I’m talking to this advisor and he gives me advice for a fee, he’s a fiduciary, but if he sells me a product for a commission, he’s not a fiduciary — how many would know that? Less than none. And there’s no mandatory disclosure, so it’s up to the investor to know the issue exists and to ask the advisor the right questions.”

A lot of these hybrids will act as a fiduciary to larger clients and as a commissioned sales rep for their smaller clients, says Waymire. “Let’s say you have $100,000. If the advisor has a 1% fee schedule, that’s a 1% fee on your assets and that advisor can make $1,000 a year in fees from your assets. Another advisor who’s a hybrid comes in and takes your $100,000 and puts it in a load fund product with 5% commission. The commission guy can make $5,000 upfront from your assets. He doesn’t get the $1,000 a year trailer like the fee guy, but you can see the issue if you’re a hybrid advisor: you can say, do I want a 1% fee — $1,000 — or do I want a 5% commission for $5,000?”

Out of 11,000 investment advisory firms who are fiduciaries registered with the Securities and Exchange Commission, 456 (4.1%) are also registered as broker-dealer firms (which total 4,000), according to the Investment Adviser Association, an organization that aims to promote a high standard of fiduciary duty. Karen Barr, president and CEO of the IAA, estimates this could translate to about 300,000 of these so-called hybrids who are registered as both.

“Most people in this industry started off as stockbrokers, and built up a base of business tied to commission, and so when they register as an IAR so they can provide advice for a fee, they don’t want all those trailing commissions to go away, so what they do is retain their securities license,” says Waymire.

Even more confusingly, the SEC may change the definition of fiduciary duty to raise the standards for brokers. While this sounds like it would be a positive move, others worry that creating one standard that also covers brokers could water it down altogether. It has happened before, says Rostad: “Over the last 40 years, the SEC has weakened and weakened and weakened the requirements for fiduciaries.” Still, he says, “if you took a random sample of RIAs [who are fiduciaries] and put them in one room and brokers in another room, they’d still be doing a better job for investors than the random sample of brokers.”

Another Criterion

Since finding a fiduciary may not necessarily cut out hybrids, you can also sort through potential advisors, or decide whether your current one is right for you, by finding out how they are paid.

Fee-Only: This type of advisor doesn’t accept any commissions, so it usually also means that the person is registered as an investment advisor, or is a CFP who doesn't also act as a broker.

Fee-Based: This term is what the hybrid uses, since he or she can receive both fees and commissions. It sounds similar to “fee-only,” probably intentionally. But with a fee-based advisor, you won’t know if she gets 99% of her business from fees or 20%, whether she primarily acts as a salesperson or primarily an adviser.

Commission-Based: This would apply to the broker-dealers who are sales reps.

The Question To Ask Your Advisor

When you’re looking for an advisor (or to evaluate your current one), first, use the SEC’s investment adviser search to find out if an individual or a firm is an RIA or IAR (and therefore a fiduciary) and whether they’ve ever been disciplined.

Then, to cut out the hybrids, ask them, "Are you a fee-only financial advisor who acts as a fiduciary 100% of the time?" If they say they’re fee-based, that means they might sometimes sell you products instead of dealing with you as a fiduciary.

Once you decide on the person you’d like to hire, get it in writing that they are a fee-only advisor who will act as a financial fiduciary with you 100% of the time and that they'll fully disclose any conflicts of interest. Those words “fee-only” will eliminate the possibility for the person to sell you products, and if they are a fiduciary, they’ll always give you advice in your best interest.

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