One premise I tell my clients up front is, "Don't believe anyone who tells you they are totally objective. Everyone has biases. The important thing is to understand what biases exist with each professional, and then determine if they are acceptable. My best qualification for writing this article is that I've been compensated every way you can be as a financial planner: commission-only, fee-only, and fee-based (fees and commissions). Clearly these 10 things don't apply to every advisor, but hopefully they'll provide some insights to help you know what to watch for:
Company names and individual titles have changed rapidly in recent years. A good example is the Principal Life Insurance Company becoming the Principal Financial Group. There are many examples of this, and it isn't by accident. Most of these companies operate the same way they used to, but have added additional products and want to be perceived as more than just insurance companies. Individual titles have also changed. Gone are stockbroker, life insurance agent, or registered representative. Now it's financial advisor, financial planner, or financial consultant. Read the list again. Sure, they convey professional counsel, but has anything changed besides the title?
From a marketing and profitability standpoint, banks and accounting firms joining the ranks of "financial advisors" makes a lot of sense. Whether it's a good thing for consumers is another matter. Traditionally people have trusted bankers and accountants for independent advice. But now that banks offer to handle your investments, insurance, estate issues, 401(k), and so on, it's no longer safe to regard their advice as unbiased. CPA's are the largest group moving into financial planning products. H&R Block is now H&R Block Financial Advisors. There's danger in having consumers expecting one type of service being cross-sold into areas outside the bank's or CPA's core competencies. One-stop shoppers may appreciate this, but you need to make sure you're only getting the services you need and desire.
Passing the bar exam does not mean an attorney is competent in estate planning. This is a highly specialized area where the law is constantly changing. Misleading seminar headlines cause many people to believe "no probate = no fees." Not so. Even with a trust, up to 5% of your estate can go to an attorney and trustee for administration and settlement fees.
If you choose to utilize a broker to buy mutual funds, their compensation differs based on what class of shares you buy.
- "A shares" typically have a high front-end load and average annual management fees.
- "B shares" move the load from the front to the back, meaning you only pay it if you cash out within a short time, usually five years. The broker gets paid by the fund organization rather than your front-end load, so the fund organization makes it up by charging you higher than usual annual management fees.
- "C shares" have no front-end load, low back-end loads, but the highest annual expenses of the three classes.
None of these is wrong per-se. If you choose to use a broker, they need to be compensated. But you need to know which shares you are getting, and for what reason. Which class is the best deal usually depends on how long you hold the shares of that fund, something your broker should be able and willing to explain to you.
Financial planning has become a hot profession over the past decade. Trouble is, due to the low barrier to entry (passing an insurance and investment exam), many sales people without experience or formal financial training call themselves "financial planners." Many of these people sell investment and insurance products without fully understanding the tax, retirement, and estate ramifications. Instead of focusing on what you really need and why, the sales pitch becomes "mine's cheaper" or "has better performance than his." Here are some relevant questions for each category of planner:
- Fee-only planners: Most provide asset management services. Do they offer choices? Are they locked into doing it only one way? Many in this group tend to have limited knowledge of insurance related products and how they work.
- Fee-based planners: Are they loyal to one insurance or investment company? Do they "push" their company's products in the recommendations? Can they do fee planning without products?
- Commission planners: My first year in the business was in this group and I wouldn't rely on these planners for serious planning. They can however be excellent for individual products, if you already know what you need.
Early in my career I learned about wholesalers. Their job is to influence planners to sell their company's funds or insurance products by helping the planner understand how the products work, providing illustration support, and expediting delivery of the product. At least that's how it works in theory. In reality, it usually comes down to paying planners higher commissions than their competition. Consider this recent example of a company offering three fixed annuity options. Each had a first year guaranteed interest rate that changed to an estimated renewal projection.
The wholesaler told the planners to present whichever option they wanted to. There's clearly a conflict here: the best product for the client results in the worst commission for the planner.
Fortunately the days of trading commissions are drawing to a close. Under this old scenario, the broker was paid to sell and buy your stocks. The question then was, "Is this recommendation in my best interest or is my broker just trying to make a commission?" Now brokerages are moving to an "assets under management charge" with unlimited trading. Problem solved? Perhaps. But a new question has surfaced: Is there a bias to collect assets and then do nothing? A valid question, since the advisor gets paid regardless of whether he does anything with your account or not. While the new method is preferable, be aware of the possibility of being ignored, and find out what you are getting for the fee being charged. Are you getting extras like quarterly meetings, annual updates of a net worth statement, and basic tax, retirement, and estate planning?
Be wary of anyone who makes this claim. Not only can't they guarantee it, it's not legal to do so. Understand that an appeal to you based on returns is preying on your emotions, specifically fear and greed. Promises during a booming economy are easy to fulfill. When the market is down it's another story. Our firm typically gains more new business when the market goes down, as people find out they aren't Warren Buffet, and realize they haven't practiced diversification to limit their downside risk. Don't base your investing on how many stars a fund has, historical returns, or promises. A consistent investment strategy based upon your goals, risk threshold, and timeframe is critical.
Some financial advisors offer to do "planning" for free, since their profit is in the products they sell. Often this translates into selling a "cookie cutter" plan? your information is sent to company headquarters, and generic recommendations for that company's products are returned. To quote a stockbroker friend of mine at one of the largest brokerage houses: "Our financial plans are really designed to reveal more of our client's assets to invest." Ouch. If you have significant estate, tax, and investment issues and want professional advice, don't try to save a buck by paying a nominal fee for advice. No one works for free. In the end, your cost will probably be about the same, but the objectivity of the advice you get may be very different.
Many people have the time and ability to invest on their own. The more difficult issue is integrating your investing with the other areas of your financial picture'taxes, estate, retirement, college planning, etc.'to find the most effective mix. Some people don't want to spend the time required to invest on their own. Others are intimidated by the technical issues of investing. Just remember, planning is a process, not an event. You need to keep up with it, especially if you're doing it unassisted.
