10 Tips on How to Find the Best Financial Advisor

enter image description here

Understand What Services a Financial Advisor Offers

The last thing you want to find is a cheap financial advisor. The most important thing you want to look for is competency.

Competency is different than trust.

Yes, trust is important, but it is a feeling. It is entirely possible to trust someone that is not trustworthy. Competency should be the number one criteria you look for.

How do you find a great, competent financial advisor at a price that is reasonable? The ten factors below should help you out.

1. Understand the Difference in Their Service Offering

The term doctor is pretty broad, right? Yet, when someone says they are looking for a new doctor, typically that means a primary care physician, not a specialist. If they were looking for something specific, instead of using the term doctor, they would have specified, cardiologist, or OBGYN for example.

This broad categorization of a profession works for the general term ‘doctor’, but is not so effective when it comes to the term ‘financial advisor’ or ‘financial planner’, although unfortunately, much of the public thinks that someone who calls themselves a financial advisor should offer a similar suite of services and advice as the next financial advisor, just as there is much consistency from primary care physician to primary care physician. This assumption is an erroneous one.

Financial planning encompasses a broad spectrum of services and financial advisors may only practice within one narrow beam of that spectrum.

In broad categories financial planning can be broken into:

Some financial advisors only manage assets and provide investment advice and do not offer a full suite of meaningful financial planning services. Some financial planners do not offer specific investment advice. Many financial advisors do not have the training and expertise necessary to be competent when it comes to retirement income planning. (You can gain an appreciation for some of the nuances in Difference Between a Retirement Planner and a Financial Planner.) You have to know what you are looking for to find a financial advisor that has competence in area that you need.

Many people pay 1 – 2% of their assets a year for financial planning services when really all they are getting is a service that selects stocks or mutual funds and rebalances their portfolio from time-to-time. That is not financial planning.

Good investment decisions need to be aligned to your plan. How can you choose the right investments without a map first? People start with the wrong question, “What should I invest in?” They should start with “Is my plan clear?” Much recent research has shown that planning can add real money to your bottom line.

2. Learn What Financial Planning Is

A Morningstar research report titled “Alpha Beta, and Now… Gamma” quantifies the difference smart planning can make. The substance of this report is accurately captured by one leading retirement academic, Wade Pfau, who wrote a blog post titled Alpha Beta and now Gamma, where he said

“By making these improved financial decisions, retirement income can be increased dramatically. On a utility-adjusted basis, a comparison of the naïve case to the improved income case shows an increase in retirement income of 29%. David also discussed in his presentation about an additional result not found in this paper: optimizing the Social Security claiming decision has the potential to raise retirement income by another 9%. Now we are talking about a 38% increase in income, in utility-adjusted terms.”

Planning matters! Planning is not the same as investment advice. A good plan should be crafted before anyone recommends an investment to you. If you interview someone and they quickly start discussing their investment approach without first talking about a financial plan, then they may not be the best advisor for you.

3. Don’t Hire an Advisor That Has a Misplaced Focus on Asset Allocation

A 2012 Center for Retirement Research paper titled How Important is Asset Allocation to Financial Security in Retirement, came to this conclusion,

“The motivation for this paper is the concern that financial advice – the topic of this conference – tends to focus on financial assets, applying tools that give prominence to the asset allocation decision. But most people have little financial wealth, and financial tools are often silent on the levers that will have a much larger effect on retirement security for the majority of Americans. These levers include delaying retirement, tapping housing equity through a reverse mortgage, and controlling spending. Moreover, even for many with substantial assets, these non-financial levers may be as powerful as asset allocation in attaining retirement security.”

What does this mean? It means many planners erroneously focus on an asset allocation model as the primary solution to your plan. This is silly! Asset allocation is important, but planning encompasses far more than how much you have in which asset class.

Investment advice, including asset allocation decisions is one of the last decisions to be made, only after other planning factors have been considered.One of those planning factors that many advisors don’t consider is taxes.

4. Do Hire a Financial Advisor That Can Incorporate Meaningful Tax Planning

Many financial advisors are not allowed to give tax advice because of the way their companies are regulated and registered. The company does not want to be liable for what their many advisors may say and so the incorporation of meaningful tax planning within financial planning does not often occur. It’s a shame because it makes a difference in the amount of wealth you keep.

In Tax Alpha, The Importance of Active Tax Management, by Tim Cestnick, FCA, CPA, CFP, TEP, the author says,

“It’s possible to reliably and consistently add 200 to 300 basis points annually through attention to taxes”

In an Ernst & Young study commission by Life Yield (a company that builds software to help advisors deliver advice that is more tax conscious) they say,

“The results are that LifeYield ROI’s tax-smart methodology would have generated up to 44% more after-tax returns and retirement income.”

Life Yield’s methodology looks at a few key things such as asset location, capital gains management and tax-managed income distributions, which I cover in my About.com blog post titled Want to Increase Your Retirement Income by 30% or More?

Because many regulatory considerations prohibit some types of advisors from incorporating tax planning you want to look for an independent financial advisor.

And don’t make the mistake of thinking tax planning only applies to the rich, either! When it comes to retirement income planning, many financial advisors woefully lack the knowledge necessary to give you good advice. For those with expected retirement incomes under about $90,000 there can be significant tax savings in looking at when you take Social Security combined with when you withdraw money from various types of accounts.

Prudential has done a significant amount of work in this area, and this US News & World Report article, Social Security Tax Breaks Drive New Retirement Strategy does a good job of providing an overview. Additional details can be found in Prudential’s Innovative Strategies to Help Maximize Social Security Benefits brochure.

More technical advice on the importance of the order in which you take money out based on taxes can be found in the Journal of Financial Planning article Tax-Efficient Retirement Withdrawal Planning Using a Comprehensive Tax Model.

The important thing is that your financial advisor keeps up on all of this and incorporates it into the advice they deliver.

Bottom Line

  • Tax planning in retirement is important! We have expertise in this area. If you’re nearing retirement make sure you work with someone who does.
  • If you want an overview of some of the tax planning work we do, check out Tax Planning 2012.

For all these technical reasons, I’ve been known to say, what you want to do is hire a Vulcan. They aren’t always the best sales people, which is good in this context.

5. Avoid Lemons

In a Times article Your Financial Advisor Might Be a Lemon the author writes about another study, Market for Financial Advice: An Audit Study, in which under cover auditors were sent in to anonymously evaluate advice given by typical advisors. The conclusion,

“Advisers encourage returns-chasing behavior and push for actively managed funds that have higher fees, even if the client starts with a well-diversified, low-fee portfolio.”

I wrote about this study in How Would Your Financial Advisor Hold Up Under an Undercover Audit?

One way you can avoid lemons is to make sure you find advisors that have less restrictions on the advice they provide and recommend the use of passively managed funds or index funds. I cover this in Should You Hire a Financial Advisor that Has a Broker-Dealer?

6. Learn How Your Advisor is Compensated

How comfortable would you feel if your doctor was compensated based on the medications he prescribed to you? When pharmaceutical company kick-backs to physicians are discovered it causes controversy for a reason. Yet in the financial services world, this does not seem to be a problem. I think over time that will change.

A fee-only financial advisor can only be compensated from you – they cannot be paid by an insurance company, mutual fund or brokerage firm. I started my career in 1995 as a commissioned financial advisor. The more I learned, the less I wanted to practice that way. I know a lot of ethical and competent advisors who can be compensated by commission based products, but I had to draw a firm line and I decided the best way to insure fiduciary-quality advice was to practice as a fee-only advisor. This is the only way advisors in our firm can practice.

Regardless of how your advisor is compensated (hourly, investment management fees, etc) the most important thing is that they answer questions about fees openly and that you feel comfortable asking about compensation at any time. You can learn more in Understanding Financial Advisor Fees.

Also, make sure you understand what you will be getting. We offer stand-alone financial planning services, and an all-inclusive service for clients that meet a minimum asset level. In our all inclusive service we provide comprehensive financial planning and investment management for one low fee that is often less than what many people are currently paying for just investment management.

7. Credentials Matter

Credentials are important when it comes to financial advisors. Look for an advisor who has their CFP® or Certified Financial PlannerTM designation. There is also a PFS designation offered to CPAs that is a well-respected designation. A CFA or Certified Financial Analyst designation shows someone has additional expertise in investments, such as financial statement analysis and risk management, but a CFA may not having financial planning expertise.

You can find additional information on other designations online at FINRAs website (Financial Industry Regulatory Authority) at their Understanding Professional Designations page.

In our firm we have four CFP®s, two who have gone through part of the CFA curriculum and two of us who are RMASM, Retirement Management AnalystsSM and a third who should soon have his RMASM designation.

We think ongoing learning is critical to giving our clients relevant advice.

8. Ask Questions – And Here’s What to Look for in the Answers

Several organizations such as the FPA (Financial Planning Association) and NAPFA (National Association of Personal Financial Advisors) offer brochures with suggestions as to what questions to ask a potential advisor. Here are two:

I think many of these suggested questions are relevant, but the most important questions you can ask are a little more subtle.

For example, ask an advisor to explain a concept to you. It could be anything like “what is an index fund” or “which do you think are better, municipal bonds or corporate bonds?” What you are looking for are answers you understand and someone who is patient and willing to communicate with you. I offer some additional question suggestions in 5 Questions to Ask a Potential Financial Advisor.

9. Avoid Fraud By Looking Out for These Things

If the potential financial advisor you are interviewing talks a lot about how they achieve outstanding investment returns, be leery. As an ethical advisor, it is hard for us to compete with lies, yet we must. Unethical people will promise investment returns that they cannot deliver. No matter what fancy charts and graphs or historical data they show you, no one has a consistent way to time the market and achieve extraordinary returns.

Rather than returns a good financial advisor should talk about planning, about what level of risk is necessary to achieve your goals and they should educate you on the realistic returns you can expect from a well built portfolio.

In addition, advisors should use a third party custodian. For example, we custody our client assets at Charles Schwab. Our client account statements come directly from Schwab and once a quarter we also send performance reports that provide details on how the accounts are performing relative to a set of stock and bond indices. Schwab is a third-party custodian.

If you use a firm that also has custody of your money, they can easily head down the funny business path (think Bernie Madoff). Any reputable firm will use a well known third party custodian such as Schwab, Fidelity, T.D. Ameritrade or Pershing.

10. Location of Your Financial Advisor

Is it important for you to meet with your advisor face-to-face, or is your key criteria finding a firm that has competency?

Depending on where you live it may be challenging to find someone that has the expertise you need and who has a pricing structure that works for you.

With web based programs that allow you to see our computer screen, and software that you can log in to, we can work with clients anywhere. Each client has a dedicated advisor and team; no call centers. We think planning is personal, and we make sure our services are delivered that way, whether you walk into our office or interact with us via web and phone.

We’re located in Scottsdale, AZ. If you’re nowhere near us and you are not comfortable working with us long distance then start your search for an advisor with some of the specific find an advisor search engines that I recommend in my 7 Step Process to Find the Best Financial Advisor article.

If you want to talk to us, give us a call, or fill out our see if we’re a good fit for you form on the right hand side of most of our web pages.

You can also learn more about how we work with clients in What Happens Behind the Scenes Before and After We Meet With You?

For additional considerations on finding a Phoenix or Scottsdale financial advisor check out:

If you take the time to grasp the ten steps above, you’ll be well on your way to finding a competent financial advisor.

Of course there are also some fun reasons to hire a planner. If you want a laugh check out my Dave Letterman style Top Ten Reasons to Hire a Personal Financial Advisor.

By Dana Anspach, CFP®, RMASM, Kolbe Certified ConsultantTM