10 Tips on How to Find the Best Financial Advisor

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, meaning someone who knows what they are doing, 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 Service Offerings

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’. 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 physicians 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. They may not offer a full suite of meaningful financial planning services. Some financial planners do not offer investment advice and only provide financial planning. Many financial advisors do not have the training and expertise necessary to be competent when it comes to retirement income planning. You have to know what you are looking for to find a financial advisor that has competence in the area that you need.

Many people pay 1 – 2% of their account value per 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 “Do I have a plan in place that will work?” 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 paper opens with the following statement.

“When it comes to generating retirement income, investors arguably spend the most time and effort on selecting ”good” investment funds/managers—the so called alpha decision—as well as the
asset allocation, or beta, decision. However, alpha and beta are just two elements of a myriadof important financial planning decisions for the average investor, many of which can have a farmore significant impact on retirement income. ”

The paper goes on to conclude that by using sound financial planning strategies, what they call “gamma”, a retiree can expect to generate up to 22.6% more in what they call “certainy-quivalent income.” Basically – more retirement income.

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

Just as the Morningstar paper above shows people place too much focus on investment selection, 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…. 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… 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, 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 another article titled How to Reduce Taxable Income by Rearranging Investments?

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.

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

For all these technical reasons, I’ve been known to say that what you want to do is “hire a Vulcan”. They aren’t always the best salespeople, but their logic is impeccable.

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.”

One way you can avoid lemons is to make sure you find advisors that are independent and recommend the use of passively managed funds or index funds.

6. Learn How Your Advisor is Compensated

How comfortable would you feel if your doctor was compensated based on the medications he or she prescribed to you? When a pharmaceutical company provides kickbacks to physicians it causes controversy. 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 by 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 ensure 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.

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 Planner 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 have 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 seven CFP®s, and  five of them are also RMA®s, or Retirement Management Analysts.

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

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

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