1. What Does a Financial Advisor Do?

Seems like an easy question, doesn’t it?

But as we’ll see, there are many types of “financial advisors” and the advice they give has many different forms, as well as limitations. This is because, believe it or not, anyone can call themselves a financial advisor.

Stockbrokers

Traditionally, people who worked at the major national firms (Merrill Lynch, Morgan Stanley, UBS, Wells Fargo, Edward Jones, etc.) were called “stockbrokers”. This is because they did just that, broker trades in stocks. They got paid a commission each time a customer bought or sold a stock. Sometimes they would give advice on other aspects of financial planning, but it was incidental to their main business, and they didn’t get paid for it. And obviously, any advice they did give would be biased towards trying to earn more commissions.

Later, as the public began to demand more objective financial advice, the popularity of “fee-only” advisors grew. These advisors did not work on commission and were paid only for advice (see more below). The national firms took notice and started to change the titles of their sales employees to “financial advisor” and “financial consultant”. The idea was to convey the impression that these salespeople were really more focused on advice than sales.

However, the culture of these Wall Street firms hasn’t changed much since the old days. Employees receive little or no training in financial planning. Firms still refer to their salespeople as “producers”. And the main goal of these brokers is to gather assets and to generate as much commissions as they can so they can reach their sales quotas.

What Is Financial Planning?

This is a good place to take an aside and discuss just what is meant by “financial planning”.

In short, financial planning involves the following steps: gathering financial data and setting goals, analyzing the data, developing and presenting recommendations, implementing the recommendations, and monitoring and adjusting the plan in the future. A good plan will address these areas: financial position (net worth and cash flow), insurance planning, tax planning, investment analysis, retirement planning, and estate planning. In my book, anyone who claims to do financial planning should offer their analysis and recommendations in writing.

In addition, financial planning can involve answers to specific questions, such as: “Should I pay off my mortgage early?”, “Do I need a will, or a trust?”, “When should I take Social Security?”, etc.

As you can see, financial planning is a broad area and it takes a lot of experience and training to be good at it. It also takes commitment on the part of the professional. It’s therefore wise to ask “Why would someone who works on commission want to do financial planning, since they don’t get paid for it?”

“Fee-Only” Financial Advisors

In the 1970’s, a movement to professionalize the field of investment advice began. A new professional designation, the CERTIFIED FINANCIAL PLANNER™ professional designation, was created. And advisors began to take advantage of the newly-available platforms at companies like Schwab and Fidelity to create Registered Investment Adviser (RIA) firms. Today, most cities have many such RIA’s to choose from.

Unlike commission-based brokers, advisors (called Investment Adviser Representatives) at Registered Investment Advisor firms get paid for advice. RIA’s are regulated differently than broker-dealers (the national firms discussed above) in that they cannot collect commissions, are paid directly by their clients, must disclose all conflicts of interest, and (most importantly) must act in a fiduciary capacity, putting the interests of their clients ahead of their own. If an advisor at an RIA does not collect commissions on the sale of insurance (or investments, in the case where they also work under broker-dealer) they are called a “fee-only” advisor.

Fee-only advisors can get paid in three ways.

First, they can charge a fee to manage assets, which is based on the value of the assets (typically around 1% per year).

Second, they can bill by the hour for advice.

Or third, they can charge a flat fee (say, $1,000 for a financial plan). Since they’re paid for advice and not to sell products, there is no incentive to favor one product over another or to churn your account for commissions.

Most fee-only advisors hold the CERTIFIED FINANCIAL PLANNER™ professional designation. They tend to be better trained and much more committed to financial planning than their brokerage house colleagues. However, they often have high minimums (as high as $1Million) for investment management.

Most fee-only advisors hold the CERTIFIED FINANCIAL PLANNER™ professional designation. They tend to be better trained and much more committed to financial planning than their brokerage house colleagues. However, they often have high minimums (as high as $1Million) for investment management.

Hybrid Advisors

What about advisors who work for companies like Raymond James, LPL or Ameriprise? These are independent companies and their advisors are independent business owners, rather than employees. These independent companies have set up both commission and fee-based tracks for their advisors. In other words, they have two branches, as it were, a broker-dealer side and an RIA side. Advisors can either sell investments at a commission or advise for a fee.

Confusing, isn’t it? How do you know which hat the advisor is wearing when they’re making a recommendation—the commission or the fee hat? How can they be objective?

And here’s where it gets even more confusing. Remember that I said that stockbrokers work on commission? Well, they do, but the big firms have jumped on the bandwagon and formed RIA firms, just like the independents. So now brokers can manage investments for an ongoing advice-based fee, as well as selling investments on commission. They can also charge you for a financial plan, though such plans are typically prepared back at their main office in New York or elsewhere, and the broker simply presents the plan to you in the form of a big binder.

Insurance Agents

These days, even some insurance agents are calling themselves “financial advisors”. Life insurance agents specialize in life insurance, disability insurance, and annuities (some also sell long-term care insurance). Most also have a securities license which allows them to sell mutual funds and variable annuities. Property-casualty (home and auto) agents also sell mutual funds and variable annuities.

Summary

The term “financial advisor” is a confusing one, since it is unregulated and so widely used. What is important to know is how a particular “advisor” is paid, and what his/her specialty is. What most “advisors” do is sell financial products, while giving financial advice on the side. You are unlikely to get unbiased advice from anyone who works on commission, so if you’re looking for comprehensive financial planning, your best bet is to find a fee-only CERTIFIED FINANCIAL PLANNER™ professional.