What is a Financial Advisor?
A financial advisor provides a variety of financial products and services to individuals, families, businesses and other organizations. Most often, a long-term relationship is established with the advisor, a relationship that includes on-going services such as investment portfolio management and annual financial planning reviews.
Though financial advice, products and services are needed by most everyone starting at an early age, a relationship with a financial advisor usually begins when there is mutual benefit to both parties in establishing the relationship. Knowing when this threshold of mutual benefit has been crossed depends on a number of factors, such as the complexity of one’s financial and personal life and the amount of wealth that must be managed, for example.
Fortunately, most financial advisors offer a free consultation and it is during this consultation that mutual benefit can be determined. In the event that mutual benefit isn’t yet present, a good advisor will still offer some guidance as to what steps you can take to address needs in your financial life suitable to your present situation.
Financial Advisors vs. Financial Planners
The phrases “financial advisor”, “financial adviser”, and “financial planner” are often used interchangeably. It is true that professionals offering the same products and services may choose to use one name or the other as a description of their profession. It is also true that, in some cases, some aspects of their work are regulated by government and private agencies. However, great caution must be taken because it is also true that a person can refer to themselves as a “financial advisor” or “financial planner” while having absolutely no professional training or certification in the field.
It is therefore critical to carefully consider the qualifications, credentials, reputation and experience of all candidates under consideration in your search for a qualified financial advisor.
Are All Financial Advisors the Same?
Not all financial advisors (or financial planners) are the same. Differences exist in a variety of areas, for example:
- Professional training, certification and experience in offering financial planning services.
- Professional training, certification and experience in offering investment advisory services.
- Do they have a college degree? (some don’t!)
- Do they have a meaningful post-graduation degree, such as an MBA?
- Do they have other professional credentials valuable to the services they offer, such as a CPA?
- Are they a Registered Investment Advisor (RIA), the highest standard available to financial advisors? (see below)
- They will vary greatly in their investment philosophies.
- Are they independent and unbiased and is this reflected in the way they are compensated, such as those who opt for a fee-only form of compensation, own their own business and do not work for a large and potentially biased brokerage firm?
- Have they grown considerable wealth in their own personal lives?
You want to make a good decision at the start when choosing an advisor with whom you’ll build a long-lasting and fruitful relationship. The above list is not complete. There are many other things to consider, and some will depend on your specific needs and situation.
Registered Investment Advisory Firms (RIA’s), the Best of the Best
There are over 650,000 licensed salespeople in the U.S., official known as Registered Representatives, who are regulated by the Financial Industry Regulatory Authority (FINRA), which is overseen by the SEC. These reps will have passed at least one securities exam and, when employed, often carry the title “financial advisor”. They are better known as “stock brokers”. In addition to these 650,000 there are many more who may be regulated by state insurance agencies.
Registered Representatives are often found employed by banks and large brokerage firms. They are held only to a standard of finding investments “suitable” to clients. Though the banks and brokerage firms who employ them may promote them as trusted and “unbiased”, they are under no legal obligation to act unbiased. They can choose to sell products to clients that offer them a substantial commission. They may be limited in the investment products they can offer as determined by what’s in the best interest of their employer.
There are only 11,000 Registered Investment Advisory Firms (RIA’s) in the country. They are legally held to act in a much higher standard than the registered representatives who account for the great majority of those referring to themselves as “financial advisors”.
RIA’s must act as fiduciaries and put the client’s needs ahead of their own. They cannot be compensated by commission. RIA’s most often charge fees as a percentage of Assets Under Management. As such, their compensation grows only as the client’s assets grow in value.
RIA’s are most often business owners, further insulating them from the influences that large brokerage firms and banks exert over their employees. As business owners, they are also in a better position to relate to the needs of their clients who may also be business owners. We discuss why RIA’s make the best financial advisors in greater detail elsewhere.
Services Offered by a Comprehensive Financial Advisor
Note that not all financial advisors offer every service listed here. Further, an advisor may have significant knowledge in all of these areas, but may not provide that specific service. For example, an advisor who is also a CPA may bring extensive tax knowledge to a client’s financial planning process while the actual tax work will be done by a tax professional. An advisor may have extensive knowledge of estate planning, while the estate creation and management is ultimately done by an attorney who specializes in estate planning.
One of two primary services offered by a financial advisor is that of financial planning (the other being investment portfolio management). Financial planning is the process of identifying the goals in a client’s life and building a plan consisting of the strategies and actions to be taken to best meet those goals.
Financial planning and aspects within financial planning are sometimes called retirement planning, personal financial planning, family financial planning, education planning, tax planning, estate planning and wealth planning. We answer the question, “what is financial planning?“, elsewhere.
Investment Portfolio Management
Financial advisors often take on the responsibility of managing the investment portfolio of their clients. Some clients are very “hands on”, and want to participate in the investment decisions, and some are very “hands off”, and prefer to leave those decisions to their advisor.
Very little happens in the financial world that doesn’t involve taxes and planning for taxes. Though a tax accountant will be needed to do the actual tax work, a financial advisor with knowledge in tax law, such as those who carry a CPA designation, offers a great advantage to their clients.
For example, a person might only see their tax accountant once per year, and this may even occur after the tax year has ended. The tax accountant won’t have the full vision into the financial and personal life, the needs and goals of the client that a financial advisor will have. They may not be in a position to offer tax advice that fits best with the overall picture of the client’s life, and they may be limited from a timing perspective in what can be done due to the infrequency of contact.
Estate planning encompasses the creation of and accumulation of wealth, its conservation and eventual distribution to the beneficiaries of the estate. A competent financial advisor will have extensive knowledge of estate planning and can often refer clients to qualified attorneys who specialize in estate planning.
Cash Flow and Liability Management
The cornerstone of financial planning is that of good cash flow management. Cash must be present to meet financial obligations throughout life as they happen, whether for the normal cost of living, or for the occasional expenses of weddings, education of children, purchasing a home and, eventually, providing for retirement. Managing liabilities is also part of good cash flow management. Extensive coverage of cash flows is an integral part of a comprehensive financial plan.
Insurance and Risk Mitigation
Good financial planning is not complete without considering and accounting for the many risk we face in life, such as an early death or disability, or a unexpected loss of property or other assets. A competent financial advisor will be able to develop strategies to best mitigate the risk you face in life, customized to your situation. The advisor will be licensed to provide suitable products to meet these needs.
How is a Financial Advisor Compensated?
Financial Advisors and financial planners can be compensated in a number of ways. For the most independent and unbiased advice, seek an advisor who is also a Registered Financial Advisor (RIA) and, as such, is held to a much higher fiduciary standard in all aspects of financial services. Seek an advisor who is not compensated by commissions, but rather as a percentage of assets under management.
Some ways that financial advisors can be compensated:
- An hourly fee for advisory services.
- A flat fee, such as for an annual portfolio review or a financial plan.
- A commission on the securities bought or sold.
- A commission (sometimes called a “load”) based on the amount invested in a mutual fund or variable annuity.
- A “mark-up” when one buys “house” products (such as bonds that the broker holds in inventory), or a “mark-down” when they are sold.
- A fee for assets under management, such as 1% to 2% annually of assets managed.
We hope you better understand the role of the financial advisor. Finding a good one is another matter. In another article, we discuss how to choose a financial advisor.