It’s every investor’s nightmare — squirreling away as much money as possible only to later discover part of it was squandered in fees, commissions and unsuitable investments a financial advisor made.
That happens all too often, even in the post-Bernie Madoff era.
With all the legalese and hidden clauses in financial paperwork, you can’t always tell who really has your best interests at heart when you first meet or begin working with an advisor.
“The paperwork is confusing on purpose because they don’t want consumers to know what they are paying,” says Larry Miles, president and CEO at Freestone Capital Management in Park City, Utah. “It’s one of the dirty secrets of the industry.”
The problem, he says, is that many advisors don’t know what business they’re in. “They think their clients hire them to beat the market, so advisors obsess over investments, but that’s not really why clients hire (advisors),” he says. “They hire advisors because they want to delegate the responsibility of making good financial decisions to someone they trust.”
Here are some signs that your advisor may be a poor choice:
— They are a part-time fiduciary.
— They get money from multiple sources.
— They charge excessive fees.
— They claim exclusivity.
— They don’t have a customized plan.
— You always have to call them.
— They don’t have references.
They Are a Part-Time Fiduciary
Before signing any paperwork, you need to know how an advisor gets paid. Some advisors are hybrids, serving as fee-earning fiduciaries part of the time and broker-dealers making commissions the rest of the time.
If the “advisor” is dually registered as both a broker and a fiduciary, turn and run, Miles says.
Brokers earn commissions paid by vendors, such as a mutual fund, insurance or real estate company, for selling their product to an investor. So instead of a low-cost fund, brokers can sell one that is more expensive but still “suitable” for the investor.
“The title ‘dually registered’ further confuses investors because you can wear both hats,” Miles says. “So it’s always which hat are you wearing right now?”
Most financial professionals usually fall into one of two camps, product- or planning-focused. A planning-focused advisor should be willing to build a big-picture plan that is independent of the products used within it. Product-focused advisors, on the other hand, are generally more focused on selling a product for a commission and may try to create a plan to fit the product.
Although they seem similar, fee-based advisors may charge fees and commissions for products they sell, whereas fee-only advisors receive compensation for their advice and don’t accept any fees or commissions from product sales.
For an advisor who is required to represent only your interests, go with a registered investment advisor. RIAs must always place their clients’ interests ahead of their own and disclose any potential conflicts.
They Get Money From Multiple Sources
You can find out about all sources of an advisor’s compensation by asking for a copy of Form ADV, which all financial advisors who recommend investments must fill out to register their license with the Securities and Exchange Commission or the state where they do business. This form includes the advisor’s fee schedule and any other compensation, such as a kickback for referring a client to an attorney, Miles says.
By reviewing this form, you’ll know whether the advisor receives commissions or not. To find out more about an advisor’s company, Miles suggests googling Form ADV Part 2 with the term “investment adviser registration” and the company’s name. The form will disclose all of the company’s business activities. Review any checked boxes on the form.
“If they are also an insurance broker or a broker-dealer, it’s a yellow flag that you want to look into because it creates a conflict of interest,” he says.
They Charge Excessive Fees
What a financial professional charges can vary according to the type of advice, whether for retirement investing or some other future goal, and how often advice is sought. Unfortunately, there isn’t an industry standard, so every advisor is different, Miles says. He suggests investors pay an hourly or fixed fee for advice about asset allocation and investment selection, but more for estate or financial planning.
You should be paying no more than 0.25% to an advisor for your asset allocation and investment selection, Miles says. “Otherwise, you are paying too much no matter if you have $10,000 or $10 million.”
Advisors may charge different fees for different services. For example, they may charge a 1% annual asset management fee that is paid in either monthly or quarterly installments, plus an additional fee to build a financial plan. This latter fee may start at $500 or cost as much as several thousand dollars depending on the complexity of the plan.
Either way, get an invoice to see how much you are paying, says Carrie Catlin, principal at Fenway Financial Advisors in Boston.
They Claim Exclusivity
Beware of any advisor who claims to have a lock on certain investments, Miles says. “If your advisor promises to get you into investments that only he or she (or their firm) can access, that’s another lie.”
Kristin Hull, CEO and founder of Nia Impact Advisors in Oakland, California, says it’s also a red flag if an advisor seems “to know everything” rather than referring to colleagues who might specialize in one asset class or another.
They Don’t Have a Customized Plan
An advisor who only offers a one-size-fits-all plan or product is also cause for concern. Typically, that product or plan is sold by someone who makes a commission on the sale and has to hit a new quota each month. When an advisor’s answer to your questions always seems to circle back to “buy this,” it’s a good sign that the advisor is trying to make your needs to fit a product rather than finding products to fit your customized plan.
One way to get a sense of what you might be getting: Ask the advisor to show you a sample portfolio before you begin, Hull says.
And make sure you share similar goals. Ask, “How will you measure my success if I choose to work with you?” Catlin says.
You Always Have to Call Them
Another sign of a bad advisor is if you always have to call them, and they never call you. “Advisors should be proactive,” Miles says. “They should reach out to you just to check in and see how you’re doing.”
Too often advisors try to fly under the radar and avoid those tough conversations with clients by not reaching out when markets get volatile or things don’t go as well as planned. That is unfortunate because it’s in the hard times that an advisor’s value can really shine.
They Don’t Have References
Advisor shopping is like finding a doctor who will do surgery on you. Talk to two or three other clients who have gone under the knife, metaphorically speaking, because you don’t want to be an advisor’s guinea pig any more than you’d want to be a surgeon’s.
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Update 06/10/21: This story was published at an earlier date and has been updated with new information.