contributed by Dale Walters
There are thousands of financial advisors out there that want your business, but can you trust them? Although there is no foolproof way to assure that the advisor you choose is ethical and will put your interests ahead of their own, there are ways to improve your odds.
Conflicts of interest
Everyone has at least some conflicts, but the questions are; what are those conflicts, are they disclosed, and how do they attempt to mitigate them?
The conflict every advisor has is that they want you to do business with them rather than another advisor. You may have circumstances or a need for services that an advisor is not competent at, yet there is an incentive for the advisor to recommend his or her services rather than refer you to another advisor that is better suited for what you need. You can address this conflict by asking questions such as; how many clients do you work with that have needs or circumstances like mine and how long have you been working them?
Accepting commissions or referral fees is another common conflict of interest. In addition to the obvious conflict, another major problem is the lack of transparency in how this type of advisor is paid and how much. You may be thinking, I know how the advisor gets paid; commissions. Yes, but is the commission a one-time up front commission, with no trailing commission? If so, this type of commission incentivizes the advisor to continually sell you something in order to be paid. Is the commission only paid out over time (called trailing commission)? This type of commission is designed to encourage advisors to provide customer service, however, the advisor may not be providing service even though he or she is getting paid to do so. Sometimes an advisor receives upfront and trailing commissions. You might also want to know how much the commission is. For example, if the advisor is giving you the option between products A and B, would you want to know if the commission on product A is 2% and product B is 10%? The only way to avoid this conflict is to hire an advisor that is paid on a “fee only” basis. A fee-only advisor is paid directly by you, the client, and does not accept commissions or any other type of compensation.
There are hundreds of designations that an advisor can obtain; some are rigorous and some are not. Some of the designations have continuing education requirements and some do not. Some have a code of ethics that is enforced and some do not.
What credentials should you look for in an advisor? Of course the answer is that it depends; it depends on what you are asking the advisor to do for you. For example, the designations for an investment manager would be different than the designations desired to complete a comprehensive financial plan. Note that if you are working with a multi-professional firm, that firm will typically have specialists in each area with the appropriate designations, whereas sole practitioners and small firms will be limited in their areas of expertise (though few will admit it).
In the investment field, one designation stands out; the Chartered Financial Analyst (CFA). To obtain the CFA designation a person must pass three, very difficult, six hour exams. You will find this designation behind the names of nearly every mutual fund and hedge fund manager. On the financial planning side, the Certified Financial PlannerTM (CFP®) is the premier designation. A Professional that holds the CFP® designation (and is working as a financial advisor, as opposed to a broker that is simply selling securities) is required to act as a fiduciary, which means they must place their clients interest ahead of their own. Typically, the best choice is someone with broad experience and training. Look for someone that has both the CFA and CFP®, or CPA and CFP® designations, for example. Also look for advisors with master’s degrees in financial planning, business administration, finance, etc.
FINRA provides a tool where you can look up and compare designations at
In the US, there are three governing bodies in our industry; the Securities and Exchange Commission (SEC), Financial Industry Regulatory Authority (FINRA), and each of the states. Though there are exceptions, in general advisors with $100 million of assets under management must register with the SEC and those with fewer assets under management must register with their state. Advisors that are registered with either the SEC or with their state are called Registered Investment Advisors.
A Registered Investment Advisor is defined by The Investment Advisers Act of 1940 as a “person or firm that, for compensation, is engaged in the act of providing advice, making recommendations, issuing reports or furnishing analyses on securities, either directly or through publications.” An investment advisor has a fiduciary duty to his or her clients, which means that he or she has a fundamental obligation to provide suitable investment advice and always act in the clients’ best interests.
Registered Investment Advisors are required by the SEC to provide a disclosure brochure to every client; this brochure is known as an ADV Part 2A. Be sure that you read and understand what is being disclosed in the brochure.
Broker-dealers, and the advisors that work for them, are governed by FINRA; these advisors are typically stock brokers and insurance agents that sell securities. FINRA standards require advisors to make suitable recommendations to their clients. Instead of having to place his or her interests below that of the client, the suitability standard only details that the broker-dealer has to reasonably believe that any recommendations made are suitable for clients, in terms of the client’s financial needs, objectives and unique circumstances. A key distinction in terms of loyalty is also important, in that a broker’s duty is to the broker-dealer he or she works for, not necessarily the client served.
For more details see the Investopedia link http://www.investopedia.com/articles/professionaleducation/11/suitability-fiduciary-standards.asp
Start your journey of seeking out a financial advisor that you can trust who is looking out for your best interests by acknowledging that conflicts exist, asking the advisor about potential conflicts and by doing your own background checks on the FINRA or SEC websites as well as thoroughly reviewing any other disclosures such as the ADV Part 2A. Also recognize that advisors have different qualifications and expertise, and therefore an advisor that might be ideal for your friend may not be the best choice for you. Here is a link from the SEC website on Investment Advisers: What You Need to Know Before Choosing One.