Demystify financial advisors

Nowadays, financial advisors are all over the places.  You see them at the banks, insurance companies, brokerage firms, wealth management companies, or mixed business of the above.  You wonder what kind of financial advisors work for your best interest.

In order to get your business, some might even say that, their consultation services are free.  The word “free” always alerts me, because there is no free service.  Everyone has bills to pay, and has to be compensated one way or another for their services.

In order to claim being a financial advisor, some minimal qualifications have to be met at the Federal and State levels in US.  They have to pass some finance-related exams like Series 6 or 7, Series 63, 65, or 66, etc.  The regulations vary for each State.  They have to get registered, and have the licenses renewed periodically.

Some could hold prestigious credentials like CFP (Certified Financial Planner), CFA (Chartered Financial Analyst), ChFC (Chartered Financial Consultant), etc.

Based on how they are being compensated, overall, there are two categories of financial advisors:

  • Fee-Only Financial Advisors (very small percentage)
  • Commission-Based Financial Advisors (majority falls into this category)

Fee-Only Financial Advisors:

The financial advisors are not compensated by selling products.  They cannot get commissions from selling the investment products that are recommended to you.  They are paid by clients for the services they provided.

The service could be charged in an hourly rate, a retainer fee, or a certain percentage of clients’ assets that are under their management.  The fees are disclosed and agreed upon by the clients, before the service is provided.

As there is no product sales involved, the advisors have avoided that layer of conflict of interest.  They could serve you in your best interest.  Can they really meet or exceed your expectations?  You have to do your own research and interviews, and find out if he or she is the best candidate for you.

In central Ohio, only quite a few wealth management companies have the fee-only financial advisors.  Of those advisors, many are either CFP-certified or are working toward CFPs.  In terms of financial qualifications, they are probably the best.

Commission-Based Financial Advisors:

Most of the financial advisors are in this category.  That’s why you see them everywhere.  They make a living by selling products, and get paid through the commissions.

They might give you some advice.  But it’s hard to avoid the conflict of interest here.

What products do they sell?  Here are some examples:

  • Loaded mutual funds: it could be front-loaded, or back-loaded.  Either way, you pay extra percentages as fees, and those fees go to the financial advisors.
  • Annuities: some annuities could really get complicated, cumbersome, and high fees on the ongoing bases.
  • Life insurance products: some products mix insurance and investment. They are not flexible, not transparent, not easy to understand, and fees are high.  Once the water is muddy, the customers like you and me won’t benefit much.  Personally, I like to see insurance and investment totally separated.  In terms of life insurance, I’m a fan of term life insurance.  It’s simple, clear, cheaper, and serves the purpose.

Theoretically, financial advisors are supposed to disclose all those fee details to clients.  But what happens if you don’t read the fine print?  Or you read it, but don’t understand the products you are sold to.  That’s not a good situation.

When you buy a pair of shoes at a shoe store, you have to know what you want, in terms of the size, wide or regular, brand, color, style, price, etc.  Then you try it, and see if they fit.  The same ideas apply to your investment.

If you don’t know what you want, that’s not good.  If you don’t know the products the financial advisors are recommending to you, that will be even worse.  What should you do then?  Just stop there, don’t buy anything.  Go home, borrow some investment books, and knowledge yourself up.

The truth of the matter is, once you have enough investment knowledge, you might want to invest it by yourself.  Why pay the extra fees, while you can do it yourself?

Some people don’t want to spend the time to learn.  In that case, they don’t understand what they get in the portfolio.  You may trust the financial advisors, but still have to do your homework:  verify.  Yes, always verify.  Watch the fees, as it could add up quickly. That’s part of your money that is taken away, no matter how the market performs.

In terms of investment products, try to make it as simple as possible.  Even the experts like Warren Buffett suggest the simple no load and low expense ratio index funds. Life is already complicated.  Don’t touch those exotic products you have no clues about.

Loaded mutual funds are expensive.  Does it mean they perform better than no load and low expense ratio index funds?  Not necessarily.  I trust Warren Buffett more than the average financial advisors on the streets.

I believe most of the financial advisors are good and honest.  But there are some bad apples there.  You heard about the Bernie Madoff case.  Why did so many people become the victims?  Part of the reasons is that, they didn’t know and understand what they got.  Or they trusted someone too much, and didn’t do the verification.

In summary, the cost effective way is to invest by yourself.  If you have to hire a financial advisor, fee-only advisors may be better in terms of serving in your best interest.  No matter what, you must understand the products you are getting into.

Related to investing and money management, here are some good articles I read lately in the personal finance community.  All the 3 bloggers are living in Canada.  Canada and US are good friends, and still are.

Questions for our discussions:  Do you invest by yourself?  Have you dealt with any financial advisors?  If yes, what’s your impression about the financial advisors?

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7 Responses

  1. Steve says:

    Good explanation of the difference between fee-only and commission-based financial advisors Helen. There is many investors that have no idea what they are paying in fees. If they are getting good service and understand the fees they are paying I think that is great. Most do not know and some of the mutual funds, annuities, and life insurance have outrageous MER.
    Answers for your “Questions for our discussions:” I DIY all my investing now, but in the early years I had a financial Advisor that helped me with taxes,accounting,estate planning and investing. Sometimes it pays for good financial advice.

    Thank You Helen! I really appreciate the mention.

    • Retire Early Helen says:

      Thank you. Regarding the investment fees, sometimes it’s worth hiring a financial advisor, as long as investors understand the details of the fees, and the products or services they get. DIY investing is great. For some of the complicated financial matters, like estate planning, taxes, asset allocations, a good financial advisor could provide better insights and options.

  2. Caroline says:

    Great post Helen! People should know what they get into before investing.
    Thank you for the shout out, really appreciated.

    • Retire Early Helen says:

      Caroline, thank you. Yeah, sometimes we saw people bought products they didn’t know the details. When seeing the fees on the statement, it was a surprise. Or they have to hold the products for a specified period of time, otherwise a hefty fee is involved. Either way, it hurts.

  3. GYM says:

    Great post and nice site layout! Thank you for the mention!

    Yes, I didn’t know that the mutual fund ‘advisors’ were actually selling mutual funds when I first invested with them. They don’t disclose that to you until afterwards (or never really).

    I feel that if you give someone your HARD EARNED money they should have your best interest at heart. But many ‘advisors don’t actually because they have their own interest at heart.

    • Retire Early Helen says:

      Thank you, GYM. Disclosure is kind of gray area. One time, I was applying for a financial advisor position of an investment company. That gave me a chance talking to several of their financial advisors. My question was: “why are people buying the loaded mutual funds, while no load and lower cost funds are available?” Their answers were: “our funds perform better”, or “we disclose those fees to clients”, or “Helen, you are the few who can invest yourself, many people don’t want to or don’t have the time to.” At that time, I felt their roles were more like a sales person instead of an advisor.

  4. GYM says:

    Oh nevermind your site is the same, but still looks good! I landed on the post page and not the home page as I usually do 😉

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