The Financial Advisor Checklist: What To Look For (And Avoid!) (EP.186)

0:28We all need to make smart decisions with our money. probably missed the opportunity to grab one of these special spots that I carved out for my readers to meet with me and learn about becoming a PlanCorp client. And so if you want to do that yourself, then you can go to callwithpeter.com. There you'll find some of those special dates that I've carved out, some additional times, because it's that time of year where people are trying to get their financial house in order and keep it that way forever. And while I'm biased in thinking that choosing a good advisor is one of the best decisions you can make, I'm not naive to the fact that choosing the wrong advisor can do more harm than good.

1:05And I think the process can be pretty confusing because there's different professionals adhering to different standards of client care and making matters worse, there's a litany of fancy titles and an alphabet soup of designations that professionals stick on their business cards. So if you're going to hire a professional, the biggest investment you can make is in the time you put into selecting the right person. And this starts by understanding some of the major differences between professionals in the industry. Because even when two professionals go by the title advisor, it doesn't mean that they provide the same service or adhere to the same ethical standards.

1:43So we're going to unpack all those things for you today in this episode. Again, there are detailed show notes at the longterminvestor.com. You can also go to callwithpeter.com right now because we have special slots open if you're interested in becoming a Planned Corp client. Now let's dive into the meat of today. I'm going to start with what I think is probably the most important, and that's just the standards of care. Most people don't even realize that different financial professionals are held to different standards of care. The fiduciary standard requires that an advisor put a client's interest first.

2:19Registered investment advisors, also known as RIAs, adhere to the fiduciary standard and they're regulated by the Securities and Exchange Commission, which enforces the rules around what it means to be a fiduciary. On the other end of the spectrum is the suitability standard, which doesn't require advice be made in the client's best interest. It really just requires that a broker make recommendations that are suitable based on a client's personal situation. Brokers or registered representatives are only held to the suitability standard and not the fiduciary standard. However, these are people who have a vested interest in getting you to buy specific financial products.

2:59So what does all this mean? Well, imagine you need a new car, but you don't know that much about the different options available. You could just head to the closest car dealer, which happens to be a, let's say a Ford dealership, and the dealer asks you to describe the kind of car you need. You begin to list the features and attributes that are best described as a Toyota Highlander, but you can find some of what you mention in a Ford Explorer too. Under a suitability standard, the Ford dealer could say, a Ford Explorer sounds like a good fit, and we have some of those right over here. And never mention that a Toyota Highlander more closely aligns with your needs.

3:37The dealer makes the sale and earns a commission, and you have a car that's suitable for your needs, but it isn't necessarily what's best for you. You see, in this situation, the Ford dealer has a clear conflict of interest. The dealer can only sell Fords and will lose the opportunity to earn a commission if the client buys a Toyota Highlander. Now, under the suitability standard, the dealer can recommend the Ford Explorer even if it's not what's necessarily best for you. And without a great deal of knowledge about the auto market, you would know that you've settled for what was only suitable.

4:11Now, let's compare that to what happens under a fiduciary standard. If the car dealer was acting as a fiduciary, the salesperson would be obligated to say, it sounds like you're describing a Toyota Highlander and we don't sell those. In order to get a car that best fits your needs, you need to go down the street to Toyota and ask for a Highlander. Now, the dealer might mention a similar Ford model, but they'd also disclose that the Ford was more expensive and not exactly what you need. So in this scenario, you have more information about your options as well as the dealer's financial incentives before choosing a car.

4:48This same thing happens in the financial world. Financial professionals working under the suitability standard can sell you certain investments or insurance products that compensate them over competing options that might be a better fit for you. Now, there's a relatively new SEC rule called regulation best interest, which was supposed to address some of the really bad practices in place on the brokerage side when brokers were able to adhere to the suitability standard alone, and it's just considered a bare bare bones minimum of client care. And so it was a win, I guess, that regulation best interest replaced the suitability standard in the brokerage side of the world, but it stopped short of requiring brokers to actually act as fiduciaries.

5:33I mean, it mostly just says that they can't call themselves advisors, but they can continue calling themselves whatever other job title comes to mind. And I have a big list, I think, coming up, but like think vice president, managing director, financial consultant, personal CFO, etc. Now, the other thing that's kind of tricky when it comes to standard of care is that it is surprisingly common for financial professionals to have multiple industry affiliations that let them act as a fiduciary in some cases and not others. Now, this allows effectively the advisor to be a fiduciary in developing a financial plan or an investment allocation, but then act under the suitability standard when implementing the recommendations.

6:16Now, I already think this is all confusing enough, and I think it's unfair, to say the least, to expect somebody who doesn't really know the ins and outs to know when an advisor is or is not acting as a fiduciary. I think most people have a hard time even conceiving that the recommendations being made aren't in their best interests. After all, attorneys and accountants are required to put the interest of their clients first. Medical professionals, they don't put their own interests before patients. So why should financial advice be any different? Many financial advisors always act as a fiduciary.

6:54You just need to know how to find them. Now, one way is to use a registered investment advisor or RIA, which is required by law to act as a fiduciary at all times. For additional assurance, you might look for an RIA who has gone the extra mile to be certified by the Center for Fiduciary Excellence or CFEX, which independently verifies that firms are fulfilling their fiduciary duty to the highest standard. Because let's be honest, the SEC doesn't audit firms each and every year. And so if you want to see if an advisory firm is CFIX certified, I have a link in the show notes at the long-term investor.com, but it's C-E-F-E-X.org.

7:35That's CFIX.org. Now, finally, I really do think this is important, I think you have to at this point expect your advisor to put their fiduciary commitment in writing. Otherwise, they can't be held accountable. Most fiduciaries will put their fiduciary commitment in a client agreement that you sign at the beginning of the relationship, but if they don't, it's perfectly fair to ask your advisor to sign a fiduciary pledge. Now, I'd mentioned the job title thing. I think this definitely adds to the confusion because there is such a wide range of job titles and professional designations that people are using to try to convey expertise.

8:12And while a job title might have some relevance to a firm's internal hierarchy, you can basically start with the assumption that all job titles from an external perspective are just some form of marketing. So I really wouldn't get too hung up on whether your advisor is titled wealth manager or planning associate or financial planner or portfolio manager, financial consultant, I mentioned personal CFO earlier, or director, senior vice president, principal, partner, the list goes on and on. The title doesn't really matter in the context of trying to find the best financial advisor for you. And while it's a challenge to understand the services someone will provide based on title, I think that all these professional designations perhaps make the situation even worse.

9:00These days, I think, it's almost impossible. We'll just go with rare, it's very rare these days, to meet a financial professional without some combination of letters after his or her name on the business card. And the problem is, not all letter combinations require the same degree of expertise, the same knowledge, or the same training. There are, however, I think three designations that stand out from the rest across the financial advice industry. They all require extensive knowledge, in my opinion, continuing education, and adherence to a really strict code of ethics. Because I don't really want to show any favoritism, although maybe it'll come out as I talk about them, I'm going to list them in alphabetical order, the first being Certified Financial Planner, or CFP.

9:47Now, in my mind, this designation is probably the most comprehensive designation with regards to financial planning. The certification itself requires a pretty lengthy education requirement and requires you to sit and pass a multi-day board exam. The curriculum covers general principles of financial planning, education planning, insurance planning, investment planning, tax planning, retirement planning, and estate planning. And you're also required to have some professional experience related to the planning process in order to use this designation. So when I see someone with a CFP designation, I know that they've gone through training to recognize issues that may affect a financial plan throughout all the different stages of your life.

10:30The next designation I'd like to highlight is the Certified Public Accountant or CPA. The CPA designation focuses on taxes and accounting with the exam covering auditing and attestation, financial accounting and reporting, regulation, and business environment concepts. Now, in my experience working with the financial advisors that are CPAs, I've always found that the prerequisite coursework of 150 semester hours of relevant courses, along with the exam, prepares a CPA to assist in strategic decision-making for individuals, businesses, and other organizations. The last designation I'll highlight is the Chartered Financial Analyst, or CFA, and financial professionals often consider the CFA designation to be the most difficult to earn.

11:20The candidates must pass three exams, which each require roughly 300 hours of study, and the most recent pass rates using the August 2024 results were between 44 % and 48%. Now, this graduate-level curriculum focuses on topics including portfolio management, economics, financial analysis, quantitative methods, and corporate finance. And before using the designation, CFA candidates need four years of professional work experience in investment decision-making. Now, having earned the CFA designation myself, I do feel like this is the gold standard for investment certifications, but I would caution against expecting superior investment performance or anything like that just because someone has the CFA designation.

12:06There really isn't any evidence of that. But when I see an advisor with a CFA designation, I feel safe assuming that they have a very deep understanding of investment issues. So now that we've addressed the titles and designations you might find in an advisor's email signature or on their business card, let's address something you generally can't figure out without asking. And that's how advisors are compensated. Now, the way a financial professional is compensated can obviously impact objectivity. Fee-only advisors are paid only by their clients, which creates the incentive structure that typically carries the fewest conflicts of interest.

12:44The most common fee-only advisor is paid a percentage fee based on the amount of assets being managed, with that percentage fee decreasing as the account size increases. Other fee-only advisors charge by the hour or set fixed retainer fees for financial planning services. Now, because a fee-only advisor's compensation is not tied to a specific product or strategy, they can objectively provide advice without being swayed by the personal benefits. And I think in general, this is what makes it easier for fee-only advisors to adhere to the fiduciary standard. Now, there's a table that I've put in the show notes that I recently used in a presentation.

13:23You can view it at thelongterminvestor.com, and it shows the differences in fee-only advisors, talking about hourly advisors, people charging by the hour, discount advisors, or full-service advisors. But at the complete opposite end of the spectrum from those fee-only advisors is a commission-only advisor who earns income on products sold to the consumer, such as insurance or mutual funds. They also can earn income from the transactions made and the accounts opened for a customer. Now, the more activity a customer has with this type of advisor, the more a commission-only advisor would earn. Now, remember, a commission-only advisor really just works for his or her company.

14:03That person does not work for you, and so the recommendations they make are going to be filled with conflicts. One subtle distinction to note, though, is between the fee-only and the confusing fee-based advisors. Fee-only advisors are desirable because they always act as fiduciaries, and their compensation closely aligns their interest with a client's interests. Fee-based advisors earn some of their revenue from fee paid by the clients, but also earn commissions from selling certain products like mutual funds or insurance policies, brokerage products, even ETFs. Now, beyond how the firm is actually compensated, I think you'll also probably want to know how the individual advisor is being compensated.

14:45So are they salaried or they paid a percentage of revenue their clients generate? I'd argue that working with a salaried advisor reduces conflict of interest further because someone that's paid a percentage of revenue their clients create might have an incentive to push you away from options that would prevent you from investing more money with them. For example, they might encourage you to roll a 401k over, even if the 401k would be cheaper. Now, I actually know an incredibly large number of advisors that do this, so I think it's fair to ask the advisor up front. as you're getting ready for retirement.

15:19I think it all starts with finding the right advisor. And hopefully I've given you some good information here today. I also have a resource called How to Interview an Advisor that you can download in the show notes at thelongterminvestor.com. And if you have questions about any of the things I've talked about today, feel free to hit reply on any of my email newsletters. I respond to every email I get. I would love to hear from you. As always, thanks for listening. And until next time, to long-term investing.

16:15is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of PlanCorp and BrightPlan may maintain positions in the securities discussed in this podcast.