There’s been a shift towards greater transparency in the financial services industry, but many investors still aren’t sure what they’re paying for when they hire a financial planner.
According to 2011 research from Cerulli Associates and Phoenix Marketing International, 33 percent of investors believed their adviser’s services were complimentary, while another 31 percent were not sure how their adviser was paid. The households in the survey ranged from those with less than $100K in investable assets to those with over $5 million. Even for households with over $5 million in investable assets, 13 percent thought the service was complimentary.
Tyler Cloherty, a senior analyst at Cerulli Associates, a financial services research firm in Boston, said many advisers are now moving toward fee-based relationships that inherently tend to have more conflicts of interest.
As many investors look for advice on how to manage their assets before the year ends to protect themselves from the possible tax increases on dividends and capital gains, it’s important to know how much advisers are paid, who they work for, and how they get paid, says Lauren Locker, chairman of the National Association of Personal Financial Advisors and head of Locker Financial Services LLC in Little Falls, New Jersey. Being aware of any ties they have with companies whose products they sell and any referral fees they earn can help consumers retain a trustworthy adviser who will keep their best interests in mind.
FEE-ONLY VS. FEE-BASED
All financial planners get paid for their services, but there are two systems of payment generally accepted by the industry: “fee-only” services and those that are “fee-based.”
Fee-only financial planners charge their clients either an hourly rate or flat rate, or a fee based on a percentage of a client’s total assets under management – usually about 1 to 2 percent, said Locker. These planners are not supposed to accept any other kind of payment from outside sources for the recommendations they make, including commissions, rebates, or additional fees from selling insurance or mutual funds. However, some firms may include real estate assets, 401(k)s and money market accounts when they calculate a client’s total assets under management, while others charge separately for managing different parts of a portfolio, she said.
Someone with $130,000 invested with a fee-only planner in mutual funds, for example, might pay a 1.5 percent fee on the account’s year-end value, which works out to about $1,950 a year. Alternatively, planners who bill clients hourly typically charge between $150 and $300 an hour.
Fee-based advisers may also charge based on a client’s assets under management, but they may also receive commissions and additional fees, which typically range from 3 to 8 percent, for selling certain products, including insurance, annuities and other investments like mutual funds. At times, this can lead to conflicts of interest. Planners who are compensated through commissions and other fees have incentives to sell products that drive higher earnings, not necessarily the best fits for the client’s needs.
For example, a fee-based advisor may receive a 5 percent load (i.e. a one-time deduction from the funds invested) to invest in a certain mutual fund, and would have more incentive to persuade a client to buy into that fund versus one with only a 3 percent load. On a $50,000 investment, a 5 percent load works out to be a $2,500 fee, leaving only $47,500 to buy shares.
“It can be really challenging, but seeking transparency on costs is very important,” said M.J. Nodilo, founder and president of Pathlight Investors LLC in Phoenix. “If the adviser is selling mutual funds, there can be another layer of fees most people aren’t paying attention to.”
While many advisers have moved to smaller, independent firms from large full-service brokers, commissions still account for roughly 41 percent of the advisers’ overall revenue, while asset-based fees account for about 49 percent of adviser income, according to data provided by Cerulli Associates and five other financial associations. Salaries, annual retainers, hourly fees and other fees make-up the remaining 10 percent of adviser compensation.
SUITABILITY VS. FIDUCIARY
Investment advisers who work for broker-dealers, such as Morgan Stanley Smith Barney, Credit Suisse, Bank of America, Merrill Lynch, Goldman Sachs, Wells Fargo, and UBS Financial Services, or any firms that buy and sell securities on behalf of their clients, are legally required to offer products that are “suitable” for their clients’ age, goals and income, but not necessarily the best products for their individual needs, according to Locker. These types of financial advisers are technically sales representatives for their respective broker-dealers and are registered with the Securities and Exchange Commission (SEC) and with the Financial Industry Regulatory Authority (FINRA).
“You want to get advice from someone who is truly objective,” says Kory Leadon, a lead adviser with Seattle-based Brighton Jones LLC, based in Scottsdale, Ariz. “Do you want to get advice on which car to buy from a dealership – or from Consumer Reports?”
While these broker-dealer representatives are legally required to uphold the vague “suitability” standard of care, a much smaller group of registered advisers are held to a higher “fiduciary” standard. That means the financial planner must put the client’s best interests first and offer full disclosure on any conflicts of interest. Many consumers don’t realize that only independent financial advisers, who are registered with the SEC or a state’s securities agency, are required to act in this fiduciary capacity, Locker said.
Some registered financial advisers also work for broker-dealers as representatives. These types of planners should always disclose to their clients whether they’re selling a security as a broker or providing advice as a financial adviser and acting as a fiduciary. There’s been buzz on new rules under the 2010 Dodd-Frank financial reform act that would require anyone who gives financial advice to act in a fiduciary standard, but the rules are currently stalled. “There is a ton of gray area,” Cloherty said. “There is a lot of cloudiness in how they are going to regulate that.”
CHOOSING THE ‘RIGHT’ FINANCIAL PLANNER
Not everyone needs the same level of services. Advisers who work for broker-dealers generally stick with recommending securities and products, but many financial planners offer comprehensive advice using a client’s entire balance sheet, including planning for retirement, paying off debt, estate planning, selecting insurance products, state and federal income tax planning, charitable giving, and choosing employee benefits.
“Not everyone has a super-complex financial situation,” Cloherty said. “If you have multiple millions of dollars, then it makes sense to go to someone [who can offer] comprehensive advice.” As a general rule, the more services offered, the higher the fee.
Clients also should ask financial planners if they have experience working with people like themselves. Does the planner specialize in working with the wealthy, non-traditional families, divorced individuals, the young, the elderly? “We always tell people to visit three advisers,” said Locker. “It’s hard work” – but then again, you’re trusting the adviser with your livelihood and financial future.
DO YOUR HOMEWORK
A financial planner who promises to return more than the market is making; who doesn’t listen to your concerns about risk; and who isn’t transparent about fees should raise major red flags, Leadon said. Here are some ways to learn more about your adviser:
• A good place to start is The National Association of Personal Financial Planners. Any adviser listed there is fee-only, adheres to a fiduciary standard, and agrees to a peer review of his or her financial plan.
• Advisers must also be registered with the SEC or their respective state securities authorities, Leadon said. By doing so, they must disclose the firm’s ownership, information about its clients, employees, business practices and any disciplinary events or fines paid by its employees. The SEC has this on file here, as well a brochure that describes the services the firm offers, the adviser’s fee schedule, any past disciplinary information, and any conflicts of interest.
• Locker said the Certified Financial Planner (CFP) designation is another good litmus test when selecting a financial planner. Advisers who are designated CFPs by the Certified Financial Planner Board of Standards adhere to a fiduciary standard and have passed a rigorous financial test. They must also keep their license up-to-date by taking periodic refresher courses.
• Any broker-dealer must register with FINRA and the SEC. Clients can see if their broker has had any past disciplinary actions here.
• The U.S. Department of Labor provides a helpful tip sheet that consumers can print and bring to their adviser appointments.