I always think it is helpful to research the definition of something before I determine if I should use it. So, what is a financial advisor and how are they regulated?
According to Investopedia, a financial advisor "provides financial advice or guidance to customers for compensation.” Okay, but we need a deeper explanation of what a financial advisor does. How about starting with who oversees their actions.
Who Oversees Financial Advisors?
These individuals are regulated by one, or a combination, of three agencies:
- Financial Industry Regulatory Authority (FINRA) – related to brokerage firms and their representatives
- Securities and Exchange Commission (SEC) – larger independent investment advisers and their representatives
- State regulatory agencies – this is for smaller independent investment advisors and their registered representatives (for example, I am registered with both the State of New York and the State of Florida)
Under federal law, in particular the Investment Advisers Act of 1940, investment advisers are regulated by the SEC or appropriate state authorities and are required to provide services to their customers under the fiduciary standard. Certified Financial Planner™(CFP) professionals providing financial planning services also must abide by the fiduciary standard as defined by CFP Board. This means the advisor is required to put their clients interest in front of their own interests. (For related reading, see: Why the Fiduciary Standard is Important.)
Broker-dealers are also regulated under federal law, including under the Securities Exchange Act of 1934, but are not required to provide services to their clients under the fiduciary standard of care. Instead, broker-dealers provide services under the suitability standard of care, which generally requires only the broker-dealer’s reasonable belief that any recommendation is suitable for the client. However, in April 2016, the Department of Labor released a ruling that will enforce the same fiduciary rules on this type of advisor when they work with retirement accounts (including IRAs). But this rule may end up being squashed by the incoming administration (which greatly disappoints me).
What Do Financial Advisors Actually Do?
One of my clients has often said to me, “I don’t know what I don’t know,” which may answer the question of hiring a financial advisor. This leads to another question, what does a financial advisor “do?” If you look at the expectations of CFP deliverables (this is not to say an advisor has to be a CFP, but it describes the process), financial advisors may do the following:
- Financial statement preparation and analysis (including cash flow analysis/planning and budgeting)
- Investment planning
- Income tax planning
- Education planning
- Risk management
- Retirement planning
- Estate planning (For related reading, see: What Do Financial Advisors Do?)
How Do You Find a Financial Advisor?
I would recommend asking a few friends who they use for an advisor, as well as looking on the CFP, Financial Planning Association or National Association of Personal Financial Advisors websites. Many of these websites allow you to narrow down the search based on your specific needs and will help educate you on the various services advisors offer.
Don't forget to interview a few to make sure you are connecting well. Yes, experience and knowledge are important, but having open communication is even more important, in my opinion.
How Do They Get Paid?
- Some earn only commission
- Some do not receive a commission, but instead charge a fee for their services
- Some have a blended schedule, where some of the products are commission-generating and some services are based on a fee
(For related reading, see: What Hiring a Financial Advisor Costs in 2016.)