Finding a new financial advisor can be overwhelming and confusing. One of the most important factors you should consider is how the advisor is paid. If an advisor says you are paying him nothing, that’s a huge red flag. Remember, there is no such thing as a free lunch.
I believe the most ethical way to work in a financial advisory position is as a fiduciary in a fee-only capacity. You should also look for someone with the CFP (certified financial planner) designation.
What Do Fee Only, CFP and Fiduciary Mean?
Fee only: The advisor in this scenario has much less of a reason to be biased in what they recommend to their clients than non-fee-only counterparts. The fee can be based on assets under management, a flat amount, hourly or calculated in other ways, but it should be clear and understandable to the average consumer.
CFP: A professional designation that requires extensive training, testing and annual study regarding personal financial planning. A CFP can understand the complexities of the changing financial climate and your ever-evolving financial life.
Fiduciary: The highest legal duty of one party to another, it also involves being bound ethically to act in the other's best interests. (For related reading, see: An Introduction to Fiduciary Advisors.)
Why is it so important for your advisor to be a fiduciary? Because they are legally bound to act in your best interest over their own. Advisors who are not fiduciaries are not legally required to recommend what is best for you as the client. When an advisor is paid on commission or has specified sales goals, their decisions can be led by their wallet and not by what is most suitable for you.
Understanding How Your Advisor Gets Paid
To help you understand how your advisor gets paid, here are some questions to ask:
1. Are you a fiduciary in every capacity when you work with clients?
Red Flag: Any answer other than yes. Be careful, because some advisors are well-trained in how to talk around this.
2. How do you get paid?
Red Flag: A complicated answer. If you are confused by the way they get paid there is a reason for that. A lot of advisors are trained to avoid this question, so you may need to dig deeper.
3. Do you or your firm make any form of commission for selling me products?
Red Flag: The firm has their own proprietary products. Advisors are most likely paid more to sell you their firm's products over other alternatives that may better suit your needs.
4. Do you or your firm get any form of kickback for selling me products?
The goal is to find any reason why they might not have your best interests in mind.
5. Do you receive any type of bonus? If so, how exactly is it calculated?
Some firms will disguise commissions by having confusing bonus structures that might not seem like commissions, but when you break it down, they are.
(For related reading, see: Paying Your Investment Advisor—Fees or Commissions?)