At Forbes we long have provided advice about how to manage your personal investments yourself. But the hard truth is that not everyone is equipped or comfortable with a “do it yourself” approach, even with the fine computer software programs now available. While no heavy lifting is involved, it requires a certain amount of knowledge and aptitude, not to mention the ability to think long-term for a future retirement. Moreover, it can be very painful at times, or, in the case of 2011, all the time. It also takes time and effort to monitor your investments.
So it’s no shame to ask for human assistance. The trick is to get good help at a price that gives you added value.
Accompanying this story is a slideshow listing 12 steps for finding and vetting a financial advisor. Take a close look at them all.
There essentially are two phases to preparing your financial future. The first is financial planning. At its core, this is straightforward, especially because it usually amounts to planning for retirement. You ascertain your current net worth — assets minus liabilities (what you owe on mortgages, credit cards, etc.). Then you estimate what you’ll need to live on in retirement, taking into account stuff like life expectancy, inflation and health-care costs. The difference between the two determines the amount of risk–stocks instead of fixed income — you’ll need to fund everything. There are a lot of variables to consider, but the thought process is relatively linear.
The second phase is implementing and maintaining your plan. This involves picking specific investments — stocks, bonds, mutual funds, ETFs or whatever — to match the amount of risk your plan says is appropriate. Then the portfolio has to be monitored and adjusted as warranted to handle changed circumstances. This can be anything from developments in your own life — advancing age, declining health, a desire to make gifts the younger generation — to persistent changes in the economy, like high volatility and low interest rates.
Whatever advice you decide you need and whomever you select to provide it, the help won’t come for free. But what you pay can vary widely, and not just because of the amount of assets you want managed. And it is often true that you get what you pay for.
It’s possible to hire a financial planner who will just develop a plan — essentially, a strategy. Such a planner is paid by the job or by the hour. Since the planner has no invested interest in how you proceed, you get conflict-free advice, which is good. It then would be up to you to follow through and implement the plan, either by yourself or by hiring someone else.
But over time there’s been a blurring of the planning and money management functions. That means more and more planners will also manage your portfolio for you. What gets tricky is how the help is paid and to whom they owe their allegiance.
There are three basic models of compensation:
1. Fee-only
For the money-management part, this person is paid a flat fee, an hourly rate or a percentage of the yearly assets under management. No part of the compensation is based on where investments are made, meaning the planner/advisor acts solely in your best interest. It’s the highest form of help — and usually the most expensive.
2. Commission
The financial advisor is compensated with commissions paid by the provider of the financial services product (i.e. mutual fund, insurance) being purchased. Often, such advisors will throw in planning services for a song. But the problem here — and it’s a big problem — is that the advisor has a financial incentive to sell you products with the biggest commission, such as a mutual fund charging a 5 percent sales load rather than put you in a no-load (no sales charge), low-annual-cost index fund, which might the better product for you. So what you save in up-front planning costs you pay out later by buying more expensive investments.
3. Fee-based
This really should be called fee and commission. The client is charged a fee for advice, but the advisor often is also paid for products recommended. Sometimes, the commissions are credited against the fee, yet the potential for conflicts is still significant.
One way to sort some of this out is to ask any prospective advisor about the F word — fiduciary. A financial professional under a fiduciary duty is required to put the best interests of the client first. This may be surprising, but stockbrokers and insurance agents are usually not considered fiduciaries. Instead, they are generally held to a lesser standard, only that the investments they recommend be “suitable” for the client. That’s a pretty low bar to get over. Almost anything qualifies so long as the funds aren’t stolen or used to buy lottery tickets, or, for a timid 90-year-old client, high-risk junk bonds.