Know Your Financial Advisor’s Motivations

I’m a newer Registered Investment Advisor with my financial planning and investment advisory business officially coming online in 2015.  I’ve been in financial services for close to 30 years, and I have seen all types of financial practitioners.  There are many financial advisory models that serve different types of clients, focus on different types of markets, and have different ways of compensating advisors for services provided.  The model that advisors are compensated through typically drives their motivations.  Some of those motivations may conflict with doing what’s appropriate for their client.

It has become clear to me that there is no perfect model in regards to being the optimal way for clients to pay for services.  Every model has some degree of conflict.  Traditional stock brokers who work for large financial organizations and receive some or all of their compensation from products sold, have the most obvious conflict. They are paid when a transaction occurs in their clients’ accounts – the more transactions, the more pay.  And some of their pay can be improved if they sell products that were created by the large organization that they work for.  When they recommend a product to a client, they just need to be able to rationalize that it is suitable for the client’s situation.  They are not obligated to act in their clients’ best interests like a Registered Investment Advisor.  The suitability model creates a pretty clear conflict by virtue of how the advisors are paid, and also who is producing their paycheck, the large financial organization that has products to sell.

That’s not to say that the suitability model is all bad. For some clients, it may be the financial advice model that works best for them and one which they’re willing to pay for.  The other model, the fiduciary model, has a few different variations, none of which are totally conflict free. As a CERTIFIED FINANCIAL PLANNER™, I follow the fiduciary model.  I do so because I enjoy not being beholden to a large financial institution’s whims,  and I want to have the freedom to act solely with my clients’ best interests in mind. My compensation, and many independent registered investment advisors like me is fee-only.  I don’t accept payment for any product transactions that I execute on behalf of a client.  But is the fee-only model conflict free?  Not entirely.  We need to look at the different types of fee-only models to understand why.

Fee based on a percentage of assets under management (AUM) – It would seem logical that if an advisor was getting paid on a percentage of a client’s AUM, that they’d be focused on growing those assets the best they can. Since there is no compensation from transactions, there is no motivation to place trades or push specific products.  The real motivation is to increase the AUM, which some say  may create a conflict. The typical conflict scenario described  is when a client who has assets not being managed by the advisor (say in a former employer’s 401k), where the assets are appropriate where they are, but the advisor convinces the client to bring the assets under his/her management, thus increasing the AUM and generating higher fees for the advisor.

Retainer – To maintain an ongoing relationship where the advisor provides comprehensive financial planning services, the advisor may charge an ongoing annual fee (generally billed quarterly or monthly).  This is a good model for a client who needs a trusted advisor to be familiar with all facets of their financial life, but it’s not for everyone.  It can be very expensive, and if a client does not need the breadth of services that are part of the advisor’s offering, it can be like buying the top of the line car with bells and whistles that you’ll never use.

Hourly financial planning – Hourly financial planning services make professional financial advice available to all types of  clients since the costs are more affordable for the client overall and someone can use an advisor’s service “ala carte”.  This type of model could create an occasion where an advisor consistently summons a current or former client back for additional planning work  in order to generate additional fees.  Overall this is probably the least expensive model for a client, but it’s not perfect for everyone.

So what’s a person to do faced with financial advisory services where there is no perfect model.  The answer, unless you’re a do-it-yourselfer (which is also fraught with potential negative impact to your financial well-being), is to do an honest assessment of your situation and desired relationship with a financial advisor. If you’re fairly  confident and good at doing your own research, but you’d like a partner and second set of eyes, then maybe an hourly planner is best for you. If you are too busy to even think about your financial life outside of paying the bills and are worried you’ll get too far down the road and realize you took a wrong turn, then a retainer model might be a better choice.  If you feel like your financial life is pretty well-managed, but you have a nest egg for which you’d like professional  financial management services, then maybe the AUM model would work best for you.

To get the right fit, don’t be afraid to kick the tires and talk to multiple advisors, then choose based on your comfort with their style and how their model aligns with your needs. A majority of advisors are happy to have a complimentary conversation with anyone interested in their services, and most will be honest with you in regard to whether your needs are a fit for their model. It’s very common for an advisor to decline to work with a potential client and to refer that person to an advisor more appropriate for the clients needs.