12 - Do you need a financial advisor?
Fiduciary duty, robo-advisors, where to start?
It’s been a while! I’ve been going through a move and have had to divert attention to a few other projects, hence the pause in content. This will be a less quantitative article as I get back into the swing of things.
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Key points:
You should ask your prospective financial advisor about their conflicts of interest. This is typically more of an issue for commission based advisors. Ask how they are compensated.
Try to find a financial advisor that works with people in your financial situation. They’ll be the best at problem solving for you.
While much of the content found in financial newsletters, including this one, caters to do-it-yourself financial planners, it’s important to recognize the role of professional guidance in handling personal finances. The process of managing your finances may not require a degree or certification, but it does demand your time, effort, critical thought, and unwavering attention. If you are trying to get a hold of your finances and doing it yourself hasn’t gotten you closer to your goals, you may want to consider professional help. It’s what they’re there for!
Who Needs a Financial Advisor?
Your decision to hire a financial advisor should hinge on the problems you aim to solve. Financial advisors come in various specializations: retirement planning, investment, debt management, budgeting, tax planning, estate planning, health and long-term care planning, and handling inheritance, to name a few. Often one advisor will partner with other advisors who specialize in different areas or they will be able to recommend other services. Watch out though, as the person who your financial advisor is sending you to may be sending kickbacks. This would be a conflict of interest.
Determining the Need for a Financial Advisor
So, how can you tell if a financial advisor is worth the money? If you have sufficient funds to start investing or are facing a significant life change—like becoming a parent—an advisor can help keep you out of trouble. An advisor is also crucial if your financial situation leaves you feeling overwhelmed, confused, stressed, or scared. They're great if you lack the time or interest to handle personal finances, don't know how to invest your savings, consistently lose money on your investments, or are going through a major life transition. However, it's crucial to note that the substantial benefits of a financial advisor generally come into play if you have at least $1 million in investable assets. Spending some quality time on r/PersonalFinance can be a helpful resource before checking out a financial advisor. If you aren’t finding the information you want there, setting up some initial meetings with an advisor to see if they can help might be in order.
Value Proposition of a Financial Advisor
What value does a financial advisor provide? They can guide you on basics like how much money you should save, the types of accounts needed, and the kind of insurance you should have. They can offer estate and tax planning guidance, help formulate financial goals, generate a financial plan, discuss financial tools, and ensure "tax efficiency." Tax efficiency is the concept of taking the full advantage of the tax code in order to maximize the amount of income you get to keep.
Charges by Financial Advisors
Financial advisors operate on either a commission-based or fee-based model. In the former, clients may not receive a bill from the advisor, but the products they are sold might be expensive, creating a conflict of interest. Advisors should disclose their relationship with all parties and products that you are referred to. You should ask and confirm this too. Fee-based advisors, on the other hand, can charge hourly (typically between $120 to $300 depending on the market, specialization, etc) or a percentage of assets under management (AUM), with 1% being the standard fee. Fee-only advisors generally have fewer, if any, conflicts of interest.
Credentials of Financial Advisors
Look for credentials like Chartered Financial Analyst (CFA) or Certified Financial Planner (CFP) when choosing a financial advisor. You can learn more about these designations here.
Red Flags for Financial Advisors
Be cautious of advisors who try to sell you products instead of teaching you how things work, as this could indicate misaligned incentives or conflicts of interest. Does the advisor stand to benefit from selling you an expensive product or referring you to another specialty for a fee? Also, consider if their client mix represents you—are their clients mainly retirees, families, etc.? Try to find a financial advisor that works with many clients in your demographic.
Understanding Fiduciary Duty
Fiduciary duty refers to a legal obligation to act in the best interest of another party. A financial advisor with fiduciary duty must prioritize your financial interests over their own. If you are trusting a financial advisor with investment decision making, ensuring they are bound by a fiduciary duty is essential. This offers you an avenue of recourse if the financial advisor does irresponsible things with your money.
Pros and Cons of Automated Financial Advisors
Automated financial advisors or "robo-advisors" offer a low-cost alternative to traditional advisors. They use algorithms to manage and allocate your investments. While they're efficient and inexpensive, they lack the personalized touch of human advisors and probably aren’t suitable for complex financial situations. This would be a good place to start if you’d like help on the investment decision making process, but it may cost slightly more than doing things yourself.
Conclusion
Deciding whether to engage a financial advisor is a personal decision that depends on your financial situation, goals, and comfort level in managing money. It's about striking a balance between cost and value. If you decide to hire one, the things to investigate are their fee structure, their credentials, and whether they act in your best interest.
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