Evaluating the
Competency and Integrity of Your Financial Advisor
Today’s financial
world is very complex. So when you are in need of financial advice or products,
where do you turn or who do you trust?
When
speaking about his investment product, a business colleague used to say, “A
person without integrity will cheat you deliberately.
A person without competency will cheat you inadvertently.”
So how do
you protect yourself against the unscrupulous and the incompetent?
The best way
is to be informed.
In my book “Money
Matters Made Simple” an entire chapter is devoted to this topic, For purposes
of this article, I’ll touch on just a few of the points from that chapter.
Evaluating the
competency and integrity of a financial advisor involves a 3-legged stool.
First leg of the stool is Credentials.
Financial
advisor, financial consultant, financial planner, certified financial planner,
investment rep, investment advisor – all
sound alike and seem interchangeable.
THEY ARE
NOT!
EACH term and
credential has a very specific meaning. Let’s start with explaining:
Certifications,
Designations and Accreditations –
The average person is confronted with an alphabet soup of acronyms dealing with advisor’s qualifications. Some certifications involve extensive training and demonstration of competence, others involve simply attending class.
The average person is confronted with an alphabet soup of acronyms dealing with advisor’s qualifications. Some certifications involve extensive training and demonstration of competence, others involve simply attending class.
As a foundation for comparison, let’s
start with the Certified Financial Planner® (CFP®) designation. To be become a
CFP® requires a demonstration of both
competency and the ability to integrate the major areas of
personal finance, which include:
·
Preparing
and analyzing Financial statements
·
Preparing
Budgets
·
types
of and managing Debt –
·
Taxes – how impact financially
·
Insurance
– appropriate use of
·
Investment – types of, diversification of,
appropriateness
·
Retirement planning – calculating financial needs to prepare for as well as during
·
Estate planning – protecting assets while alive as well as after your
passing.
In addition,
the CFP® MUST ADHERE TO CFP ETHICAL STANDARDS and fiduciary responsibilities or risk losing their designation.
Because obtaining
the CFP® is among the most vigorous processes, it is considered to be among the
prestigious. Throughout most of the country, a person is required to have CFP®™
or comparable designation to refer to themselves as “financial planner.”
Someone who calls themselves a financial planner without the appropriate
designations should raise a red flag.
Some
designations involve a more limited scope of personal finance such as Accredited
Financial Counselor (AFC); others are geared to specific areas i.e., divorce
planning, retirement specialists or geriatric planning. Each carries different
requirements, some no more than attending a class. They may – or may not –
carry a fiduciary requirement.
Where does one go to learn meaning of
and compare various designations? One website is FINRA.org.
FINRA (Financial Industry Regulatory Authority) is the agency that
regulates investment representatives. Their site offers information on the
various designations and the requirements for achieving them. Another good site
for research is Investopedia.com.
Second set
of credentials involves specific licensing, such as for insurance, real
estate, securities (investments). WHY is licensing important? Because an advisor
can only be compensated for products or services for which they are licensed.
For
instance, a person licensed for insurance but not for securities can only be
compensated for insurance, they can’t sell investments. The same is true of
securities reps that are not insurance licensed.
Here’s where
it gets a bit more complicated: some products are a hybrid of insurance and
investments. These hybrids – called “variable” products - evolved because investments
inside insurance products have preferential tax treatment. To be compensated on
those products, then, requires the agent to have both insurance and securities
licenses. The products in question include variable life insurance and variable
annuity.
But here is
where much confusion enters: some insurance products mimic variable products.
These products do not actually invest. Instead they use an index to determine
your return. Indexed annuity is one example. I have heard them advertised as “get
the same return as the market without the risk” and touted as “like investments.”
But they are insurance products not investments!
SO BE
CAREFUL – know what you are getting into and do your homework.Good
question to ask the advisor: are there
other products that are a better fit for my situation?
IF NOT
OFFERED, ASK ADVISOR FOR HIS/HER CREDENTIALS. Ask what licenses they hold and which
(if any) accreditation and certifications have been obtained? This will tell
you whether they are limited in what they can offer which influences the
advisor’s recommendations.
The second leg of 3 legged stool is Compensation.
Just like
you expect to be paid for the work you do, so does your financial advisor. And
just like most humans, advisors are influenced by the compensation they will
receive for their work. Whether consciously or not, an advisor’s recommendation
may be influenced by a number of factors such as
·
Whether
higher commissions are paid on certain products,
·
Whether
sales of certain products will qualify him/her for awards, trips, bonuses, or
·
Whether
the sales will contribute to earning higher compensation levels.
So know how
your advisor will be compensated.
Compensation
may be one or a combination of 3 methods:
1. Salaried employee
from who typically one can expect unbiased recommendations. The employee,
however, may be influenced by employer
incentives to promote specific
products or services.
2. Commission – to
receive a commission almost always requires licensing such as is required for
securities (investments), insurance, real estate broker, and mortgage broker. The
agent may be influenced by higher commissions on certain products, such as proprietary
products. Sometimes the commission is paid by you upfront or on the back end,
such as with certain classes of mutual funds. Other times it is factored into
the price you pay. This is especially true of insurance products so you may be
unaware of how much commission was paid to the agent. It is okay to ask whether
and how much commission will be received. It is also oaky to ask whether the advisor
will receive incentives.
3. Fee based –can
take several forms:
a. Retainer –
which is a pre-set dollar amount paid monthly or quarterly in return for
specified services;
b. Flat Fee for
service such $2000 to prepare a comprehensive customized financial plan;
c. Hourly rate;
or
d. Management fee
– typical of when someone manages your investments and receives percentage based
on the value of assets being managed.
These compensation
methods are not mutually exclusive.
If this
information is not volunteered, ask!
Know how they are compensated so you can make an informed decision as to
whether the recommendations are in your best interest or the advisor’s interest.
The third leg is Experience.
Prior experience influences advisor’s
recommendations. How
long has the person been in the current role? What was his/her previous career?
For instance,
back in 1999 when the stock market was exploding, one agent with whom I was
acquainted (who had been an investment rep for 3 years and had not experienced
a full market cycle) stated he never put his clients into bonds. After all, he
said, why would he when he got such fabulous returns for them in the stock
market. Both he and his clients rued that decision when the market plummeted in
2000.
In summary, learn as much about your financial advisor as you are able and make informed decisions!