Let’s say you are shopping for a car. Would you buy one without first closely examining it for fit, performance and affordability? Of course not. Want to go big? The Astin Martin AM-RB001 goes for a nose-bleed-inducing price of nearly $4 million. Alternatively, your local Nissan dealer could hook you up with the Versa Note for under $16,000. So, what do you want? Which can you fit in? When does total cost become an impediment to action? Many of the decisions you make in life involve a complex matrix of questions that need to be answered. One of the most compelling is who, if anyone, you go to for help with your financial planning. That decision may have a greater impact on you and your family’s life than any other you might make. So, why put less effort into making that selection than you would picking a car?
There is no reason why you have to hire a financial planner, of course. It is going to cost you. That’s how they make a living. If you don’t yet have a long-term financial plan, you have to make one of two decisions. Either decide you’re going to make your own financial plan and stick to it, or pay an expert to do it for you and stick to that one. Oh, that’s right; there are other options. Do nothing and work the rest of your life, or invent the next killer app.
The advantage of going with option two is that a good financial planner has, or should have, sufficient education and experience that enables them to bring to the table more knowledge about the financial world than you can. Yes, you can fix your own car, but is that the best use of your time? You can try to do your own financial plan, but it is best to start when you’re young to allow enough time to make and recover from mistakes you might make along the way.
The first thing to be aware of when considering a financial planner is that the position requires a high degree of trust. In some cases, you might be turning over your entire nest egg and all of your personal information to a person you may know very little about. Even if you do happen to know them, it does not mean they will always have your back. To make more money for themselves, they might be tempted to do things that are not in your best interest. That may sound cynical, but consider Bernie Madoff.
You should feel free to run a background check on anyone you’re considering hiring. Find out if they have ever been convicted of a crime or investigated by a regulatory body or professional association. If so, run for the exit. BrokerCheck is a free online tool to research the background and experience of financial brokers, advisers and firms.
Examine their credentials, among which you might find Certified Financial Planner (CFP), a Chartered Financial Analyst (CFA), a Certified Public Accountant or a Chartered Financial Consultant. Some experts say the CFP is the gold standard, requiring years of experience, taking an extensive course, passing a six-hour examination, plus mandatory continuing education.
The CFP certification process, according to the CFP Board, “identifies to the public that those individuals who have been authorized to use the CFP certification marks in the U.S. have met rigorous professional standards and have agreed to adhere to the principles of integrity, objectivity, competence, fairness, confidentiality, professionalism, and diligence when dealing with clients.”
Look for someone who claims to be a fiduciary—that is, someone who puts your interests above their own. In the case of the financial planner, it means that they won’t try to steer you into an underperforming investment with high commissions or hidden fees. While standards for a fiduciary are somewhat muddled, you have every right to grill a perspective planner and ensure the concept is understood and adhered to throughout the organization you’re partnering with. Also, don’t go to sleep once you have chosen a planner. Even if you may need financial planning assistance, you can certainly check your own investments annually or quarterly and measure your return on investment.
First, determine how much financial planning advice you might need. If you’re young and childless, for example, you may need only several hours of an adviser’s time. They can tell you how much to set aside in your 401K or other retirement savings accounts, maybe give some guidance about buying a home, and send you on your merry way. That way, you pay only for the hours spent constructing the plan.
The older you are, the more complicated the plan may become, accounting for mortgages, education planning, insurance, retirement planning, etc. You’ll pay more for that, of course, but it’s a step below paying someone to be your asset manager. An asset manager invests and manages your financial resources, providing guidance through various stages of your life. The asset manager generally charges you a certain percentage of your total assets under management each year.
How much will any financial planning advice cost you? This is where you have to pay the strictest attention. A mistake here could cost thousands of dollars and force you to delay your retirement.
There are generally three types of models by which advisers are paid for their services.
Commission-based: Stay vigilant when you are working with commission-based advisers. While they may have products that might fit your profile nicely, they make all their money based on what they sell you, e.g., brokers, insurance agents, registered representatives. They sell such products as annuities, insurance and mutual funds and may be working for large financial institutions that also need to be paid. Some of these products might be excellent, but bear in mind that the seller has incentives to sell products that might not sell themselves and for which there might be significant, sometimes hidden, or at least less than transparent, fees. Your needs may be secondary.
Fee-based: This is a hybrid and relatively new on the financial landscape. Fee-based advisers charge fees for financial planning but usually are affiliated with a broker/agent and licensed to sell investments or insurance for a commission. Here again, there might be a conflict of interest between the adviser and client. Will the temptation of making more money trump the needs of the client? Studies have shown that most customers don’t understand the subtleties of the fee-based model.
Fee-only: According to many investment professionals, the fee-only adviser may be your best bet, because you pay fees only for services rendered. You can pay for a simple financial plan, walk out of the office and never see the planner again except for tweaking as your situation changes. This is wise if you can follow the plan. If you can’t, either because you don’t have the discipline, or your portfolio is too big to manage by yourself, more interaction might be needed. In addition to flat fees, fee-only advisers can also charge an annual fee based on the worth of your investments.
This, too, bears watching. Say you are paying your adviser 1, 2 or 3 percent of your total assets. He or she might be tempted to discourage you from liquidating some of your retirement account to buy a second home, for instance, in order to keep the cash coming into their own account each year. You must insist on a fiduciary relationship, and you must monitor the fees you pay and determine how they affect your investments over time. President Reagan more than once cited a Russian proverb during negotiations with the Soviet Union: “Trust, but verify.”
In her book, “Smart Women Love Money: 5 Life-Changing Rules of Investing,” author Alice Finn provides an illustration of how much fees can eat into your retirement savings. Take the example of a 35-year-old woman who has about $100,000 in savings. Historically, she could expect to earn 6.5 percent on her portfolio.
“If she pays 1 percent a year in fees, she will end up earning 5.5 percent a year instead of 6.5 percent, and within 30 years, her $100,000 will be worth almost $500,000—not too shabby,” Finn said. “But if she ends up paying 2 percent a year in fees and therefore earns only 4.5 percent a year in returns, she will end up with only $375,000, paying more than 30 percent ($125,000) of the $400,000 profit she could have earned, in fees. Take those fees up one more notch to 3 percent, and her $100,000 will grow to a mere $280,000 over the next 30 years. In other words, this woman will have forfeited more than half her potential investment gains and almost half her ultimate potential wealth by paying those extra two percentage points in fees. This is the downside of compounding.”
Finn, who has been ranked among the top 100 wealth managers in the country, also makes the point that the more money you have, the greater the potential wealth you will forfeit if you pay too much in fees. She said that there is one simple question you should ask directly of anyone managing your money: “Can you please tell me all the fees I am paying to you and everyone else investing my money?”
So, do your homework and your due diligence before you make what could be one of the most important decisions in your life. You might want to do it now before you are tempted to buy the Astin Martin.