How To Evaluate a Financial Advisor

There are several benefits to hiring a financial advisor. However, you must hire a suitable advisor to reap these benefits fully. There are many options available based on the type of services these professionals provide, their fee models, working preferences, location, and more. Yet, even after selecting the best professional, if your financial advisor does not work for you, your present and future financial health could be in jeopardy. Therefore, it is crucial to know how to evaluate your financial advisors to ensure they are working to your benefit and delivering as per your expectations.

This article lists four ways to help you assess a financial advisor’s merit and protect your financial interests.

How do you evaluate an advisor?

1. Verify the professional’s credentials

When hiring a financial advisor, it is vital to verify their credentials. Verifying credentials ensures that the financial advisor has the requisite knowledge, skills, and ethical standards to manage your finances effectively. Although the financial industry is fairly regulated, there are loopholes that can leave you stuck with someone who is not ideal for managing your finances. With the myriads of certifications available, it can be confusing to discern which ones matter. Each certification caters to a distinct purpose, and not all of them are the same. Therefore, educating yourself on what each certification stands for and identifying the ones relevant to your needs is essential to selecting a suitable candidate. Let’s explore some of the key certifications you should look out for.

1. The Certified Financial Planner (CFP) designation is one of the most respected in the industry. CFPs are trained in comprehensive financial planning and cover areas such as retirement, investments, tax planning, etc.
2. Financial advisors with the Chartered Financial Analyst (CFA) credential are experts in asset management and investment strategies.
3. Another significant certification is the Chartered Financial Consultant (ChFC), which focuses on advanced financial planning, retirement planning, estate planning, and taxes.
4. The Certified Public Accountant (CPA) designation is crucial if you need expertise in tax planning and tax filing. As the name suggests, CPAs are well-versed in accounting.
5. The Chartered Life Underwriter (CLU) certification focuses on life insurance and estate planning. If your needs include insurance and estate planning, hiring a CLU could be beneficial.
6. The Registered Investment Advisor (RIA) and Investment Adviser Representative (IAR) titles indicate that the financial advisor is registered and adheres to fiduciary standards, which means they are legally obligated to act in your best interest. Moreover, IARs are certified by passing the Series 65 or Series 7 exams and the Series 66 exam conducted by the Financial Industry Regulatory Authority (FINRA).
7. The Certified Financial Fiduciary (CFF) ensures that the financial advisor is committed to upholding fiduciary standards.
8. For those approaching retirement, the Retirement Income Certified Professional (RICP) designation focuses on retirement income planning.
9. The Certified Private Wealth Advisor (CPWA) is geared towards wealth management for high-net-worth individuals, along with niches in areas like estate planning and tax management.

Checking these credentials and understanding what they represent can help you make an informed decision when selecting a financial advisor. You can use BrokerCheck to validate a financial advisor’s credentials further. This is a free tool provided by FINRA that helps you research the professional backgrounds of financial advisors and advising firms. The information on BrokerCheck comes from the Central Registration Depository (CRD), which is the securities industry’s online registration and licensing database. BrokerCheck provides a qualifications section that gives you a preview of the professional’s registrations and licenses as well as the industry exams they have passed. To be registered in the securities industry, financial advisors need to clear one or more qualifying exams, including the Securities Industry Essentials (SIE) exam. This section also includes the financial advisor’s employment history, including full- and part-time work, as well as their education.

2. Check their fee model

When hiring a financial advisor, it is essential to understand how they will charge you throughout your association. Knowing the fee structure helps establish the right expectations and ensures transparency in your financial relationship. If your financial advisor charges fees that seem excessive or unjustified, it might indicate they are not working in your best interest.

Financial advisors use various fee models, and understanding these can help you choose the one that aligns best with your financial situation and preferences. There are three primary types of fee models – commission-based, fee-only, and fee-based.

1. Commission-based financial advisors earn money through commissions when you buy financial products that get them the most money. This model can sometimes lead to conflicts of interest, as the financial advisor might prioritize products that benefit them financially rather than those best suited to your needs.
2. Fee-only financial advisors charge fees based on hourly rates. They can also charge annual fees or a percentage of Assets under Management (AUM). This model tends to be more transparent as the compensation is directly proportional to the performance and success of your portfolio.
3. Fee-based advisors combine elements of both models. They may charge AUM or hourly rates for their advice while also earning commissions on certain products.

If you are hiring a financial advisor for the first time, it is crucial to clarify their fee model before entering into any agreement. Discussing and understanding the fee structure beforehand will help you avoid surprises and ensure that the financial advisor’s compensation method is suitable for your needs. Additionally, exploring different fee structures can help you find options that better align with your financial situation and preferences. For those who have already worked with a financial advisor, it is advisable to review the total fees paid periodically. Ask your financial advisor for a comprehensive breakdown of all fees, including any commissions or expenses incurred over the past year. Typical costs to review include:

1. Management fees for managing your finances
2. Transaction costs for any investments bought or sold
3. Any additional charges

You must inquire about the expected fees for the upcoming year as well. Your financial advisor should clearly explain any significant changes in the fee structure. A financial advisor should be transparent and able to describe how their fee structure works. They should be able to justify all costs. If you notice any fee changes, you must ensure your financial advisor provides a thorough explanation. Increased fees should ideally be accompanied by enhanced services or better performance. Otherwise, it might be a sign to reassess your relationship with the financial advisor.

It is also essential to ask your financial advisor if they have quotas or commissions. These incentives can sometimes drive financial advisors to recommend products or services that fulfill their targets rather than genuinely benefiting you. Understanding whether your financial advisor is subject to quotas can help you gauge the authenticity of their advice and identify any potential vested interests.  When selecting a financial advisor, it is essential to match their fee structure with your financial needs and goals. Choosing the right fee structure depends on your specific needs. So, if you are seeking one-time guidance, opting for a financial advisor who charges by the hour might be the best choice. On the other hand, working with a financial advisor all year round might be more beneficial if you require continuous assistance. Similarly, commission-based models can be suitable if you are only looking for specific products, like life insurance or investment funds.

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3. Check for regulatory compliance

Ensuring your financial advisor has a clean regulatory record is crucial for understanding their track record and integrity. A history of regulatory issues, such as client complaints, disciplinary actions, or legal disputes, can indicate potential problems, and it may be wiser to avoid working with such individuals. Conversely, professionals with spotless records are typically ideal for your financial needs. Checking a financial advisor’s regulatory compliance helps you understand their past and provides insights into their professional conduct and reliability. A spotless regulatory record often reflects a high level of integrity and ensures adherence to top standards. Moreover, identifying financial advisors with a history of issues helps you avoid potential risks and protect your money.

There are multiple ways to check for regulatory compliance. You can review a professional’s regulatory history on the U.S. Securities and Exchange Commission’s (SEC) investment adviser search tool. This tool provides the financial advisor’s current registrations and licenses to ensure they are legally permitted to offer financial advice. It also lets you check the industry exams they have passed, such as the Series 65 or Series 66. Additionally, it provides insights into their past employment to help you understand their experience in the industry. You can also use the tool to review any customer disputes or issues that may have been raised by clients. The tool can be ideal for investigating any past regulatory or disciplinary actions to assess the financial advisor’s compliance with industry standards.

Secondly, you can use BrokerCheck. BrokerCheck offers a comprehensive report for investment professionals who are currently or were recently registered with FINRA or a national securities exchange. The platform includes information about customer disputes and even criminal events, including pending actions or allegations that have not been resolved. It is important to note that an individual will remain in the BrokerCheck system for up to ten years after their registration ends. After this period, they stay in the system if they were subject to certain situations, such as:

1. Regulatory action
2. Convicted of certain crimes
3. Pled guilty of certain crimes
4. Found to be subject to a civil injunction regarding investment-related activities
5. Determined by a civil court to have breached statutes or regulations related to investments
6. Recognized as a respondent or defendant in arbitration or civil litigation due to alleged sales practice violations, which led to a judgment being awarded against them
7. Named as a respondent or defendant in arbitration or civil litigation alleging a sales practice violation that resulted in an award or judgment against them

As a supplement to BrokerCheck, FINRA provides the Disciplinary Actions Online database, which includes actions issued from 2005 onward, eligible for publication under FINRA Rule 8313 and opinions issued by the SEC and federal appellate courts related to FINRA disciplinary actions that have been appealed.

4. Confirm if the financial advisor is a fiduciary

Ensuring that your financial advisor is a fiduciary is crucial to ensure that the professional prioritizes your best interests. Fiduciaries are legally obligated to act in your best interest, which is a significant advantage when seeking professional financial guidance. The SEC requires fiduciaries to adhere to strict standards, ensuring their investment advice is aligned with your financial goals, even if it is not necessarily beneficial for the financial advisor.

Working with a fiduciary financial advisor offers several benefits. Firstly, their legal obligation reduces the risk of biased recommendations. Without a legal obligation, the professional’s advice may be influenced by commissions or other incentives. Secondly, fiduciary financial advisors must maintain transparency about any potential conflicts of interest. This allows you to make well-informed decisions about your financial future. Fiduciaries must maintain a high level of integrity and ethical standards. Unlike non-fiduciary financial advisors, who may only need to recommend suitable products, fiduciaries must ensure that their recommendations are the best possible options for you.

How do I know if my financial advisor is a fiduciary?

One of the simplest ways is to check their certifications. Certain certifications indicate that a financial advisor follows fiduciary standards. For instance, the Certified Financial Planner (CFP) and Accredited Investment Fiduciary (AIF) designations signify that a financial advisor adheres to fiduciary principles. Additionally, you can check if the advisor is registered with the SEC as a Registered Investment Advisor (RIA). RIAs are held to a fiduciary standard and must act in your best interest. You can verify their registration status through the SEC’s Investment Adviser Public Disclosure (IAPD) website. Another way to authenticate a financial advisor’s fiduciary standard is by checking their fee structure. Fiduciaries typically operate on a fee-only or fee-based structure. They rarely charge a commission for the products they recommend. You can also determine if your financial advisor is a fiduciary by simply asking them and inquiring whether they operate under a fiduciary standard.

To conclude

Evaluating a financial advisor’s qualifications, suitability, and alignment with your goals is a crucial step that should not be taken lightly. Your association with a financial advisor can span years, which makes it essential to invest time and effort into finding the right match. Taking the time to evaluate their qualifications and suitability thoroughly ensures that you establish a strong foundation for this long-term relationship. Assessing a financial advisor’s qualifications allows you to gauge their expertise and experience in relevant areas of financial planning that can benefit you. It also establishes transparency and helps you trust their advice.

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