Do I need a financial advisor?

The term financial advisor has conjured up for most images of some sort of voodoo magician who does ‘stuff’ with our money. A friend of mine said, “he said a lot of things I did not understand but he seems to know what he’s doing.” And then, there are people who actively work with their financial advisor and are very involved with them. Whether you have a financial advisor or not, whether you love your current financial advisor or not, it’s always a good idea to periodically assess whether you need one and/or whether the one you have is working well for you. 

Having a financial advisor does not mean outsourcing your brains

I want to start with this statement. Let’s be clear – you can outsource your money management to a financial advisor but you cannot outsource your brain or the thinking. What that means is you still need to know what your financial advisor is doing with your money and why. If you don’t, you are going down a very dangerous path – where you have let someone else control your finances. Even a well meaning financial advisor may end up doing things that you don’t necessarily want simply because you may not have taken the time to think through your approach. So let me break down the things you absolutely need to make sure you are involved in.

Its the 3 things I talked about in my article on “Where should I invest my money – Part 1”?

1. Asset allocation – what kind of investments do you want to make and what % to each investment? You can certainly get input from your advisor but you need to be the one driving this. 
2. Asset location – understand the tax implications of these investments. You don’t need to know exactly how much taxes you will pay in each but know the basic tax treatments of these investments.
3. Investment philosophy – this is an important one and something you need to have an opinion on. Do you want to be an active vs passive investor? Do you want to be a buy and hold long term investor vs short term investor?

It’s also important for you to know how your brain will behave when you see your investments go up and down. A good financial advisor will first try and understand your behaviors by asking you a few questions to assess your risk appetite . If you are the kind of person who likes to see your portfolio daily and get worried about the gyrations, then you probably want to keep a more conservative, lower risk asset allocation. Alternatively, if you don’t care about the short term gyrations, you can take a more aggressive asset allocation. 

If you have fundamentally thought through the above then you have put in more work than most people, as you work with a financial advisor. You are in the driver’s seat then. 

What kind of a financial advisor do I need?

Wait a minute – there are different types? Yes, we fundamentally have 3 types of advisors:

1. Fee only financial advisor – this is a type of advisor who does not manage your investments but simply gives you advice and guidance on where and how to manage your investments. The advisor will charge you a fixed fee for this advice. This might be a one-time fee or possibly a monthly retainer, or simply an hourly rate.The fees here are completely transparent and you will know ahead of time how much you are going to pay.
2. Fee-based advisor who actively manages your assets – these are advisors who will do everything explained in 1 but also actively manage your investments for you by investing it in different assets on your behalf. They charge a fee as a % of the amount of money you have invested through them. Typically these are around 1% – 2% of the total fee. This model is also called ‘Assets Under Management (AUM)’ where they are paid a fee for the amount of money they invest irrespective of how well the investments perform. 
3. Commission-based advisor – these are advisors who may or may not do everything in 1 but they may get compensated in ways that include 1 and 2 but for sure they also earn commissions from the organizations they invest your money with. 

What kind of an advisor you need fully depends on how comfortable you are in managing your investments. People who feel they need a lot of hand holding prefer to go with 2. Unfortunately, when they go to 2, they tend to outsource their brains and thinking as well and don’t have much of an idea on what the financial advisor is doing with the money. This is not always true obviously but unfortunately this happens more often than we would like. I will explain in a bit why you don’t want to go with 3. 

Fiduciary vs non-fiduciary

Before I go further, it is very important for you to understand another terminology here that you absolutely MUST ask before you hire a financial advisor. Bear with me as I walk you through the jargon here. 

You must ask if your financial advisor is a fiduciary or not. A fiduciary is one who is expected to act in your best interests and is held to a very high standard and is regulated by the SEC. Ok that’s confusing – I would expect any financial advisor to act only in my best interests. How else would they act? This is where some of us (like I used to be) can be naive. There are a lot of financial advisors who are not fiduciaries and instead of meeting the fiduciary standard, they simply only have to meet what is called the suitability standard. Ok stay with me here. The fundamental difference between the 2 is the decision making process – a fiduciary is expected to go through a very thorough analysis of the investments and explain that to you and make sure you understand it before making the investments. A non-fiduciary does not need to do all that. He/she can simply invest your money in certain investments without having much of a discussion with you and a lot of times their role ends right there. 

The other key distinction almost always is that how a fiduciary is compensated vs a non-fiduciary. In general, a fiduciary financial advisor is compensated only as a flat fee (fee-only) or as a % of Assets Under Management AUM (fee-based), whereas a non-fiduciary can be compensated not only for their time and % of AUM but in addition commissions from the organizations they invest your money with. This is not always true but that’s why it’s important that the very first question you ask before you hire a financial advisor is how do they get paid? 

So what does all this mean?

As you all know, in my blog I generally do not take a hard stance one way or another. I like to provide you with the information and allow you to make those decisions. However, this is a subject where I will take a hard stance. 

First and foremost, I would recommend you want to work only with a fiduciary financial advisor who does not make any money through commissions – so they are either fee-only or fee-based. Run a million miles away from the financial advisor who is NOT a fiduciary and who gets paid through commissions. Almost always there are conflicts of interest and they tend to push financial products that are not necessarily to your interest. 

I personally prefer to work only with fee-only financial advisors because ultimately I am a big believer in investing in passive index funds. I don’t need to pay an advisor 1%-2% of my investments every year to invest in passive index funds – I can do that myself. 

Go to https://www.napfa.org/ to find accredited fiduciary fee-only financial advisors in the US. Of course, make sure to also get recommendations from trusted friends and family. 

So to keep this simple, ask these 2 questions first before you hire a financial advisor:

1. Are you a fiduciary? 
2. How do you make money? Are you fee-only, fee-based or commission-based?

So do I really need a financial advisor?

Ultimately, if you are someone who is very confident of where to invest your money and feel like you know what you are doing, you may be someone who does not need a financial advisor. But it might be worth it to hire a fee-only financial advisor just to check and see if you are on track to meet your financial goals. They often have tools that you can take advantage of, to model your financial picture in the future. I fall under this bucket – even though I feel confident about where and how to invest the money, I have a financial advisor who I like to check-in with to validate my thinking as well as see if I am on track. For those who are interested in getting his contact, you can reach out to me. He has a unique low cost business model that I appreciate. I won’t advertise his name here because I don’t want anyone to get the impression that I am pushing someone’s services. 

On the other hand, if you feel like you do need a lot of hand holding despite being committed to not outsourcing your brain, you can go with a fiduciary financial advisor who is fee-based. 

Ultimately beyond all the above, if you do decide to go with a financial advisor, find one who you are comfortable with, who takes the time to understand your goals and preferences, explains things to you in a way you understand, and who keeps investment costs low for you. A financial advisor needs to be an important partner in your financial journey. So take the time to meet and interview a few of them before you finalize one. If you already have one, see if they meet all the standards I discussed above. If they do meet the standards,  great! – you can continue with them. 

Thank you for reading and I wish you success in your financial journey.

Disclaimer: I am not a financial advisor and all the information in my articles are from my personal experience and are for informational and educational purposes only. Please consult with a financial advisor or CPA for professional advice.