Author: Jon Luskin
“How do you make money?”
That’s what you should ask a financial advisor before that advisor ever opens their mouth. And if the answer isn’t:
“I’m paid directly by my clients.”
Then you need to run far away, and run screaming the entire time.
In case you think this is a dramatic response, think again. Working with a financial advisor who is compensated by any way that isn’t directly by their clients is a recipe for some very bad financial advice.
Why is an advisor being compensated directly from their client so important? It all boils down to incentives. If a financial advisor isn’t paid directly by their client, then that advisor is paid somehow. Usually, that somehow is via a commission from an insurance company or a big bank pushing a financial product (like an annuity). And, you likely don’t need that financial product.
The problem is that the advisor is working to get paid. That can mean doing a disservice to the person asking for help, for the person seeking genuine financial planning advice.
Would You Take Automobile Maintenance Advice from a Car Salesman?
Don’t believe me? Let’s consider an example: buying and maintaining a car.
Would you take auto maintenance advice from a car salesman? Of course not! Why not? Because the car salesmen’s advice would likely be:
“Buy a new car.”
No matter what question you ask, it’ll be suggested that you buy a new car. That’s because selling cars is how the car salesmen gets paid. The car salesmen doesn’t get paid for giving automobile maintenance advice. In fact, the car salesmen may even give you bad automobile maintenance tips. That’s because the salesman wants you to buy a new car sooner. If the car salesman gives you auto maintenance advice that ends up in your car getting destroyed, then the car salesman has the chance to sell you a car! Giving advice that ends with you buying a new car is good business for the car salesman.
It’s the same for the financial advisor. If the financial advisor only makes money when that advisor sells you a whole life insurance policy, then you buying a whole life insurance is going to be the financial silver bullet that solves all of your money problems. (Of course, you may already know that buying a whole life insurance is not the panacea to solve all your financial problems. In fact, buying an overpriced whole life insurance policy will likely increase your financial problems.)
Free Financial Advice
Perhaps you’re not convinced. After all, financial planning advice can be expensive. And there are a lot of financial advisors out there that are willing to help you for free. So, why not get some free financial advice? Here’s why:
Yes, getting stuff for free is always awesome. But, getting free stuff only really counts if what you’re getting is any good.
- Coupon for free chicken nuggets from Chik-Fil-A? That’s awesome.
- Free lift ticket on your birthday at Big Bear? Completely awesome.
- Free credit score from CreditKarma? Super awesome.
And while there may be such a thing as “free financial advice,” there certainly is not a thing as free financial advice that you actually want to use. If a financial advisor offers advice for free, it’s time to turn around, start screaming, and start running. That’s because free financial advice is usually just a sales pitch for a terrible financial product – be it a whole life insurance policy, over-priced mutual fund, or anything else.
Free “financial advice” is akin to watching an informal. One could make the argument that there are no commercials during an infomercial. But, that would be missing the point. In an infomercial, the entire segment is one big long commercial. And just like in an infomercial, if the products were any good, those products probably wouldn’t need an infomercial to sell. The best products truly speak for themselves.
The Wrong Way for Financial Advisors to Make Money
So, now we know that free financial advice is bogus. If you want to get real financial planning advice, you are going to have to pay for it. If you’ve decided that it does make sense to pay for financial planning, know that there are several ways that a financial advisor can get paid.
Commission for a Selling Something You Probably Don’t Need
The first way an advisor can get paid we’ve already covered. It’s for selling a bad financial product that you probably don’t want. And at the risk of subjecting you to industry jargon, the financial advisor who gets paid for selling stuff is known as a commissioned salesperson. Commissioned salespersons are the folks that you must absolutely run screaming from.
If a financial advisor says they are “fee-based,” it’s also time for running and screaming. Fee-based is a term created by commissioned salespeople to further confuse hard-working Americans. If you hear “fee-based” from a financial advisor, run away. Oh, and while you’re at it, remember to scream.
Here’s one dead giveaway for a financial advisor that you do not to work with: if that financial advisor has an insurance license number. You’ll find this insurance license number on their business card and their e-mail signature, just like the below:
If you see an insurance license number, it’s time to lace up your running shoes and clear your throat. Because you’re about to start running and screaming. On that same note, you can look up an advisor to see if they have licenses to sell investment products. If you see either the:
- Series 63
- Series 66
- Series 6, or
- Series 7
then you know that it’s time to break out your running shoes.
Unfortunately, this area can get complicated. You want an advisor to hold a Series 65. But, you don’t want a 63 or 66. Confusing, right? A series 65 isn’t a license to sell products. It’s a license to give investment advice.
The Right Way for Financial Advisors to Get Paid
While “fee-based” is bad, “fee-only” is great. Fee-only means the advisor only gets paid by their client directly – and not indirectly from a company selling expensive financial products, like an annuity or whole life insurance. The term commission-free can be used interchangeably with the term fee-only.
This brings us full circle to the beginning of this post, when you ask the financial advisor:
“How do you make money?”
A fee-only financial advisor can be paid in several ways.
Hourly Fee-Only Financial Planning
Financial advisors who charge an hourly rate are one type of fee-only financial advisor. This is the same way other professionals operate – such as attorneys.
One great resource for finding fee-only advisors is via the Garrett Planning Network. Hourly financial planning can start at $150/hour. If a financial advisor is a member of the Garrett Planning Network, you know that the financial advisor is getting paid the right way: directly by the client.
Fee-Only Financial Planning via a One-Time Fee
When you pay a one-time financial planning fee (which can start at $1,000 and go up to $10,000 or more), you’re likely working with a fee-only financial advisor. Given the high price, you should be getting a robust financial plan and unbiased financial planning advice. You can find fee-only financial planners who charge a one-time planning fee at the National Association of Personal Financial Advisors (NAPFA).
Fee-Only Financial Planning for an Ongoing Retainer
The ongoing retainer is my favorite billing model for fee-only financial planners. This is because you get a financial planning professional to maintain your financial plan. This gives you the best chance of achieving your financial goals. The ongoing retainer model works so well because clients aren’t disincentivized to reach out to a financial planner for fear of incurring an additional charge for each question they ask. (This is one challenge of using the hourly model). Moreover, the fee-only financial planner billing on the retainer model stays in the client’s life ideally forever. This means the advisor is able to help the client to accomplish all of their financial To-Do’s. That is not the case with the one-time fee model.) With the other two fee-only models, the advisor gives advice to the client, with the adviser crossing their fingers that the client will actually follow through on their prescribed financial planning
That is not the case with the one-time fee model. With the other two fee-only models, the advisor gives advice to the client. After that, the adviser simply hopes that the client will actually follow through on their prescribed financial planning To-Do’s.
Ongoing retainers can start as low as $99/month. But, the price can go up to several thousand dollars a year. You can find fee-only financial planners working on the retainer model at the XY Planning Network.
Assets Under Management (AUM) Billing
When an advisor charges a percentage of your investment account being managed, that advisor is also a fee-only advisor. However, AUM billing is my least favorite fee-only billing model. This is because AUM billing model still leaves a rather undeniable conflict of interest. This is the incentive to keep your investment portfolio as big as possible, and to grow your portfolio as fast as possible. Fortunately, some savvy consumers are starting to figure this out.
In my days as a fee-only financial planner, I’ve witnessed rather inappropriate strategies in the quest for keeping AUM fees rolling in. This has included taking out loans against an investment portfolio. And you may not need me to tell you that’s a bad idea.
However, for some people, the AUM billing model may be the only option. This may be the case if your budget is simply too tight to make any of the other fee-only billing options possible. Some advisors at NAPFA, Garrett and XY can offer AUM billing.
How is a Financial Advisor Paid?
So, remember, the first thing that you want to ask a financial advisor is:
“How do you make money?”
Now you know that you want a financial advisor to be paid by you directly. And, you’ve got several options for how you can pay that fee-only financial advisor directly:
- For a flat project fee
- For an ongoing retainer
- AUM billing
So, if you ask a fee-only advisor how they are compensated, you can rest assured you’ve found a better advisor when they answer:
“I’m paid by my clients directly.”
One More Question to Ask a Financial Advisor
“Are you a fuduciary?”
OK. I know I titled this blog post, “The One Question to Ask a Financial Advisor,” but there are actually two questions. However, “Two Questions to Ask a Financial Advisor” just isn’t a catchy blog post title.
You want your financial advisor to be a fiduciary. Fiduciary means that the financial advisor is legally required to put you first. A fiduciary acts in your best interest, over their own. Usually, a fee-only financial advisor is also a fiduciary. But, it never hurts to ask the fiduciary question. Of course, if the advisor answers “no” to the fiduciary question, don’t fret. At least, you’ll be getting some good exercise as your run as away from that financial advisor as quickly as possible.