Michael D. Bradley holds the Chartered Financial Analyst designation and is managing partner at Bradley & Company, LLC. All opinions expressed here are his own. Whether it’s your bank teller, some guy you knew in college hassling you through LinkedIn or your Dad’s broker, there’s no shortage of people offering to help you plan your financial future, the challenge is figuring out which type of financial advisor you should seek.
Further complicating matters, there’s often a disconnect in what people describe themselves as doing and
But what’s really important is how they get paid and what the pros and cons are of each business model of financial advice.
Here’s how to tell the difference between all three:
The term “broker” can be used to describe either insurance salespeople or stockbrokers that get paid on a commission. These types can be found at insurance companies, acting as independent agents, advisors at large “wirehouse” firms that prefer to be paid on a transactional basis. This person will be paid to get you to do some kind of financial product – agree to buy or sell a security or agree to a long term contract with an insurance company. Generally they’ll be paid a sales commission from the company selling the product or a brokerage commission from their firm in the case of a stock or bond.
Pros: Commissions tend to assume that the purchaser will hold the product for several years, meaning that the advisor will make more money than they would if they were working under one of the business models below and may, accordingly, be sufficiently compensated to make a smaller client make sense for them. Depending on your tax situation, this may also be among the most tax efficient ways to pay for advice.
Cons: Generally brokers are acting as salespeople and not held to a “fiduciary standard”, meaning that they aren’t compelled to put their clients’ interests above their own, but are instead held to a lower “suitability standard.” Obviously brokers have certain conflicts of interest and may be inclined to sell clients investments purely for the purpose of generating a commission.
This is usually used to describe a “fee-based” advisor who is paid a percentage of clients’ assets under management. This type is found at Registered Investment Advisors, trust companies, and some wirehouse advisors prefer to be paid in this manner for their services. The model is based on the assumption that the advisor will work closely with the client and make changes to their portfolio as the clients’ circumstances change. They usually offer advice on a wide variety of topics as well, including mortgages, retirement plans, stock options and a myriad of other ways.
Pros: When people think of a “financial advisor”, this is what they imagine. Because of how they’re paid, they’re not biased towards one particular investment product or strategy.
Cons: Because they get paid a percentage of assets under management, they’re job is to generally not get fired and may be lazy in managing your money. They’re also inclined to neglect your portfolio if you’re a smaller client.
True financial planners are held to a fiduciary standard, and generally hold the CFP® credential. Often, insurance advisors or wealth managers will position themselves as a financial planner to stir up business they will eventually lead to commissions or assets under management.
A financial planner usually describes an advisor who, for an hourly or project based fee, helps their clients develop a written financial plan that they will execute elsewhere.
Pros: If a true financial planner, they’re among the most unbiased sources of advice. Because they are paid a “fee” (as opposed to commission or fee-based), they tend to be more interested in working with less wealthy clients.
Cons: Generally financial planners are not investment experts, and may not give the most comprehensive or competent insight on how to invest. Also, they tend to have limited resources to help you execute a plan.