At the end of the day, your money is finite. Your money can work for you or it can work for the advisor. It can't work for both. Recognizing that trust is essential in any relationship with a financial advisor, we recommend you take three steps before placing that level of trust.
- Do your homework on what kind of financial advisor deserves trust based on how they get paid, the services they provide and their level of education and training.
- Ask for all fees to be explained before you enter into the engagement. Make sure those fees don’t create conflicts of interest.
- Have a sober understanding of the financial stake you have in trusting this person.
Trust in institutions is at an all-time low in America and yet the financial services industry continues to thrive on the perception of trust. There are tens of thousands of financial advisors in the country and millions of people who entrust their savings to these advisors.
In most cases, the advisors have inherent conflicts that make it hard for them to provide truly unbiased advice. The advisor might sell insurance and, thus, be biased toward recommending annuities or whole life insurance policies that generate large commissions. The advisor might be a broker-dealer who earn kick-backs or commissions from selling mutual funds or other financial products and therefore could push clients into specific types of investments. More commonly, though, advisors simply charge a percentage of assets under management (AUM) and so are predisposed to recommend that clients deposit funds into those managed accounts versus paying down debt or contributing to employee-sponsored retirement plans.
Those AUM fees add up, especially as assets accumulate. An individual with $500,000 in stocks and bonds in an account managed by a financial advisor is likely to be paying $5,000 per year—or more—in advisor fees, which many investors overlook because they are automatically deducted from their account.
Despite the high fees and inherent conflicts, millions of people trust their financial advisor. The advisor might be a friend, neighbor or family member. They might be involved in community or church organizations. They may have attended familiar schools or colleges. They could work for a big company with a recognizable name. The might have some impressive looking letters behind their names. The advisor may just have a pleasant manner.
Importantly, the advisor probably seems to know more about the intricacies of financial products and services than the client. Most people are just looking for someone—anyone—to help them understand what they perceive as a complex financial world (because the financial services industry has a vested interest in making it seem complex). The client places their trust in the advisor and the advisor, in return, delivers peace of mind to the client.
While we understand this dynamic of trust, we think there’s a better way to determine trustworthiness. We encourage people to evaluate their choice of investment advisor with great care and a healthy level of skepticism. First, make sure that the advisor has worked to remove all conflicts of interest from their practice. No advice is better than conflicted advice, so steer clear of an advisor that sells insurance. Really, you should avoid any "advisor" that sells anything.
Next, make sure you are comfortable with the fee arrangement. Advisors that work on commissions are to be avoided. Advisors that charge a percent of assets under management are a step up, but still clearly incented to steer funds into their managed accounts. Advisors that charge a flat fee are in the best position to help evaluate a range of planning and investing topics, including optimizing work retirement plans and HSAs, building emergency funds and other intermediate-term savings, determining student loan repayment strategies, using direct-sold 529s for college savings, evaluating term life and disability insurance, and investing in a way that's both completely understandable and very effective.
Finally, make sure the advisor is highly educated, humble, and insatiably curious. Financial planning is a complex process, with intricate tax issues and multifaceted cost-benefit trade-offs. It requires constant self-education and a commitment to life-long learning. The advisor should also have a strong academic background and experience working with people like you. Since it's so easy to work with advisors anywhere in the country via videoconferencing, you probably don't want to work with friends or family members. Some professional detachment is probably best for both you and the advisor.
Trust is a funny thing. Place trust too easily and your labeled gullible. Place trust too slowly—or not at all—and your deemed cynical. Scientists believe we are wired to trust people, because trust is essential to survive in a complex, interconnected world. We have to learn to distrust. Given the financial stakes involved in selecting an advisor, we’d err on the side of cynicism. Do your homework and make the advisor earn your trust