How to Find a Financial Advisor, Step by Step

Paul Solman answers a Next Avenue reader’s question about how to choose an advisor who puts your financial interests first.

This little financial advisor would put anyone’s books in the black. Find a better one using advice from pension expert Zvi Bodie. Photo by Andrew Rich/Getty Images.

Paul Solman frequently answers questions from the NewsHour audience on business and economic news on his Making Sen$e page. Friday’s comes from a reader at Next Avenue. The NewsHour has partnered with Next Avenue, a new PBS website that offers articles, blogs and other critical information for adults over 50.

Janice Wagner — Bay City, Mich.: I am currently managed by an investment company. I would like to know who in my area is “an independent financial advisor.” I have been unable to find this type of advisor. Do you have any lists for different areas?

Paul Solman: I assume you mean your money is managed by an investment company, even if it sometimes feels as if you yourself are.

Do I have a little list of financial advisors? No, I don’t.

I referred your email to my own main financial advisor, friend and Boston University pension expert Zvi Bodie, also known as “Bodie-Sattva,” on the Making Sense page. Zvi suggested contacting the NAPFA, the National Association of Personal Financial Advisors, for someone in your area. He also recommended his own online library of resources for getting started with a financial advisor.

Here is a follow-up from Bodie, based on his book with Rachelle Taqqu, “Risk Less and Prosper.”

Zvi Bodie: You’re looking for an enduring relationship based on mutual respect and trust, so plan on investing at least as much effort as you’d put into choosing an automobile, especially a used one. You should make sure you choose an advisor who puts your interests first, and avoid advisors whose services are “free.” Free advice is usually worth less than you pay for it.

Advice offered “for free” often comes from brokers and salespeople whose products have commissions embedded in them. Many brokers and insurance agents call themselves financial advisors, so names don’t necessarily tell you all you need to know. It’s in the broker’s interest to make the sale, whether the product is best for you or not. Even upright, highly ethical brokers are subject to this conflict, which can operate at a subconscious level.

Nor is “independence” a sign of objectivity. Just because advisors are independent does not mean that they don’t receive commissions (or referral fees) from third parties. You have to ask.

Your interests are best served by an advisor who is a fiduciary. A fiduciary must disclose how the advisor is compensated along with any related conflicts of interest. A good place to begin is with the website of NAPFA, the National Association of Personal Financial Advisors, whose members are all committed to upholding a fiduciary standard.

Non-fiduciary broker-dealers and their registered representatives are held to the lower standard of suitability, which allows them to offer only “suitable” advice, even if they are aware that it isn’t the best advice for their client. Under the suitability standard, an advisor could, for example, recommend a mutual fund that returned a fee to the advisor, even if the advisor knew that a comparable, less expensive fund was available.

Treat all referrals from friends and family as a prelude to more questions. Some of the worst horror stories of fraud and scams came about because the victims took recommendations from a friend’s suggestion on pure faith. The recent Madoff fraud is just one recent reminder.

Fee-Only vs. Fee-Based Compensation

A fee-only compensation arrangement minimizes conflicts of interest. But be sure you ask for, and get, a compensation structure that is fee-only, and not simply fee-based. Fee-based advisors can switch back and forth between planning fees and commissions when they are dual- registered advisors, so beware.

Fee-only advisors can structure their fees on a retainer basis, or as a fee for service– for example, a flat fee for a financial check- up– or as a percentage of assets under management (which is most common). Some advisors and planners also have hourly rates, although this option has become less usual.

Although these formulas are all acceptable, the assets-under-management model can sometimes contain hidden pitfalls that a flat fee or hourly rate don’t share. It creates an incentive for the advisor to grow your assets to mutual advantage, but it sometimes leads advisors to steer you toward extra risk, or toward oversaving. (Yes, there is such a thing!)

For example, the advisor may talk you out of buying insurance
products that would lower your risk but reduce the amount of your investments under management. These are matters you can clarify in your interview.

Interviewing Candidates

Plan to interview at least three candidates. Find out an advisor’s qualifications, experience, credentials, and licenses. Look for an advisor who sees managing your investments as an integral part of helping you to achieve overall financial well-being. If the advisor does not offer comprehensive services, including career counseling, insurance, estate and tax planning, find out how they expect to get a whole picture of you.

And ask how they coordinate their advice with other professionals who advise you because you’re hoping to simplify your life, not make it more complex. Finally, be sure that they will provide you with a personal investment policy statement and a plan that incorporates it.

It’s the rare advisor who doesn’t offer at least lip service to the centrality of your goals and personal circumstances. Ask how the advisor will integrate your goals with your investments.

Do they use safe investments, such as I Bonds and TIPS, to help make sure that you reach your goals? Be sure their answers are clear. Require that the advisor provide you with two plans: a minimum risk plan and an average risk plan.

One common mantra to watch out for is that you have to take on more risk or else you can’t reach your goals. That’s a misstatement that can cost you heavily. Or you may encounter a related reaction, outright hostility to safer investments, including a blanket repudiation of TIPS and I Bonds as a “way to make you poorer.”

Once you’ve qualified your candidates, your personal comfort level is extremely important. Part of the equation includes an advisor’s explanatory skills, which are distinct from powers of persuasion.

It’s important that you understand the advice you are receiving very clearly. The best advisor will understand your situation and can fit your investment plan to you, while explaining things clearly. Look for someone who is a professional counselor first and foremost, and not just a businessman and/or investor.

See the Certified Financial Planner Board of Standards, “Questions to Ask When Choosing a Planner.”

Paul Solman: I would only add that if I were interviewing a prospective financial advisor, having spent the past 37 years learning about economics and finance myself, the first thing I would do is follow Zvi’s advice and contact the NAPFA. Then I’d contact a financial planner from their list. Then I’d check her or his references.

And then, If he or she checks out, I would ask a few critical questions as a test. Here are those questions and what would have to be included in the answers for me to hire the advisor:

1. What’s the very safest possible investment?
Some mention of I-bonds.

2. Do you invest in individual securities or mutual funds? Why?
A discussion of mutual funds, and how they diversify risk.

3. If funds, what are their management fees?
An explanation or admission that, as with the annual fees of planners to manage your money, mutual funds charge too as a percentage of assets being managed. The advisor should emphasize the importance of fees: the lower, the better.

4. Do you invest in index funds? If not, why not?
Index funds had better be the starting place in this answer. The would-be advisor should point out that they’re cheaper than non-index funds. Because a fund’s management fee is probably the most important variable in choosing one over another, the advisor had better provide a compelling reason not to index. (Check with me if you get a non-indexing answer you find plausible and I’ll see if I think it holds up.)

5. What asset allocation would you suggest and why?
Asset allocation is the mix of your investments by type: stocks, bonds, real estate, commodities, etc. It is generally a more important decision than which fund to pick. I have heard two credible allocation heuristics over the years.

First: as between stocks and bonds, the percentage in bonds should equal your age. (Until you reach age 100, I guess.)

Second, as shared 30 years ago by America’s first Nobel laureate in economics, Paul Samuelson: put 25 percent of your assets in short-term bonds, 25 percent in long-term bonds, and the remaining 50 percent in stocks.

My own asset allocation is, roughly speaking, some combination of the two, if tilted to the conservative. For years, my wife and I have been primarily invested in TIPS – Treasury Inflation-Protected Securities — as a way to preserve capital for our old age. Our chief concern: that we do not outlive our savings.

But as I explained recently, I’ve gotten cold feet about TIPS, which are now priced at dizzying highs by historical standards. As a result, we are moving half our liquid assets into a restricted retirement fund with a 3 percent guaranteed return that I lucked into years ago. It is unfortunately closed to further investors but I have been appropriately grandfathered in.

Our asset allocation today? Here’s a pie chart depicting it, as of February 2013:

Paul’s breakdown is for information and disclosure purposes only, and not meant to be financial advice.

I figure that’s the most honest answer I can offer to readers: putting my mouth where my money is. But it is surely not an advertisement for my investing approach, especially as my “restricted” bond fund isn’t available to the “non-grandfathered.”

This entry is cross-posted on the Making Sen$e page, where correspondent Paul Solman answers your economic and business questions

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