Financial Advisors – A Brief Tutorial

How many types of financial advisors are out there? Four? Five? Eight? The answer depends on the source of the information and the different job descriptions being used. Unfortunately, common titles do not provide much clarification, and we are warned that titles do not necessarily mean someone has specific training, credentials, or registrations.

A financial advisor can be anyone who helps you manage your money. They can provide investment advice, debt management, savings preparations, retirement planning, estate planning, and tax planning. There’s no specific licensing or certification process required for someone to call themselves a financial advisor.

Financial advisors can be fiduciaries or non-fiduciaries. Fiduciaries are legally required to act in their clients' best interests. Specifically, fiduciaries are required to: (1) make recommendations and take actions that accurately reflect their clients' financial objectives, timeframes, and risk tolerance; and (2) avoid exposing their clients' assets to excessive risk. If a financial advisor is not held to a fiduciary standard, they may only be held to a suitability standard, meaning they are required to offer suggestions that generally fit their clients’ financial situation, whether or not they have higher fees or bigger commissions than other options. In other words, non-fiduciaries may prioritize their own interests or those of the institution they represent over the interests of their clients.  

If you specifically want an advisor who owes you fiduciary duties, you should find a credentialed financial advisor:

Registered Investment Advisor (RIA)

The U.S. Securities and Exchange Commission (SEC) states that any financial professional or firm that engages in the business of providing advice to others or issuing securities reports or analysis for compensation is technically an "investment adviser" and must register with either the SEC or their state, depending on the advisor’s assets under management. [While "advisor" with an "o" is the most common spelling, the laws regulating these professionals generally use the term "adviser" with an "e."]

An investment advisor is a company or an individual who provides clients with advice and manages their investments. An investment advisory firm is called a Registered Investment Advisor (RIA), and employees of a RIA who work as advisors are called Investment Advisor Representatives (IARs). Investment advisors who manage $110 million or more in client assets must register with the SEC. Those who manage less than $110 million in client assets register with the securities regulator in the states where they do business.

RIAs have a fiduciary duty to their clients and are required to act in their clients' best interests. This means the RIA may not recommend products and services that pay the highest commission or fee if not a proper investment for the client.

Chartered Financial Analyst (CFA)

A CFA designation means the person has in-depth training in the core skills of investment strategy and high-level money management. To earn the title of CFA, charter holders must demonstrate expertise in financial research, portfolio management, investment consulting, risk analysis, and risk management. The CFA certification is widely considered the apex for professional development in investment management.

Most CFAs work for institutions managing large portfolios and do not work directly with regular financial consumers. Earning a CFA is often a requirement for becoming a chief investment officer at an investment firm or public company; engaging in credit analysis, corporate accounting and auditing; or doing financial planning for high net-worth individuals.

Chartered Financial Planner (CFP)

Financial planners take a holistic approach, providing advice about every aspect of their clients’ financial lives. A financial planner aims to build a plan that encompasses budgeting, emergency savings, college funds for your kids, insurance needs, retirement planning, and estate planning.

Some financial planners sell investment or insurance products, and some may also be brokers. There is a very wide variety of different services and offerings among financial planners—and there are no federal or state authorities who directly regulate them. Basically, anyone can call themselves a financial planner and begin taking on clients. Therefore, look for the designation of Certified Financial Planner. The CFP designation is the highest professional standard in the financial planning industry. CFP denotes that a financial planner has extensive training and knowledge, as there are rigorous education requirements and a lengthy certification exam to earn the certification. In addition, CFPs are now required to always act as fiduciaries for their clients.

Chartered Financial Consultant (ChFC)

Chartered financial consultant is a certification often received by financial advisors and planners. The certification is offered by the American College of Financial Services and is the only institution which does so.

It is sometimes considered an advanced form of the CFP credential. Both types of professionals offer full-service financial advice on matters ranging from investments to retirement planning to wealth management. However, the ChFC certification process is considerably more difficult than its CFP counterpart.

Other types of Financial Advisors

Registered Representatives

Historically, individuals seeking to invest in stocks and bonds engaged stockbrokers. Today, people in this role are referred to just as brokers because they now also sell mutual funds and insurance products to clients. Registered Representatives are employed by broker-dealers (i.e., Merrill Lynch, Morgan Stanley, or Goldman Sachs), licensed, and regulated by FINRA. Brokers are typically paid directly by clients in the form of commissions for trading stocks and bonds, as well as for selling mutual funds and other financial products.

Keep in mind, brokers are not bound by the fiduciary standard and can recommend investments that pay them a commission, even if the investment isn’t in your best interest or there are cheaper options available.

Robo-Advisor

A robo-advisor is a digital financial advisor that some companies provide for their customers. A robo-advisor uses computer algorithms to manage your money based on answers to questions about your goals and risk tolerance. Robo-advisors, for the most part, construct portfolios that follow passive strategies like indexing, and they do not allow you to choose individual stocks or trading strategies. You do not need much money to get started with robo-advisors and they cost less than human financial advisors. These services can save you time and potentially money too.

However, a robo-advisor cannot speak with you about the best way to get out of debt or fund your child’s education. It also cannot talk you out of selling your investments out of fear or help you build and manage a portfolio of individual stocks.

How do these service providers get paid?

Financial advisors are paid for their services in several ways:

Fee-Only: A fee-only advisor charges a flat fee, hourly rate, or percentage of the assets they manage for you. Fees can range from 0.5% to 1% or higher, while a typical hourly fee for financial advice will depend on your geographic location. Fees will also vary by the advisor’s experience. Some advisors may offer lower rates to help clients who are just getting started with financial planning and can’t afford a high monthly rate.

Fee-Based Model: Under this model, advisors earn revenue from a combination of client fees and commissions. They will charge fees to their clients directly for managing their assets and financial planning, while also earning commissions on the side.

Commission-Based Model: Under this model, financial advisors typically work on commission for the products they sell to clients. As a result, the client could end up with financial products that charge higher fees than other similar products on the market, which can lead to the advisor earning a high commission.

How do you choose a financial advisor?

You want to choose a financial advisor who looks out for your best interests. A good financial advisor will be educated and well-informed about a wide range of financial and market trends and investment options. They will educate you, rather than sell you, so you can make an informed decision on what investment options are best for you. A well-suited investment advisor will understand your risk tolerance, engage you in the process, and encourage you to make smart financial decisions without pressuring you to make hasty decisions. They will be available to you as necessary and check in with you periodically to reevaluate your financial needs. You should interview several financial advisors before making a final decision.    

There are several databases you can access to find and evaluate financial advisors:

Be sure to check an advisor's credentials and history through BrokerCheck prior to engaging an advisor's services.

National Association of Professional Financial Advisor

Certified Financial Planner Board of Standards

Alliance of Comprehensive Planners

Garrett Planning Network

Choosing the correct financial advisor is an important step in protecting your assets, growing your wealth, and securing your future. There are a lot of financial professionals out there, so take your time to carefully evaluate what you expect of your financial advisor and thoroughly vet your options. Your decision could result in a life-long relationship of sound financial advice and support.     

Investing involves risks, and no investment strategy can guarantee success. The information provided here is for general purposes and should not be considered as legal, financial, or investment advice. If you are interested in hiring a financial advisor be sure to vet them properly.