If you want to know what a financial advisor does, the most common method is to ask — and the most common response from an advisor is that they help clients achieve their financial objectives by getting to know their needs, yada yada yada. Now, if you really want to know what an advisor does for a living, find out how they’re paid. How an advisor earns their income reveals more about what they do than anything else.
Many financial advisors have acronyms after their names that signify industry designations that they’ve earned. Familiar acronyms include CFP for Certified Financial Planner and CFA for Chartered Financial Analyst. These designations require significant work and years of commitment, but they don’t tell you what a person does for a living. How an advisor is paid determines what business they’re in.
The ambiguous world of financial advisors can be broken down into three broad categories: financial planner, broker/agent, and investment manager. Each job is different and each occupation receives income in different ways.
Financial Planner: If an advisor receives income directly from a client in the form of an hourly fee or an annual fixed retainer fee based on the amount of time to be devoted to a client’s situation, then that person is a financial planner. These fixed-fee advisors are the only practicing financial planners in the industry by occupation.
The number of practicing financial planners is relatively small, perhaps only a couple of thousand in the entire US. That being said, there are literally tens of thousands of advisors who, when asked, say they’re financial planners because they have a CFP. This is misrepresentation. These advisors are financial planners by certification, not by occupation. They’re not performing financial planning as their primary source of revenue.
Broker/Agent: If an advisor receives commissions or payments from the companies whose products or services they sell, they’re a broker or insurance agent. This means an advisor’s annual income is contingent on the product mix they sell each year. By definition, a commission-based advisor is biased in their advice because their income depends on the products they sell. I’m not saying you shouldn’t work with an advisor who is compensated based on commission; just know what their incentive is.
A broker/agent is easy to identify because they must disclose on all correspondence which brokerage firm holds their licenses. Look for this statement, “Securities offered through (named company). Member FINRA/SIPC.” This disclosure is a clear indication you’re talking with a broker. The phrase identifies the brokerage firm that holds the advisor’s sales license and states that this company is a member of the Financial Industry Regulatory Authority, the regulatory body that governs brokers.
Investment Manager: If an advisor receives their income from charging investment management fees, they’re an investment manager. Generally this fee is charged as a percentage of assets under management (AUM). An example of an AUM fee is 1 percent on a $1 million account, which is $10,000 per year.
Like many brokers, it’s common for investment managers to misrepresent themselves as financial planners. They say they do financial planning, but this is only a front to bring in clients under some other billing arrangement. In this case, it is AUM fees.
Brokers and investment managers who say they are financial planners and then try to sell commission products or investment management services are by default in breach of ethical standards. Don’t be misled by the certificate on an advisor’s wall or what they say they do. Find out how an advisor is paid. This tells what business they are really in.
The Securities and Exchange Commission requires advisors to disclose how they are compensated in public documents known as ADV Part 1 and 2A. This information is available on the web at www.SEC.gov. A broker may not have an ADV because their company files it. However, there is a section on the SEC website for brokers. An advisor who is an insurance agent only would be registered in the state in which they are conducting business. Most states have websites for checking out insurance agents.
In full disclosure, my firm, Portfolio Solutions, LLC, is an investment manager. We’re paid a low AUM fee for managing portfolios of index funds and ETFs. We’re not affiliated with any brokerage firm or insurance company, and we don’t do financial plans as a loss leader.
