If you are looking to work with a financial advisor, a good first question to ask is:
What type of advisor is best for me given my unique financial circumstances and goals?
With a variety of professional designations and advisor classifications to choose from, understanding the difference between advisor types is an important first step in identifying an advisor who is well suited to help you optimize your planning and achieve your financial objectives.
Financial advisors can be categorized in a variety of ways depending on the designations and certifications they have and the services they offer (financial planning, investment advice, investment management, estate planning, retirement planning, etc.). However, two of the most important methods of classifying advisors involve taking into consideration how they are compensated and whether they work as a fiduciary.
These different classification types are explained below:
- Non-fiduciary advisors: Often non-fiduciary advisors are stockbrokers or registered reps who focus their efforts more on transactional business than on long-term financial planning. They are typically required to consider if an investment is suitable (the “suitability” standard) before recommending it to a client.
- Fiduciary advisors: Advisors who work as fiduciaries (“fiduciary” standard) are held to a high ethical standard: they must put the best interest of their clients first at all times when offering financial advice. This is considered to be a more stringent standard than simply considering whether an investment is suitable for a client.
- Commission-based advisors: Advisors who are compensated via commissions on a per-trade basis, often stockbrokers and registered representatives, must be careful to avoid engaging in “churning.” Churning is defined as trading in client accounts primarily to earn compensation rather than for the benefit of the client.
- Fee-only advisors: Fee-only advisors are generally more focused on helping clients make long-term financial planning decisions, rather than offering short-term trading advice. They may earn fees for their advice on an hourly basis, or as a percentage of assets under management (AUM).
When looking to select the financial advisor who is right for you, two key questions to ask concern the compensation method used by the advisor and their fiduciary status. While transaction-based, commission collecting financial advisors may be helpful if you simply want to make a few trades, if you are looking for a long-term financial planning relationship, a fee-only fiduciary advisor is generally a better fit.
The following are benefits of fee-only fiduciary advisors:
- No incentive to churn: Because they are compensated by fees based on hourly compensation or as a percentage of AUM, there is no incentive for a fee-only fiduciary to “churn” your account. This type of conflict of interest can occur with advisors who are compensated via commissions, due to their ability to increase their income by making trades in your account even if doing so is not in your best interest.
- Client-aligned advisor compensation: Fee-only advisors, whether paid by the hour or as a percentage of AUM, are compensated in a way that incentivizes them to help you grow your assets over the long run. Advisors paid by the hour are motivated to provide the best possible advice to ensure their continued employment, while advisors whose compensation is based on AUM are motivated to grow client asset value as doing so increases their income.
- The fiduciary standard: Fiduciary advisors are required to provide financial advice that is in the best interest of their clients. This ensures that your advisor is focused on helping you achieve your financial objectives and not on making trades to pad their income. The fiduciary standard is considered to be more stringent than the suitability standard that non-fiduciary advisors are subject to, which only requires that the advice they provide be suitable for their clients. The suitability standard is more ambiguous, which opens the door to actions that are not in a client’s best interest such as churning. Working with a fiduciary advisor gives you the peace of mind of knowing that your advisor is acting in your best interest at all times.
Finding an advisor who fits your financial needs is not just a matter of looking at an advisor’s experience and certifications. It also depends on the advisor’s focus, support team, and approach to planning and investing. For instance, some advisors specialize in tactical trading, while others focus on specific segments of financial planning: estate planning, insurance planning, etc.
If you are looking for an advisor who can help you draw up a financial plan, implement it and monitor your progress toward your goals over time, it is important to ask if the advisor takes a comprehensive approach to financial planning. The reason for this is that failing to take a holistic view of the planning process and instead analyzing different aspects of your finances in isolation can lead to trouble down the road if unexpected events occur.
Finding an advisor or advisory group comfortable with providing ongoing consultation and monitoring of your progress towards achieving the goals set out in your financial plan is vital to boosting your chances of reaching those goals. Given the volatility of today’s markets, “set it and forget it” is unlikely to be an optimal strategy for achieving your financial objectives over the long run. Adjustments to your financial plan and investment approach/allocation may be called for from time to time, making it essential to look for an advisor who will stay on top of things for you and take action as needed to help keep you on the road to meeting your goals.
At Clariti, an important goal shared by many of our clients is for their investments to generate a sustainable cash-flow stream in retirement. This requires a balanced approach that considers both return, risk, and cash flow needs. A portfolio withdrawal rate (cash needed / investment balance) that is too high can short-circuit any investment plan. We measure cash needs before designing portfolios. Although this sounds like an obvious step, it is not done by the vast majority of investment advisors. We use a 6-step process for this purpose:
- Establishing and defining the relationship between you and us
- Gathering your personal information and understanding your goals and objectives
- Analyzing and evaluating your current financial status in the areas noted above
- Developing and presenting recommendations and/or alternatives
- Implementing the agreed-upon recommendations
- Monitoring the recommendations and making changes as needed
At Clariti we pride ourselves on providing financial-planning-driven wealth management. Many other firms provide investment management only or offer only ancillary financial advice. Others pitch products, not solutions. As noted above, we follow a six-step process that includes collecting and analyzing all of your financial documents at the onset of the relationship. We then proceed to review every area that impacts your personal finance, such as income and estate tax planning, cash flow/debt management, insurance, retirement planning, or employee benefits. Our goal is to leave no stone unturned.
Once we go through our extensive planning checklist and provide a comprehensive list of recommendations and design a diversified investment plan and document guidelines in an Investment Policy Statement (IPS). The benefit of an IPS is to have a written understanding of investment guidelines, created in a rational setting, which will enhance consistent, disciplined, and prudent investment management.
Having clearly established guidelines should reduce the probability of initiating impromptu portfolio changes that could hinder the achievement of established objectives. Recommended investments are assigned to taxable, tax-deferred, or tax-free accounts with the goal of maximizing tax savings. After the portfolio is implemented, we monitor, rebalance and reallocate the portfolio based on changes to the economic environment and adherence to the agreed-upon IPS. Finally, we periodically review planning sections to uncover new planning recommendations as your financial circumstances change.
While some advisors focus strictly or mainly on the investment portion of wealth management, our belief is that to optimize your chances of success, wealth management should be driven by financial planning.
When planning for retirement it can be counterproductive to take a “siloed” approach such as focusing strictly on how much you need to set aside to reach your retirement number without taking into account other aspects of your financial plan. While it’s true that taking a siloed approach could end up working out okay if nothing unexpected happens between the time you draw up your retirement plan and the time you retire, often this is not the case.
For example, you might find that a child’s college education costs more than expected, reducing the amount you can save for retirement below the amount you need to build your desired retirement nest egg. This is just one scenario, of course, there could be any number of other challenges that cause you to deviate from your expected retirement savings plan; you might decide to buy a house that requires a down payment that is larger than you expected, or an accident or medical emergency could reduce your earnings power for a time.
These unexpected events are likely to be less damaging to your retirement planning if you create a comprehensive financial plan that takes into account your complete financial situation, rather than looking at your retirement planning in a vacuum.
This type of planning would consider the scenarios described above and incorporate methods of dealing with them. Rather than just focusing on how much you need to save to fund your desired retirement lifestyle, a comprehensive approach would call for setting aside funds for other goals as well so that you don’t get blindsided by unexpected expenses down the road.
This could take the form of saving for college using a specific account such as a 529 Plan or building a general emergency cash reserve that could be used for a variety of purposes. Another such step might be to purchase disability insurance as protection against loss of income due to an injury.
Taking a comprehensive approach to financial planning involves preparing for both positive and negative scenarios. This means looking at a range of performance results when planning your investment strategy for a goal like retirement rather than strictly using past investment performance averages. While an average can be useful in giving you an idea of the most likely results based on past performance, it does not provide an accurate picture of a worst-case result.
If you plan for retirement without taking into account what would happen if market performance is worse than expected, you might find yourself having to adjust your retirement lifestyle expectations or even delay retirement if your investment returns significantly undershoot the average.
To make the most of your resources, it is important to analyze current and projected financial conditions from all angles to design a saving and investment strategy that enables you to reach your goals in a variety of market environments. Whether your main focus is saving for retirement or some other objective or generating income in retirement, considering all relevant factors is crucial to put yourself in the best position possible to achieve your financial goals.
For instance, if your advisor presents you with potential worst-case investment scenarios you can use this information to inform your retirement savings plans. If feasible, you might decide to increase your retirement savings to boost your chances of being able to fund your desired lifestyle in retirement, even if the market does not perform as well as expected during the savings period.
In addition to examining multiple investment scenarios to help improve your ability to make realistic plans to achieve your financial goals, helping protect you and your family from the financial impact of uncertainty can also involve protecting your assets, income, and health through insurance.
Health, life, and disability insurance all can provide significant financial protection in case of accidents or other unexpected events. Your financial advisor or advisory group should have the expertise to help you evaluate different insurance packages to see which provides the best protection for the price.
Clariti offers comprehensive financial planning services. We are Wilmington, Delaware fee-only fiduciary planners and we help our clients build, implement and monitor their financial plans, offering them advice tailored to their individual financial situation, including their risk tolerance, time horizon, and investment objectives. We continuously monitor your progress toward your financial goals, with an eye to making adjustments if necessary when the investment climate or your personal circumstances change.
Contact us today for a free, no-obligation consultation to determine if our comprehensive, client-centric approach to financial planning is the right fit for you.