Financial advisors can spice up your financial life or they can be a waste of money. Just like lingerie. Similarly, whether to use an advisor is a personal decision and influenced by your confidence, experience, desire, and preferences. The biggest benefit of a financial advisor is in the advice and planning that they give more so than the sexier investment management aspects. However, just like slinky outfits, there can be a large variation in the material substance and its pricetag – they are often not strongly correlated.
We need to be educated consumers when we shop. Hopefully, you already have some experience in shopping for underwear since it is a necessity for high income professionals and other small business owners – just like choosing an accountant. Let’s apply the same rigor and enthusiasm to selecting a financial advisor.
It comes down to getting valuable advice at a value price.
Features of an advisor more likely to give you good advice:
1) Financial Advisor qualifications & designations
Many “financial advisors” are simply mutual fund salespeople which does not require extensive training and certification. For a financial advisor, you should look for someone who is a Certified Financial Planner (CFP). That means they have at least three years experience, have taken training approved by the Financial Planning Standards Council and passed an associated exam.
If they are going to handle my investments, I would also want them to have a Chartered Financial Analyst (CFA) designation which means that they have at least four years of related investment experience and have passed as series of three exams.
2) Up-to-date Training & Continued Professional Development
Ask them what their most recent training or course was about, and how they keep up on recent tax or regulation changes.
Whatever their designation and training, it also pays for you to know some of the basics about financial planning and investing. Despite the improvements in the industry, there are still many advisors who are misguided, as recently described by Robb Engen.
3) Fiduciary duty to advise putting your best interests first
While we would all hope that financial advisors would have a fiduciary duty to put their clients first. This is not tightly regulated.
Most advisors are classified by the Canadian Securities Administration search engine as Dealing Representatives which means they are required to recommend products that are “suitable” to their clients. Suitable does not necessarily mean best – just because something fits, does not mean the you should wear it.
There are very few people registered as an Advising Representative. An Advising Representative has a fiduciary duty to put their clients first, but are also going be costly – they are mostly found in Toronto based firms dealing with high and ultra-high net worth clients.
A CFP, while not registered as a fiduciary, has a code of ethics that they are to follow. This includes providing objective advice that puts clients first, and a complaint can be filed against them if they do not.
While I think most people want to be good and want to be helpful, they are also human. So, it is also important to ensure that the environment they work in re-enforces good behaviour and doesn’t provide temptation or pressure to be naughty.
4) Their incentives are aligned with giving you the best advice.
This is a big one. Be careful to find out and consider how your advisor is paid.
Avoid “advisors” with commissions for products that they sell
These advisors are often more like salespeople than advisors and focus on the mutual funds or insurance that they sell. Others may not receive direct commissions, but they get performance bonuses from their employer that sells the products and the commission cost is buried in the MER of the product. You are more likely to get unbiased advice from someone who is not paid this way. This is why I don’t buy lingerie at the bank.
Some investment advisors are paid for the brokerage of stock transactions
The cost of buying or selling stocks or ETFs this way can be in the hundreds of dollars per trade rather than <$10 with a discount brokerage. The bias of an advisor using this pay model is to have you buy and sell more frequently rather than buy and hold. Churning a portfolio usually only makes the advisor/brokerage rich while eating into your returns with fees, taxes, and possibly poorly timed trades.
Fee-based financial planners have better alignment of their incentives with growing your wealth.
A fee-based advisor gets paid by an annual or monthly fee that is based on a percentage of your portfolio. The larger your assets under management (AUM) grows, the more money they make – aligning their incentive with your goal!
Be careful that it is not a linear relationship – your fee should not double as your portfolio doubles unless the work to manage it has also doubled. With smaller accounts, this may be true. As you get up over $100K, while the cost still rises, the costs as a percentage of AUM should shrink.
It may also be more difficult to find an advisor using this payment model when you have a small portfolio. However, as a physicians, dentist, or other high income professional where there is very high income earning potential, many fee-based advisors will be eager to take you on as client. They know that establishing the relationship now, will pay off later when your portfolio does bloat.
The fee-based advisor model still introduces some potential for bias.
Advisors who are paid via %AUM could be biased to steer you away from assets that wouldn’t be under their management (and fee generation). Real estate and other alternative investments would be good examples – they may prefer that you to put that money to work under their watchful eye.
That said, active real estate investment requires skill and can have a high potential to be a pain in the butt – think landlord with deadbeat tenants or toilette explosions. Passive real estate investing would be an option that avoids the dirty part, but still requires skill and risk taking. Alternative investments can also be complex, situation specific, and risky – there may be some wisdom in its own right to steer away from them.
Fee-only advisors provide a la carte financial advice
This can be a flat hourly rate or a set fee for a specific task. This is likely to yield you the most unbiased advice if you are using an advisor for general financial planning advice on its own. It may be a good option for those who want to manage their own portfolios as DIY investors. Even experienced investors or personal finance geeks like myself can benefit from a second opinion. Sometimes your outfit looked great in the mirror or dim lighting, but in the daylight – not so much.
There are also some more complex financial planning maneuvers that a professional opinion would be helpful for and some financial products (like insurance) do require you to interact with a licensed agent in the area.
5) They take the time and effort to understand your situation and goals, so that they can give advice tailored to you.
If you are going to buy lingerie, you want to make sure that it fits you for your goals. Some like it snug and curve hugging and others benefit more from illusion and imagination. One size does not fit all. It is helpful if your advisor specializes in or has a large clientele of people with a similar professional or financial situation to you. That helps give some broad stroke perspective and experience in optimizing your financial plan.
Even if they have hundreds of similar clients, your individual situation and preferences will be unique. Just like a proper treatment discussion for a patient, financial informed consent needs to identify and account for those.. You should expect that they will spend at least an hour or two getting to know these nuances before coming up with a plan for you. They also need to take in what you have discussed and tailor a personalized plan. That should also take more than a few seconds, if they aren’t simply listening for show, and then giving you their cookie cutter plan.
Your life and financial situation is not static and your advisor should also be reaching out to meet and revisit your plan with you annually. You should also contact them to revisit your plan if your situation changes radically.
6) They are part of a co-ordinated ensemble
A good financial plan includes not only personal finance or investment planning, but also tax planning, insurance, and estate planning. Like a sexy outfit, you want to make sure that all of the parts and accessories compliment each other. You do not want your earrings to clash with your dress – and of course you need the right shoes.
You want a team of experts in financial planning (a CFP), investing (a CFA), tax planning (a CPA), and the proper legal structures used for your planning (lawyers). They need to work closely together to make sure each aspect of your plan is compatible and complimentary to the others. You also want to make sure that these experts are also experienced with your specific situation whether that is an incorporated professional, business owner, or an employee.
7) You want value-priced valuable advice
You probably don’t want to get the cheapest advice that you can find. There may be some lingerie at the thrift store (I can confirm that there is – I have seen it!). However, you don’t want to get any bonus arthropod “guests”.
What you do want is the best value. On one side of the value equation is getting the best advice, but on the other side is not paying more than the advice is worth to you. The White Coat Investor refers to this balance as the “Good advice for the right price” and has a great article about financial advisers in the American context.
We discussed what to look for to get valuable advice above, but let’s also comparison shop based on price.
As mentioned in item #4 of getting good advice, you need to consider how your advisor is paid and specifically how much it will cost you. Below is a table comparing the general approaches and their cost. Yes, there can be more variations in advisor fees depending on what you negotiate, but these are typical.
|Approach||Advisor Fees*||Investment Fees||Total MER||Annual Cost on…|
|Fee-based Advisor and ETFs||0.5-2%||0.05-0.5%||1.1-2.5%||$1500 to $2500||$10000 to $15000|
|Fee-based Advisor and Mutual Funds||0.5-2%||1.0-2.0%||1.5-4%||$2500 to $3500||$25000 to $40000|
|“Free Advisor” and Mutual Funds||0%||1.5-2.5%||1.5-2.5%||$1500 to $2500||$15000 to $25000|
|“Free Advisor” and ETFs||0%||0.05-0.5%||0.05-0.5%||$50 to $500||$500 to $5000|
|Flat-fee Advisor and DIY ETF Investing||Expect $100-$400/h||0.05-0.5%||0.5-0.5% plus advice cost||$1500 to $5000||$5000 to $15000|
|DIY Advice and ETF Investing||0%||0.05-0.5%||0.05%-0.5%||$50 to $500||$500 to $5000|
|*Advisor fees drop with increasing portfolio value. Average fee is 1.5-2% for 1st 100K and 1.0% for a million, and 0.5-1% for multiple millions. It is also worth noting that advisor fees for taxable accounts are deductible against your income. If you are in a high marginal tax bracket, then that can lower the effective cost when you account for tax saving by about 50%.|
The above table is largely based on simple math, but it is useful to illustrate a few points:
- Mutual funds are the most expensive route regardless of the quality and cost of personalized advice you receive because of the fees baked into the funds.
- A fee-based advisor with ETFs provides a good balance of advice and cost. The larger your portfolio (and the higher your marginal tax rate if a taxable account) the better the deal gets.
- There is a broad range of cost for the same type of strategy. There is generally a relationship between cost and service, but make sure the level of service justifies the cost. High range costs better have amazing service to be worth it.
- A high quality “free advisor” with ETFs is the cheapest way to get advice. It is also hard to access for many. Most “free advisors” are generally sales personnel. It also would probably be considered a bit crass to go into a store to monopolize the sales personnel and “take the lingerie for a spin” with no intention of buying.
A good option for many be to separate the “Financial Advisor” role and the “Portfolio Manager” role.
This option gives you the benefit of professional planning advice as needed using a Fee Only Advisor and saves on portfolio management costs if you decide that DIY portfolio management is worth your time.
You could use a flat-fee or fee based advisor where their expertise is most valuable – to help give you a comprehensive plan and get you started. Remember that advisor fees on taxable accounts are deductible against your income. Mutual fund commissions and MERs are not. You also cannot deduct advisor fees that are purely for non-portfolio related advice. If I were getting advice, I would have them glance at my portfolio also.
As you gain experience, you can at some point decide to take over and maintain your plan on your own. On the other hand, as your portfolio gets larger, your relative fees for managing it may also shrink (even though the absolute cost still rises).
You could also learn about personal finance and set up a plan for yourself de novo – there are lots of resources out there. Dr. Networth gave a good round-up of the basics of passive index investing recently on his site. Financially Free MD also has several good articles about the basics of incorporation for Canadian physicians. The Loonie Doctor website also covers many of these topics, from the basics to really detailed analysis in the Canadian physician and high income professional context. The Physician Financial Independence Canada Facebook group is also a great source for live interaction around financial questions with other physicians. Whatever path you take for your financial advice and planning – physicians learning about finance from other physicians is vital.