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With new digital tools popping up left and right, there have never been so many options when it comes to choosing who (or what) to help manage your money. But with regulations constantly in flux, the landscape has never been more confusing — or potentially dangerous — for investors.
Just recently, Charles Schwab released a new digital financial planning tool, free to its clients, that the company says can generate a retirement plan after just a 15-minute survey. Sounds good, right?
Maybe — but a lot of thought should go into which type of financial advisor makes sense for you. Experts say you really have to do your homework before trusting someone (or some robot) with your entire life’s savings.
“The regulators have failed investors,” says Barbara Roper, director of investor protection for the Consumer Federation of America. That places the burden on the investors to protect themselves, she adds.
The many types of financial advisors
The term “financial advisor” covers way more job descriptions than you might be aware of. These advisors can range from financial coaches (who may start with basics, like enhancing financial literacy) all the way to wealth advisors (who work with the really, really wealthy).
One of the most common types of advisors are investment advisors, whose clients pay them for investment advice, often a fee of around 1% of assets under management. These advisors can advise on specific securities or market trends but can also help clients make a holistic financial plan. They are registered with the Securities and Exchange Commission (SEC).
For those looking for more transactional help, there are stockbrokers, who buy and sell securities like stocks and bonds on behalf of their clients. The types of securities they can work with depends on their level of training. They’re usually associated with a brokerage firm and can make trades for both retail investors (everyday investors like you and me) as well as institutional investors. They are overseen by a regulatory organization called FINRA.
One credential to look for when searching for an advisor is the certified financial planner, or CFP, designation. These planners have rigorous certification requirements, including coursework through the CFP Board Registered Program (which takes 12 to 18 months on average), a 6-hour long exam and 6,000 hours of professional experience or 4,000 hours of apprenticeship. CFPs often work with specific types of clients, like small businesses. They also have to adhere to a code of ethics to put their clients’ interests first.
Finally: robo-advisors. You’ve likely heard about these in these in recent years as people turn from traditional human advisors to these digital management services, which generally come at a much lower cost. Many robos also have a hybrid model, which provides some contact with a person in addition to the robo offerings.
The complicated regulations
It would seem that the job of a financial advisor would entail putting their clients’ best interests first — but that’s not always the case. Only some financial advisors must adhere to the fiduciary standard, meaning they must put their clients’ best interest ahead of their own, even if that means recommending strategies that could reduce their compensation. Registered investment advisors have this obligation, while critics say that brokers do not, despite a recent regulation that was intended to strengthen their standards. This comes as a surprise to a lot of people: a 2019 survey from the digital wealth manager Personal Capital found that 48% of Americans mistakenly believe that all financial advisors must meet this standard.
Consumer protection advocates have long been pushing for a more strict and clear fiduciary standard across the industry. But they’ve been disappointed with many of the moves made to further the protection of individual investors. Just this year, for example, the SEC implemented the new Regulation Best Interest (Reg BI). It’s supposed to hold brokers to a higher standard. Instead of having to put their clients’ interests first, brokers had only to recommend products that were suitable for the client.
The problem with the new regulation? The SEC didn’t clearly define “best interest,” says James Watkins, an attorney and managing member of InvestSense, a consultant that helps pension plans and others meet their fiduciary duty to act in their clients’ best interest. So it doesn’t protect investors to the extent that a true fiduciary rule would. The SEC said it will be defined on a case-by-case basis, but “this lack of of a clearly defined ‘best interest’ standard only serves to create unnecessary uncertainty and unnecessary risk exposure for both advisors and investors,” Watkins says.
It’s also important to keep in mind that brokers may have a different pay structure than advisors. They may make money by selling you products that are okay for you (and will offer them a bigger commission) but are not necessarily the best for you.
If it’s not clear, don’t be shy about asking prospective advisors how they’re compensated. Watkins also recommends asking if an advisor is “open architecture” or “closed architecture.” The former means that the advisor can sell anything to you, while the latter means the advisor is limited in what they can sell (because they are receiving some sort of compensation from whomever is marketing the investment, like a mutual fund manager). So it’s best to find someone who is “open architecture.” And seek out advisory firms that are fee-only, paid exclusively by the client, so you know third-party incentives aren’t involved at all.
The best way to protect yourself is to choose a financial advisor who voluntarily minimizes the conflicts of interest in their business model and voluntarily adheres to a fiduciary standard higher than the one the SEC enforces, Roper says.
One way to do this is through the CEFEX certification, which audits and certifies firms and advisors and certifies them as meeting a true fiduciary standard.
The importance of a background check
People will travel to farther gas stations or appliance stores to find the cheapest gas, dishwashers or dryers. They’ll spend hours at the dealerships before buying a car. But they won’t always go that extra mile to find the right financial advisor, says Alan Rosca, a securities attorney.
“We should spend the same amount of time before we give somebody our hard-earned money,” he adds.
Rosca recommends looking up a broker on FINRA’s BrokerCheck,
where you can do some digging into someone’s experience and see if prospective advisors have faced any disciplinary actions. You can also use the SEC’s Investment Adviser Public Disclosure website to confirm that a Registered Investment Advisor has the certifications they say they do.
Since there are various ways an advisor makes money — like commission for selling products, annual percentage of an investors’ assets or an hourly fee — you shouldn’t be afraid to ask for the details.
“Different payment structures might create different incentives,” Rosca says. “Like if somebody is paid only to sell investments, it means if he doesn’t sell you anything, he doesn’t make any money.”
So, what’s up with these robo-advisors?
Rosca likes digital platforms because they democratize investing, and giving more options to investors never hurts (as long, of course, as you do your research).
But not everyone is a fan of robo-advisors.
One of the biggest drawbacks is that to have good risk management, someone needs to check in on the account regularly and determine whether or not changes need to be made — that might not happen with a robo-advisor, Watkins says.
“They’re going to try to get the most clients while maximizing profitability. The concern is whether clients might receive ‘cookie-cutter’ portfolios, giving them all basically the same thing,” he adds. “But what might be right for you isn’t right for me.”
If you’re going to go with a robo-advisor, a hybrid option might be best. Then you can have the ease and low cost of a robo-advisor, but know you can chat through risk management with a human. Schwab Intelligent Portfolios Premium and Vanguard Personal Advisor Services are two examples of hybrids.
Most robo-advisors are registered with the SEC — but again, this doesn’t necessarily mean there is enough protection for investors, so do your own due diligence.