After managing my own money for years, I know the most important thing I could ask a financial advisor
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- Financial advisors can be paid through several methods, including client fees and commissions or referral fees from mutual funds and service providers.
- A fee-only financial advisor eliminates conflicts of interest, such as an incentive to put your funds in a higher-cost fund for a kickback from the fund manager.
- If you hire a financial advisor of any kind, you should ask about how they get paid and if they are a fiduciary, which means they have to put your interests first.
- If you're looking for a financial advisor, SmartAsset's free tool can help find you a licensed professional near you »
Most people can easily handle their own finances these days.Between books, online resources, and low-cost robo-advising tools, you can put a basic financial plan together without an MBA. But if you have a complex situation or simply prefer the help of an expert, a professional financial planner can be a good investment.
If you do decide to work with a money professional, you have a lot of options. That's why it's important to do a bit of your own due diligence. If you don't, you could find yourself losing out on tens or hundreds of thousands of dollars due to fees alone.
This is just part of why I would only ever hire a fee-only financial advisor if I wanted help with my money.
Why a fee-only financial planner makes sense
Financial planning can be a complicated business. Just like you, people working in the field need to make money somehow. However, unlike most professions, financial advisors have a unique position of managing other people's money.
Historically, financial advisors get paid via one of two popular methods. First, they may charge a percent of your assets under management. If an advisor charges 2% per year and you have $100,000 with the advisor, they will charge $2,000 per year. But if you have $200,000, while they will do pretty much the exact same thing, they will charge you double: $4,000 per year.
Clearly, this incentivizes advisors to work with wealthier clients. It also gives them the incentive to help your money grow, but they will earn more by bringing on a new client than helping existing ones succeed, in most cases. Just like working with a real estate agent to sell your home, there are some win-win motivations, but there can also be some selfish motivations to just get the sale.The second major type of financial planning fees is called "fee-only." This means the planner gets paid a flat, predictable fee for the service you provide. They don't have any personal stake in whether your portfolio goes up or down. Instead, you get an allotment of their time and expertise for a monthly charge.
Fee-only means they don't make money through some sometimes controversial methods. You'll usually pay monthly, quarterly, hourly, or a project-based flat-fee that you both agree on. That's the most equitable way to work with a financial advisor or planner.
Financial planning commissions are a serious conflict
Some financial advisors get paid commissions by investment companies and insurance companies for funneling your money into their products. While this can lead to a good product for you in some cases, the conflict of interest is clear.
For example, let's say your advisor explains that $5,000 of your portfolio should go into a domestic bond fund. There are many good reasons for this and you agree. But which bond fund should they choose? You both agree that an intermediate-term bond fund makes the most sense for you. But even then, there are many mutual funds and ETFs to pick from.
At my brokerage, there are nearly 3,000 mutual funds not including ETFs. They range in fees from a 5.55% expense ratio at the highest to 0.02% at the lowest. With a commission-based planner, they may have an incentive to put your money in a fund that charges a higher fee because they get a commission even though a better performing or comparable fund that charges a lower fee is available.
I personally believe this should be illegal, but in today's system, it is not only allowed but very common. The only way you know how your advisor gets paid is to ask. This is why it's a good idea to interview multiple financial planners and ask a range of questions. It can save you big when it comes to fees and getting in the right fund.
Never hire a financial professional who is not a fiduciaryIn the most egregious examples, a planner could put your money into a fund that charges more and performs worse. In fact, according to just about every analysis of funds that exist, the best overall performance comes from index funds with low fees. Actively managed funds underperform, and the math of what you lose from high fees is astounding.
In addition to picking a fee-only planner, you should make sure to hire a planner who is a fiduciary. This means they always have to put your financial interest first, even with it costs them. While removing commissions from the equation helps, hiring a fiduciary locks in an agreement that your needs come first.
A quality financial planner can do wonders for your finances in some situations. If you decide to hire one, make sure you understand what they charge, how they get paid, and who they are looking out for first. As long as you find a true win-win with an advisor you can trust, you can get down to business putting your money to work for you. After all, that's what hiring a financial planner is all about.
Need help with your money? SmartAsset's free tool can help you find a licensed financial advisor near you »
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