- A financial advisor is often responsible for more than just executing trades in the market on behalf of their clients.
- Advisors use their knowledge and expertise to construct personalized financial plans that aim to achieve the financial goals of clients.
- These plans include not only investments but also savings, budget, insurance, and tax strategies.
- Advisors further check in with their clients on a regular basis to re-evaluate their current situation and future goals and plan accordingly.
The Many Roles of a Financial Advisor
A financial advisor is your financial planning partner. Let's say you want to retire in 20 years or send your child to a private university in 10 years. To accomplish your goals, you may need a skilled professional with the right licenses to help make these plans a reality; this is where a financial advisor comes in.
Together, you and your advisor will cover many topics, including the amount of money you should save, the types of accounts you need, the kinds of insurance you should have (including long-term care, term life, disability, etc.), and estate and tax planning.
The financial advisor is also an educator. Part of the advisor's task is to help you understand what is involved in meeting your future goals. The education process may include detailed help with financial topics. At the beginning of your relationship, those topics may include budgeting and saving. As you advance in your knowledge, the advisor will assist you in understanding complex investment, insurance, and tax matters.
Step one in the financial advisory process is understanding your financial health. You can’t properly plan for the future without knowing where you stand today. Typically, you will be asked to complete a detailed written questionnaire. Your answers help the advisor understand your situation and make certain you don't overlook any important information.
The Financial Health Questionnaire
A financial advisor will work with you to get a complete picture of your assets, liabilities, income, and expenses. On the questionnaire, you will also indicate future pensions and income sources, project retirement needs, and describe any long-term financial obligations. In short, you’ll list all current and expected investments, pensions, gifts, and sources of income.
The investing component of the questionnaire touches upon more subjective topics, such as your risk tolerance and risk capacity. Having an understanding of your risk assists the advisor when it’s time to determine your investment asset allocation. At this point, you'll also let the advisor know your investment preferences as well.
The initial assessment may also includes an examination of other financial management topics, such as insurance issues and your tax situation. The advisor needs to be aware of your current estate plan, as well as other professionals on your planning team, such as accountants and lawyers. Once you and the advisor understand your present financial position and future projections, you’re ready to work together on a plan to meet your life and financial goals.
Creating The Financial Plan
The financial advisor synthesizes all of this initial information into a comprehensive financial plan that will serve as a roadmap for your financial future. It begins with a summary of the key findings from your initial questionnaire and summarizes your current financial situation, including net worth, assets, liabilities, and liquid or working capital. The financial plan also recaps the goals you and the advisor discussed.
The analysis section of this lengthy document will provide more information about several topics, including your risk tolerance, estate-planning details, family situation, long-term care risk, and other pertinent present and future financial issues.
Based upon your expected net worth and future income at retirement, the plan will create simulations of potentially best- and worst-case retirement scenarios, including the scary possibility of outliving your money. In this case, steps can be taken to prevent that outcome. It will look at reasonable withdrawal rates in retirement from your portfolio assets. Additionally, if you are married or in a long-term partnership, the plan will consider survivorship issues and financial scenarios for the surviving partner.
After you review the plan with the advisor and adjust it as necessary, you’re ready for action.
Advisors Plan Action Steps
A financial advisor is not just someone who helps with investments. Their job is to help you with every aspect of your financial life. In fact, you could work with a financial advisor without having them manage your portfolio or recommend any investments at all.
For many people, however, investment advice is a major reason to work with a financial advisor. If you choose this route, here’s what to expect.
The advisor will set up an asset allocation that fits both your risk tolerance and risk capacity. The asset allocation is simply a rubric to determine what percentage of your total financial portfolio will be distributed across various asset classes. A more risk-averse individual will have a greater concentration of government bonds, certificates of deposit (CDs) and money market holdings, while an individual who is more comfortable with risk may decide to take on more stocks, corporate bonds, and perhaps even investment real estate. Your asset allocation will be adjusted for your age and for how long you have before retirement. Each financial advisory firm is required to make investments in accordance with the law and with its company investment policy when buying and selling financial assets.
Financial Advisors and Investments
It’s important for you, as the consumer, to understand what your planner recommends and why. You should not blindly follow an advisor’s recommendations; it’s your money, and you should understand how it’s being deployed. Keep a close eye on the fees you are paying—both to your advisor and for any funds bought for you.
Ask your advisor why they recommend specific investments and whether they are receiving a commission for selling you those investments. Be alert for possible conflicts of interest.
A commonality among firms is that financial products are selected to fit the client’s risk profile. Suppose, for example, a 50-year-old individual who’s already amassed enough net worth for retirement and is predominantly interested in capital preservation. They may have a very conservative asset allocation of 45% in stock assets (which may include individual stocks, mutual funds and/or exchange-traded funds (ETFs)) and 55% in fixed-income assets such as bonds. Alternatively, a 40-year-old individual with a smaller net worth and a willingness to take on more risk to build up their financial portfolio may opt for an asset allocation of 70% stock assets, 25% fixed-income assets, and 5% alternative investments.
While taking into account the firm’s investment philosophy, your personal portfolio will also fit your needs. It should be based on how soon you need the money, your investment horizon, and your present and future goals.
Regular Financial Monitoring
Once your investment plan is in place, you’ll receive regular statements from your advisor updating you on your portfolio. The advisor will also set up regular meetings to review your goals and progress, and to answer any additional questions you may have. Meeting remotely via phone or video chat can help make those contacts happen more often.
In addition to regular, ongoing meetings, it’s important to consult with your financial advisor when you anticipate a significant change in your life that might impact your financial picture, such as getting married or divorced, adding a child to your family, buying or selling a home, changing jobs, or getting a job promotion.
Signs You May Need an Advisor
Anyone can work with a financial advisor at any age and any stage of life. You don’t have to have a high net worth; you just have to find an advisor suited to your situation.
The decision to enlist professional help with your money is a highly personal one, but any time you’re feeling overwhelmed, confused, stressed out, or scared by your financial situation may be a good time to look for a financial advisor.
It’s also fine to approach a financial advisor when you’re feeling financially secure but you want someone to ensure that you’re on the right track. An advisor can suggest possible improvements to your plan that might help you achieve your goals more effectively.
Finally, if you don’t have the time or interest to manage your finances, that’s another good reason to hire a financial advisor.
Those are some general reasons you might need an advisor’s professional help. Here are some more specific ones.
None of Your Savings Is Invested or You Don’t Know How to Invest
Because we live in a world of inflation, any money you keep in cash or in a low-interest account declines in value each year. Investing is the only way to make your money grow, and unless you have an exceptionally high income, investing is the only way most people will ever have enough money to retire.
You Have Investments, but You’re Consistently Losing Money
Even the best investors lose money when the market is down or when they make a decision that doesn’t turn out as they’d hoped. But, overall, investing should increase your net worth considerably. If it’s not doing that, hiring a financial advisor can help you find out what you’re doing wrong and correct your course before it’s too late.
You Don’t Have a Current Estate Plan
A financial advisor can also help you put together an estate plan to make sure your assets are handled according to your wishes after you die. And if you aren’t properly insured (or aren’t sure what insurance you need), a financial advisor can help with that, too. Indeed, a fee-only financial advisor may be able to offer a less biased opinion than an insurance agent can.
Helping You Reach Your Goals
Financial advisors can assist you with investing and reaching your long-term goals in so many ways.
Financial advisors know more about investing and managing money than most people. They can guide you to better choices than you might make on your own.
Financial advisors help keep you on track by talking you out of making emotional decisions about your money. For example, buying a stock that’s been skyrocketing or selling all your stock funds when the market plummets.
It’s in the name: Financial advisors can make suggestions about the best strategies to implement to improve your finances. This can include everything from what investments to make to what insurance to buy.
As your life circumstances change, a financial advisor can help you adjust your financial plan so that it always fits your current situation.
Many people don’t take the steps they should manage their finances because they’re too busy or too uncertain about what to do. Working with a financial advisor means someone else can handle what you don’t have time for and make sure your money is being deployed in the best way.
The Costs of a Financial Advisor
A rule proposed by the Department of Labor (DOL) would have required all financial professionals who work with retirement plans or give retirement plan advice to provide advice that is in the client’s best interest (the fiduciary standard), as opposed to simply suitable for the client (the suitability standard). The rule was passed, its implementation was delayed and then a court killed it.
But in the roughly three-year interval between President Obama's proposal of the rule and its eventual death, the media shed more light than it had previously on the different ways financial advisors work, how they charge for their services and how the suitability standard might be less helpful to consumers than the fiduciary standard. Some financial advisors decided to voluntarily move to a fiduciary standard or more heavily promote that they already operated under that standard. Others, such as certified financial planners™(CFPs), already adhered to this standard. But even under the DOL rule, the fiduciary standard would not have applied to non-retirement advice – a standard that is bound to cause confusion.
Under the suitability standard, financial advisors typically work on commission for the products they sell to clients. This means the client may never receive a bill from the financial advisor. On the other hand, they could end up with financial products that charger higher fees than other similar products on the market. These same financial products may result in the advisor earning a high commission.
Under the fiduciary standard, advisors either charge clients by the hour or as a percentage of their assets under management (AUM). A typical percentage fee is 1%, while a typical hourly fee for financial advice ranges from $120 to $300. Fees vary by location and the advisor’s experience. Some advisors may offer lower rates to help clients who are just getting started with financial planning and can’t afford a high monthly rate. Typically, a financial advisor will offer a free, initial consultation. This consultation provides a chance for both the client and the advisor to see if they’re a good fit for each other.
Combination of Fees and Commissions
Financial advisors can also earn a combination of fees and commissions. A fee-based financial advisor is not the same as a fee-only financial advisor.
A fee-based advisor may earn a fee for developing a financial plan for you, while also earning a commission for selling you a certain insurance product or investment.
A fee-only financial advisor earns no commissions.
The Securities and Exchange Commission (SEC) proposed its own fiduciary rule called Regulation Best Interest in April 2018. In some ways, it was considered to be less strict than the DOL’s fiduciary rule, while also addressing some of the concerns of the critics of the DOL's fiduciary rule. At the same time, the SEC's rule was more all-encompassing because it would not be limited to retirement investments.1 2
Considering a Robo-Advisor
A digital financial advisor, also called a robo-advisor, is a tool that some companies provide for their customers. A robo-advisor uses computer algorithms to manage your money based on answers to questions about your goals and risk tolerance. Robo-advisors don’t require you to have much money to get started, and they cost less than human financial advisors. Examples include Betterment and Wealthfront. These services can save you time and potentially cost you less money.
However, a robo-advisor can’t speak with you about the best way to get out of debt or fund your child’s education. It also can’t talk you out of selling your investments out of fear or help you build and manage a portfolio of individual stocks. Robo-advisors typically invest clients’ money in a portfolio of exchange-traded funds (ETFs) and mutual funds that provide stock and bond exposure and track a market index. It's also important to keep in mind that if you have a complex estate or tax issue, you will likely require the highly personalized advice that only a human can offer.