In more than a decade of working with federal employees, I am still surprised by the number of people who have never worked with a financial advisor. Why is that?
One of the biggest drawbacks I have heard is apprehension of what the advisor is going to sell you. There is a way to take the product sale out of the equation.
This is a somewhat lengthy read but may be very useful if you have ever thought about hiring an advisor.
What product will you be sold?
We have all been there and had the experience – this “really nice guy” was recommended to you, or even did a presentation for your agency or union and offered to do a “free benefits analysis” for you.
The end result of the “free analysis” – buy this awesome product that will make your life so much better!
This situation can be very frustrating for someone that is not well versed in finance and financial products, so how should you go about seeking advice?
A starting place for finding a financial advisor
All “financial advisors” (I use quotes because that is a very loose term for some in the profession) fall into one of three categories.
- Insurance agent – If an insurance agent is holding himself out as a financial advisor, he should not be. The only way they can be paid is by a commission after a product sale.
- Fee-based advisor – These advisors are typically securities licensed and insurance licensed. Some may have their Investment Advisor Representative license as well (the license required to give investment advice). They are governed by a suitability standard at times and other times by the fiduciary standard.
- Fee-only advisor – This type of advisor is required to act as a fiduciary at all times. The only way he is paid is from the client. He can give advice on products but does not accept commissions.
One important thing to note about the above: just because someone tells you they are an expert on federal benefits does not mean you should trust the advice they give you.
The Insurance Agent
If we look at the insurance agent, his advice is going to come down to what product is the best fit for you. That product is likely to be life insurance or an annuity. In either case, the agent will get paid a commission. At that point you are left wondering who stands to gain more from this product sale – you or the salesman.
Neither product is necessarily bad, but a square peg won’t fit in a round hole either. For example, life insurance is crucial to protect your dependents, but it’s not necessary for everyone.
When it comes to insurance coverage, most people want the best and most efficient insurance for their situation. There is an obvious conflict of interest in talking to an insurance salesman to buy insurance, because the more money you pay the more he gets paid.
Insurance agents adhere to the suitability standard, not the fiduciary standard. I’m certain that some agents do a really good job and think they are doing the best thing for their clients, however, it’s really easy to be swayed by a 100% commission!
Many insurance agents push annuities. Equity index annuities (EIAs) are very conservative and not very liquid. Guess what else is very conservative but much more liquid than EIAs? Your G fund. This is a topic for another day, but long story short, I think it is a terrible idea to take money from your TSP to invest in an EIA. I’ll cover why in a future piece.
Fee-Based Advisors
A fee-based advisor can receive commissions for selling products as well as fees for giving advice.
A large percentage of advisors fall under the fee-based category. This generally means that they can be paid a fee for giving advice, but they also may do business in a way that allows them to earn a commission.
A fee-based advisor has the option to put your interests above his or her own, but is under no obligation to do so as long as the product they are recommending is suitable. Working with a fee-based advisor does not guarantee that they’ll always work in your best interest.
Some careful diligence is needed when searching for a fee-based advisor. There are fee-based advisors that do a really good job, but there are also ones that focus on selling products. They are not required to act as a fiduciary at all times.
Fee-Only Advisors
Only a small (but growing) percentage of financial advisors use the description fee-only. A fee-only advisor is one that can’t receive commissions of any kind. The only person that pays the advisor is the client, no insurance companies and no investment companies.
A fee-only advisor can be paid a few ways:
- A fee for giving advice or doing a plan
- A fee of assets under management (AUM)
- A flat fee for assets under advisement and financial planning
The bottom line is a that a fee-only planner is paid a fee for giving advice. The reason for choosing a fee-only advisor is very simple: most conflicts of interest are removed from the advisor client relationship.
Here is a link to an article that discusses more details about fee-only advisors as well as places to find them. Most organizations for fee-only planners require a designation such as CERTIFIED FINANCIAL PLANNER™ professional or Certified Financial Analyst.
Using a fee-only advisor does not guarantee that you will receive good advice, but it greatly reduces conflicts of interest.
A great question to ask a prospective financial advisor is this: “How are you paid? What do you make on products that you recommend?” If the answer is anything other than a fee from my clients, then you are not dealing with a fee-only advisor.
Do you even need a financial advisor in the first place?
You may not need an ongoing advisor, especially in the accumulation stage of life. For example, if you are in your thirties and focusing on paying down debt, saving, and you have a good understanding of finances and investing, maybe you don’t need help. Someone in the same scenario that is a delegator could benefit from the services of an advisor.
The distribution stage of life can be more complicated and is an area in which many people could use ongoing advice. Things such as tax efficiency and drawdown strategies can become very complicated.
One way that I believe almost everyone could use help is by doing a financial plan periodically. This would involve paying a fee to receive advice and at the very least confirm that you are doing everything right.
Examples
Let’s look at a couple examples of how this could work.
The Middle-Aged Couple
A couple in their 50s decides they could use some help with their financial planning and decide to work with a fee-only advisor. Among their questions are whether they should keep their life insurance and get long term care insurance.
Solution from fee-only advisor
The advisor is paid a fee to give advice on whether insurance is needed in this situation. The advisor then directs them to an appropriate source to get coverage yet receives no commission or kickback for doing so. The advisor recommends they get the best, and most cost-efficient insurance available.
The Federal Employee
An even more interesting scenario to look at is the 60-year-old federal employee who has many questions including how to invest in the TSP. A “fee-based” advisor, or a product salesman, may see this as an opportunity to sell an Equity Index Annuity that pays him a 5-8% commission.
- An advisor that is paid to do a plan can give advice in the client’s best interest.
- An advisor that is paid a flat fee for ongoing planning or even a fee of assets under advisement has no incentive at all to move money out of TSP.
- If an advisor is paid a fee for assets under management (AUM), then he does have an incentive to move money out of TSP, but said fee would likely be around 1% of AUM versus a 5% (or higher) commission. If an annuity is the appropriate solution then he can recommend an annuity as well, he just doesn’t receive a commission.
The Do-It-Yourselfer
One more example is the do-it-yourselfer that could have benefited from a one-time financial plan.
I met with a federal couple last year that has always done their own retirement planning and had close to two million dollars in assets. After doing some analysis of their current strategies, it was easy to see how they could have benefited greatly if they would have pursued some planning advice 10-20 years ago. Their assets today could have been significantly higher by implementing some tax planning strategies.
By most measures, this couple was very successful and had done a good job of saving, but by implementing some tax planning strategies they would be much better off today.
Regardless of the cost they would have paid for a plan, it would have been a fraction of the benefit they would have received.
Getting to Know Your Advisor
There is one other benefit that comes from doing a financial plan: getting to know the advisor and how he operates.
Most plans will take 3-8 weeks from start to finish. That will give you some time to get to know the advisor and see if you like each other (yes, you should like your advisor). “Trying it on for size” can help you decide if you would like to work with the advisor on an ongoing basis before turning your life savings over to someone to manage.
Here are some common characteristics of people that can benefit from retaining an advisor on an ongoing basis.
- Delegators that value quality advice
- Get anxiety when making big financial decisions
- Unsure of the effect taxes have on investments
- Let emotion play a part in investment decisions (like 2008)
- Want advice from a professional for all of life’s financial decisions
- Are concerned about running out of money in retirement
So do you need an advisor or not, and if so, what kind?
This is up to you to decide. If you are confident in all things financial, then you many not need an advisor.
As I mentioned above, I don’t believe everyone is a good fit for ongoing financial advice, but some people are better off retaining an advisor. At a minimum, paying for advice periodically can pay off for many people.
If you think you can benefit from financial advice, the next step is to decide what kind of financial advisor you are going to use. It’s possible for a fee-based advisor to provide good advice, but there are many conflicts of interest in that model. The fee-only model removes most conflicts of interest, making it easier to provide unbiased advice.
