The Shocking Truth About Professional Financial Advice

Truth #1: Realize All of the Ways You're Paying for Financial Advice

When you're getting professional financial advice, you need to fully understand all of the ways you're paying for that advice.  The best professional advisors will be transparent about how they are getting paid, but unscrupulous advisors will not.  Others will only tell you half the story.

See this scary article about how a financial advisor was NOT disclosing his fees.

Some of the common ways you're going to pay your advisor include:

• Upfront Fee: This is a base fee you'll pay up front for a consultation
• Management Fee: This is a fee, usually as a percentage of assets, that you pay for the advisor to manage your money
• Broker Commissions: This is how much the advisor gets paid by the investment you're buying
• Annual Fees: This is what the investment charges you to hold the investment. You can use a free service like FeeX to find out the hidden annual fees.

So, do you know the truth?

When I worked at the financial services firm in college, it was common practice to not disclose how much commission was being made by the investment advisor.  Instead, the advisors would joke around after a client meeting how much they made off an unsuspecting client.  For example, instead of a bond fund, the advisor would give financial advice to a client to steer them into an annuity as the "safe bet".  However, a $1 million annuity would give the broker a $100,000 commission.  Insane!

I'm completely comfortable paying someone for a job well done, but I have a big problem when someone giving me advice is not being transparent.

When it comes to fees, most financial advisors fall into three categories:

• Commission-Based: This is a financial advisor that is compensated for the purchase or sale of investments or insurance. The commission is typically paid by the financial firm whose product was purchased.
• Fee-Only: This is a financial advisor who only charges a a fee for services rendered. Now, this can be a one-time meeting and arrangement, or it could be ongoing (such as annual financial check-ups). The fee can also be a flat-fee per appointment, hourly, or a percentage of the assets under management. However, a fee-only advisor receives no compensation based on the investments or products they recommend.
• Fee-Based: This is a financial advisor that will charge a fee to put together a financial plan. However, that plan typically has commission-based products or services, and if you select that plan, the advisor is compensated with a commission as well. This is a hybrid model, so the conflict of interest still is present.

It's important to note, however, that all of these fees can be added into each other. Even if you go to a fee-only planner to get a financial plan, the investments you have will still have annual fees. You just need to know what you're paying for - and a good financial advisor will tell you.

Truth #2: Make Sure You Understand Your Options

If you're getting professional financial advice, chances are it's because you are looking for better options, or different options.  However, many financial advisors will simply present one option and say that's the best answer to your situation.  Why?  Well, it could be due to Truth #1 above, or it could be because they can only steer your into the "Approved Company Funds".  Whatever the reason, I'm a firm believer that you need to understand your options before making any decisions.

The best professional financial advice will answer this simple question every time: Why select this fund over that fund?   Pretty basic, but many don't.  The best advisors will give you a class of investments that they think will suit you, for example, small cap funds.  Then, they will provide a list of the best small cap funds, and maybe even recommend one from the list, even though all are good.  That's how things should be done, but they're typically not done that way.

Along the same lines, a good professional advisor will look at your overall portfolio allocation when making investment decisions.  It doesn't do the client any justice if the professional financial advisor only looks at one account, and omits other accounts like 401ks or IRAs.

A good example is my company's 401k provider.  As an "upsell" to employees, the 401k management company offers a service called Financial Engines, which will look at and optimize your 401k.  You pay an annual fee for this service, and all they do is rebalance your 401k on your behalf.  

However, the company has no information on your other investments, and can't see how your 401k fits into your overall portfolio.  The bottom line is this service is a waste of money, but many people will fall for that financial advice and see their returns eaten away each year.

You also need to make sure you're picking a financial advisor based on your needs!

How Roboadvisors Stack Up

Roboadvisors - these companies such as Betterment, WealthFront, and more - that connect your accounts and create target asset allocations and recommends, are steps in the right direction. However, they still have a couple of flaws:

• They can't answer the question "why this fund over that fund"
• They typically can't build an asset allocation around all your accounts (such as your employer 401k, which could be your biggest investment)
• They have fees on top of the investment choices as well

Regardless of your choice, make sure you understand your options!

Truth #3: Don't Fall For Hyped Returns

Finally, too many people fall for hyped returns when it comes to financial advice.  It's marketing 101 - people love to see results, and a savvy (and possibly unscrupulous) financial advisor will play that.  So if you hear phrases like:

• Professional portfolio advice costs money, but it's worth it
• It costs, but returns are higher than doing it alone
• You'll get returns that consistently beat the market
• Look at the X% return that I've yielded for these clients

The bottom line is that, over the long run, most actively managed portfolios and returns actually underperform the market.  Furthermore, no financial advisor can guarantee any kind of return for their customers.

The best advisors will lay out scenarios and highlight how funds and portfolios have historically performed.  They will also see what you care more about: income, growth, principle protection.  If you're not having discussions about these things, and instead the advisor is steering you into funds or a portfolio based on returns alone, that should be a big red flag!

Don't fall for hyped returns...look for a solid history and scenarios that show various market returns over time.

So, Do You Need Professional Financial Advice?

I'm a believer that most people don't need professional financial advice.  For many, especially college students and young investors just starting out, a basic investing account that focuses on broad market ETFs of mutual funds will make a lot of sense. And yes, using a service like WealthFront can be a smart choice.

For many investors, the bulk of their investments are in a 401k or IRA.  After that, they may have a standard brokerage account as well.  Regardless, their portfolios are pretty simple and easy to maintain.  They don't require tax advice, for the most part, and sticking to index funds makes a lot of sense.

If they want a little more diversity, they could always go with target date funds, as long as they are aware about the biggest problems with target date funds.

The only real scenario when I can see professional financial advice being practical is a situation when someone receives a windfall, and hasn't had to invest large sums of money before.  And, even in this scenario, I'd highly recommend a fee only planner that is very transparent about how they make money.

These shocking truths about financial advice run rampant through the financial services industry.  It's sad, but true.  As such, the best thing that an investor can do is arm themselves with knowledge so that they can know what to do when they encounter these situations.

What are your thoughts on professional financial advice?