A change this month in how professionals offering investment advice are regulated has added a layer of confusion to the already murky process of choosing a financial planner and/or an investment advisor.

Beginning Oct. 1, anyone offering investment advice on a fee basis must be a Registered Investment Advisor and function as a fiduciary. That is a far higher standard than the "suitability" standard under which the brokerage industry has traditionally operated. Under that standard, brokers didn't have to do what was in the best interest of their customers. Under the fiduciary standard, the advisor must do what really is best for the client.

Picking a financial planner and/or an investment advisor is a tricky process. Planners are often asked how much they have under management, but the question can be irrelevant. When asked of an advisor that manages money and that is what the discussion is about, the question is entirely appropriate. When asked of a financial planner in the context of financial planning, it is totally inappropriate and irrelevant.

There are many excellent Certified Financial Planners that do not manage money and charge only fees to do the planning. For planners who wear both hats, the amount of money they manage on the investment side has little or nothing to do with the financial planning function. The amount of money they manage should have no relevance in evaluating them as a financial planner and the question should not be asked.

So how should you choose a financial planner and an investment advisor? To answer those questions it helps to understand that there are three moving parts to the entire financial service industry.

The first moving part includes any entity that "manufactures" a product. Manufacturers include companies like, Prudential, Metropolitan Life, Merrill Lynch, Smith Barney and Morgan Stanley. They and others create products, like life insurance, annuities, mutual funds, ETFs, stocks, bonds, real estate and commodities.

The second moving part of financial services is the distribution system. Distribution includes anybody that moves the product from the manufacturers to the consumer. There are two kinds of distributors that do this -- captive and independent.

The captive distributors are the brokers of the brokerage houses and agents of the insurance companies. These people work on a commission basis. They lack objectivity from two standpoints. First, they tend to favor their company's proprietary products. Second, they generally only sell products that pay a commission. Brokers have to sell a certain amount of product to keep their jobs. Non-producers are quickly fired. These sales people, often using terminology that makes them sound like a planner or advisor, are product-driven, not client-driven, and therefore lack objectivity.

The second kind of distributor, the independent, is licensed with an independent broker/dealer (B/D). These licensed people are called registered representatives. A securities company is considered independent when it does not have any proprietary product. A significant number of the registered representatives are people working on a commission.

While the independent securities company generally has no proprietary product, they have "preferred" product vendors. These "preferred" providers are generally the ones that help subsidize the cost of annual meetings and special reward trips for top producers. Consequently, the representatives that use the preferred products are generally most favored by management. This favoritism is generally not publicly recognized or overtly acknowledged, but its subtle effect is obvious to those representatives within the company. This arrangement can create a conflict of interest for some representatives.

Then there are people, like me, that are registered representatives with the B/D and also agents of a registered investment advisor (RIA). As agents of an RIA, they may also be financial planners. They are charging a fee to manage a portfolio on behalf of a client. They may also charge a separate fee to do financial planning. In either case, they are working on a fiduciary basis. There are no commissions paid under this arrangement and mutual funds that generally have a load (a commission) are used without a load being charged. The load is waived. This creates a level playing field where the advisor has the most objectivity.

Some advisors do not actually manage the portfolios, but have a third party called a "separate account manager" manage the money. The advisor monitors the "outside" management and acts as a go-between in meetings with the client to service the relationship. The advisor receives a fee for helping to manage the relationship and make sure the client is reaching their goals within the timeframe and risk tolerance agreed on.

The third moving part of the industry is the advisory function. This is the part where you look for objective financial planning and objective money management.

It is important that you look for a separation of these three moving parts when you are seeking either a financial planner or investment advisor. You want the advisory function to be independent from the other two moving parts -- manufacturers and distributors that take commission.

Understanding all of this provides a basis on which you can choose an investment advisor and/or a financial planner.

In your search for a financial planner, here are some additional points to ponder:
  • Make sure the planner is a Certified Financial Planner -- not only the first of the financial planner designations, but the only one that is granted, monitored and controlled by an independent standards board. It also requires a rigorous course of study including a day and half of final examination.
  • Always ask a planner how he/she is compensated.
  • Ask if they are with an independent securities company. If so, what are the company's favored products and how do they manage the potential conflict of interest? Is the planner a member of the Financial Planners Association? Any professional planner should be.
  • Are they product-driven or client-driven? Ask them how they can prove it.
  • How long have they been a planner?
  • What is their academic background?
  • Have they ever been sued or penalized by any regulatory agency?
  • How does their financial planning process work?
  • Ask them to disclose any conflicts of interest. Ask if they are acting as a fiduciary or under the much less stringent suitability standard.
  • Ask if you can look at a list of clients and arbitrarily pick two or three to talk with. Don't bother asking for referrals.

If you are looking for an investment advisor to manage money, ask these questions:
  • Are you a Registered Investment Advisor or an agent of one?
  • Are you acting as a fiduciary?
  • Are you charging a fee only?
  • What is your investment philosophy?
  • Do you manage the portfolios or do you use a separate account manager?
  • How do you put together a portfolio?
  • How do you choose mutual funds or a separate manager?
  • How often do you give performance reports?
  • How often will you meet with me (us)?
  • Can you show me a sample Investment Policy Statement?
  • Do you consider my time horizon, goals and risk tolerance in designing my portfolio?

Your financial life may depend on your choice of an advisor or planner that is really in your corner. Hopefully, these guidelines will help you.
Vern Hayden runs Hayden Financial Group, a small boutique that does financial planning and investment management in Westport, Conn. An author of several books, Hayden specializes in portfolio management, specializing in mutual funds on a fee-only basis and financial planning with a focus on retirement planning.

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