Hiring a financial planner should be something you give a great deal of thought to. You will be trusting this person to guide you through major financial decisions and help you reach your life’s goals. So why would you settle for the random financial planner who passed out business cards at a work event, or the first one you found on Yelp? (See also: Who to Hire: A Financial Planner or a Financial Adviser?)
Unfortunately, the decisions that you ought to spend the most time on — like which financial planner to hire — are often the ones that you hurry through. It can feel overwhelming to figure out how to vet multiple financial planners in order to find the best fit for your needs, so you end up following the path of least resistance. (See also: 7 Occasions When You Should Definitely Hire a Financial Adviser)
Before you find yourself settling for a financial planner, consider the following.
1. Not all financial planners are created equal
There are many different types of financial advisers and planners, and only some of the titles that various financial professionals can use are regulated in any way. When you meet with someone calling themselves a financial planner, you could be sitting across the desk from a Certified Financial Planner, an insurance agent, a registered representative, or a registered investment adviser. (See also: Ask These 5 Questions Before Deciding On a Financial Advisor)
You need to understand what each of these titles mean so that you know what kinds of advice to expect from each type of planner.
This is the most loosely defined of all types of advisers, since there is no regulatory body that oversees self-proclaimed financial planners. However, if you meet a Certified Financial Planner (CFP), you know that they have completed an education requirement, passed an examination, have at least three years of experience, and have agreed to the CFP Board’s standard of ethics. In addition, CFPs have a fiduciary duty to put clients’ interests above their own.
Since financial planning has such a loose definition, you can find a financial planner who can help you with any number of personal finance goals — from retirement planning, to general budgeting, to saving for college, to estate planning. The best financial planners embrace this jack-of-all-trades aspect of their profession and strive to help their varied clients reach all of their financial goals.
An insurance agent has been licensed within their state to sell life insurance products, including everything from traditional life insurance to annuities. Some financial planners are also licensed as insurance agents, which means they can give you general financial advice, as well as sell you insurance products.
The thing to remember about insurance agents is that they will generally recommend an insurance product to meet whatever needs you have. As long as you are in the market for such a product — whether it’s life insurance, an annuity, long-term care insurance, or disability insurance — this can be a great fit. Just make sure you are not seeking general financial advice from someone who is only licensed as an insurance agent.
These advisers, also known as stockbrokers, generally work for or are affiliated with a broker-dealer — a company or firm that trades securities for clients.
Since registered representatives work for a particular broker-dealer, they are often advised by their companies as to which stocks to recommend, which products to sell, and which investment strategies to follow, although that does not preclude them from giving you good advice. Just remember that registered representatives often work on a commission basis, so it’s in your best interest to always ask how your adviser is compensated.
Registered investment adviser
An RIA’s primary function is to provide advice to clients on the best way to manage the moving parts of their complex finances. These types of advisers offer both investment advice and portfolio-management services. They are also among the most regulated of financial advisers. Registered investment advisers tend to work with extremely wealthy clients who have very complex financial situations.
What to do
Ask your prospective financial planner what licenses and certifications they hold. This will help you to understand exactly what type of adviser you are interviewing and will give you a sense of how well their expertise matches with your needs.
2. Compensation can be confusing
Different types of financial professionals are paid in different ways — and the compensation is not always transparent for the client. That’s why you need to know upfront exactly how your financial planner will be paid for their time. Otherwise, you risk paying far more for their advice than you may have wanted.
In general, there are three ways that a financial adviser can be paid.
Advisers who get paid on a commission only make money when you purchase a particular product through them. The main issue with commissions is that they can cause your adviser to have a conflict of interest — they may become more incentivized by earning a commission than making sure you have an appropriate plan and product for your financial goals. That said, there’s nothing wrong with working with a commission-based adviser, as long as you understand exactly how they will be paid based on the various products offered.
These advisers are paid directly by their clients, which means their advice may be more objective than that of commission-based advisers. However, you will still need to know exactly how they calculate their fee, since it may be taken as a percentage of your account value, as an hourly rate, or as a flat fee.
Fee-based advisers are not the same as fee-only advisers. These advisers are compensated directly by their clients and through commissions from the sales or recommendation of products.
What to do
Ask any prospective financial planners to explain to you exactly how they are compensated. If all you hear is that you don’t need to worry about payment, it’s time to walk away. Generally, the only reason your adviser will harp on the fact that you pay nothing out-of-pocket is because they want to conceal their sales incentives. (See also: 9 Signs You Need to Fire Your Financial Planner)
3. Investment strategies can vary a great deal
Some investors like to chase returns and are willing to take some big risks for potentially big rewards. Others prefer to maintain their principal and invest more passively for slow long-term gains. While any financial adviser should be able to accommodate the investment strategy that works best for your risk tolerance and timeline, it’s important that your adviser respects and understands your basic investment philosophy. (See also: Find the Investing Style That’s Right for You)
Though there are a number of different investment strategies, these are some of the most common:
Buy and hold
This is a long-term investment strategy where an investor purchases company shares or funds and holds them for a long time, counting on the long-term overall increases in the market over time.
This active investment strategy is based on the idea that you can buy shares or stocks when they are priced low and sell them when they are priced high. Since this strategy hinges on being able to predict what the market will do, it is very risky.
Dollar cost averaging
With this strategy, you invest an equal amount of money regularly into a portfolio. Since the market fluctuates, sometimes your regular investment will buy more shares because the shares have gone down in value — and sometimes the investment will buy fewer shares because each share costs more. This strategy helps to reduce the risk of losing a large lump sum of money in a downturn. And since you’re investing gradually, it may be a way to ease any nervousness you have about getting into the stock market. (See also: Is Dollar Cost Averaging the Right Strategy for You?)
Value vs. growth trading
Value traders try to identify stocks that are undervalued, and therefore have the potential to rise once the market catches on to their worth. Value stocks tend to pay dividends. Growth traders, on the other hand, are looking at companies that are growing faster than others. They offer a higher upside potential, but are also riskier than value stocks and don’t usually pay dividends.
What to do
Even if you are not sure of your own investment philosophy, it’s a good idea to ask any prospective planners to explain what they consider to be important in investing. Not only will this help you to determine if you are a good fit with the adviser, it can also help you better understand the reasoning behind various investment strategies. If any aspect of the adviser’s answer to this question is unclear, ask them to explain. Better to feel foolish because you are asking questions than to feel foolish because you lost your shirt.