How to Choose the Right Financial Planner Without Costly Mistakes

Hiring the right financial planner can improve your financial situation immeasurably, while hiring the wrong one can quietly lead you to spend much more than you intend to. Before jumping to names, it is helpful to have some background on the context of personal finance: the options for people who choose to handle things themselves, the situations in which hiring help is a good choice, and how to differentiate between the two.

There are three general approaches to personal finances: do nothing, do everything yourself, or hire someone. None of these paths have any inherent virtue or lack thereof, but understanding their weaknesses is vital to choosing the best one. Doing nothing is surprisingly common, although most people won’t admit it, and can be tempting because most financial issues only come up when something bad happens, such as being fired. Doing things yourself is much harder than it seems and requires more regular and intense work to pay down debts and save up for long-term goals than most people can bring themselves to do on a regular basis, but it usually has a light workload for the actual maintenance of the system, which only needs to be done a few times per year. Its virtue is that it is the only option that does not have someone else’s motivations interfere with one’s own financial goals. Finally, paying someone to handle things for you usually only becomes a good option when someone is making a large change in their life, such as getting married or buying a house, because the cost of hiring help for smaller tasks often outweighs the cost of mistakes made on such tasks.

Financial professionals can fall into any of the three categories of approach discussed above, and in addition have one of several payment structures that strongly influence, and often dictate, their recommendations. Planners who receive a commission for selling certain products have an obvious incentive to recommend exactly the item they are paid to sell rather than what the client needs most, and rarely consider less glamorous but often necessary financial instruments such as paying off debts and maximizing workplace retirement funds, which do not provide them with any income. Planners who are paid a percentage of one’s holdings to manage them face similar issues, although to a lesser extent, since actions that reduce someone’s wealth, such as paying off a mortgage or buying a rental property, are still beneficial to the planner, albeit to a lower degree, while leaving one’s money untouched does not benefit them at all. Planners who are paid an hourly rate or a flat fee, however, do not face any of these issues, since their compensation depends solely on the time spent working on the client’s finances and not their recommendations or the actions the client takes after the engagement.

One phrase that often appears in this context, and has nothing to do with the other two, is the word “fee-based.” When it comes to financial advisors, this term has very little actual meaning due to another phrase that sounds almost identical but covers an entirely different subject. “Fee-only” advisors charge a price for their services, which can either take the form of an hourly rate, a flat fee, or a percentage of one’s holdings, and do not receive any compensation from any other source. “Fee-based” advisors also charge a fee in addition to receiving commissions from products recommended to the client, which means they have the same potential conflicts of interest as planners who are openly paid via commissions do but obscure them under the banner of “fee-only” in advertisements to appear more trustworthy. Consumer watchdogs will often mention this issue, and the solution is to simply ask the planner in question to clarify what portion of their compensation, if any, comes from third parties. If “fee-only” is an genuinely important consideration for the client, the answer to this question should disclose something about a planner’s actual practices. Even with “fee-only” advisors in mind, the discussion about compensation methods remains relevant, since those who employ the hourly rate or flat fee method can still be significantly more expensive on average than those who charge a percentage of one’s holdings, and the range of percentages for “fee-only” planners falls between 0.5 and 1.5 percent per year on average, so it is worth asking around about a specific planner before choosing them based solely on a general statement.

A surprising but true fact is that most qualifications and designations in the financial field do not actually mean anything, because anyone is allowed to call themselves a financial planner or a financial advisor. The same is true for terms such as “CFA” or “CFP,” despite them being rather prestigious, but there is a crucial difference: Certified Financial Planner ™ is an actual professional designation that one must earn, while others are merely titles one adopts without any formal requirements. To be certified as a CFP ™, a financial planner must have completed a course of study and training, passed a comprehensive exam, gained experience working in the field, and demonstrated an understanding of ethical principles, and according to the CFP Board, which administers the certification process, a CFP ™ is obligated to act as a fiduciary in all matters related to providing financial advice to the public. This is significantly more rigorous than simply claiming to be a fiduciary at times instead of always, which other financial advisors, including those who hold the CFA designation, can do at best.

Beyond asking the right questions about the qualifications and compensation methods of a potential financial planner, prospective clients should take advantage of the tools at their disposal to verify the answers, since doing so takes no extra time beyond those ten minutes already spent. The easiest way to do so is to use FINRA’s BrokerCheck (brokercheck.finra.org) for information about people who work as brokers, investment adviser representatives, or both, and the SEC’s Investment Adviser Public Disclosure database for investment advisers for information about their qualifications and disciplinary history. Additionally, a reputable adviser should be able to provide the Form ADV Part 2A, issued by the SEC, which details how they and their firm are compensated.

An effective financial planner will be someone whose role goes beyond the financial advisor and into the realm of a translator, who can understand the client’s needs and concerns and effectively explain their options to them, helping them to recognize and formulate issues they may not have realized they had, and provide an impartial assessment of one’s financial affairs and a realistic yet beneficial course of action in potentially stressful circumstances. The same impartiality and objectivity, if provided by a planner who communicates clearly and concisely with the client, can be beneficial to married couples who cannot openly discuss their financial disagreements. None of this applies to everyone, since some people find the idea of a financial planner, and their ability to do what most financial planning software can do for a fraction of the cost, undesirable, and in many cases people who regularly consult a financial planner still need to speak to a separate tax lawyer about their tax-related concerns, so a referral from a trusted professional may be enough for such people. Referrals in any capacity, however, should not be a replacement for asking the hard questions discussed above, since those who are open about their expectations and methods and willing to explain them in detail in a manner the client understands, rather than talking down to them or obscuring their intentions behind complex jargon, will have already answered the ones that matter.

This article is for general educational purposes and isn't personalized financial advice. Consider your own circumstances, and verify any advisor's credentials and registration status directly through the resources noted above before engaging their services.