When to RUN from a Financial Advisor

Editor's Note: The following guest post is from Ryan McPherson, CFP®, EA, a financial advisor and the founder of Intelligent Worth, a fee-only fiduciary planning firm in Atlanta, GA. He works with young(er) professionals, focusing on attorneys, starting in the early and expansion stages of their careers and adult lives. Additionally, he is a member of NAPFA and the XY Planning Network. I've had a couple of phone conversations with him and felt like he understood the role of a modern financial advisor, so I asked him for the warning signs to look out for when someone is interviewing/talking with a potential financial advisor. His article does not disappoint. It's so good that I decided to break it up into two parts. Check back again on Friday for the rest of the article (update: part two). Ryan and I have no financial relationship.

This post stemmed from a comment about financial advisor red flags on the Biglaw Investor’s The Ideal Financial Advisor article.

The comment got me thinking…what traits, descriptors, and behaviors would I tell someone to avoid if she were interviewing advisors or trying to assess her own.

1 – It’s free

No, no it’s not.

Unless you’re receiving financial advice at a pro bono clinic, someone is paying. (Hint: it’s you.)

When someone says, “I don’t pay for financial planning,” the person isn’t aware of how she’s being charged. Unfortunately, this statement is often coupled with the purchase of a financial product with an embedded (aka, hidden) commission.

Be wary of “free” offerings as concealed commissions are probably lurking.

If an advisor claims that her services are free or that you don’t pay her, ask how she’s able to run her business, if clients don’t pay and services are simply given away.

Regardless, someone pays, which leads us to…

2 – Unclear fee structures

Advisors know how they’re paid – trust me.

When asking about fees, you want to hear a clear description:

• We charge a flat fee of $3,000 to $10,000 annually based on the complexity of your situation;
• We charge 1.0% on the first million dollars of invested assets; or
• We charge 1.0% of your net worth + 0.50% of your adjusted gross income (AGI).

(I don’t advocate for the latter two fee structures, for reasons we’ll get into later, but for initial descriptions these work well.)

If you decide to purchase a product (insurance, annuity, or a non-traded REIT/BDC/closed-fund) ask how much the advisor makes from the sale. Fee-based advisors may receive a commission from selling any of these. You should know how much the advisor stands to earn to mentally weigh whether those commission dollars may have influenced her recommendation.

Don’t accept “I don’t know.” The advisor can look this up; it’s not hard.

3 – Fee-based

This is very different from fee-only.

Fee-based is a euphemism for fee and commission. These advisors can charge commissions and fees, introducing a host of unwanted conflicts.

If an advisor’s business cards, email signature, materials, or website say:

• Securities offered through [company name];
• Registered Representative of/with [company name];
• General Securities Representative; or
• Securities Agent: [long list of state abbreviations]…

…she is likely fee-based.

The advisor may receive commissions for selling securities or other products through a broker-dealer.

What’s wrong with this?

In a perfect world – nothing. Advisors would act appropriately regardless of their compensation model. However, we don’t live in that world and you want an advisor’s compensation structure to promote the correct behavior.

Here’s how problems arise. Let’s say you need financial planning projections and have $250,000 to invest. Your prospective fee-based advisor is comparing the following fees and products:

• 50% asset management fee would pay the advisor $3,750 over the next 12 months;
• Complexity-based flat fee would pay the advisor $3,500 for the year;
• Variable annuity (for the entire $250,000) may pay an upfront 5% commission of $12,500; or
• Non-traded REIT (for the entire $250,000) may pay an upfront 8% commission of $20,000.

You can see how widely ranging potential fees, $3,500 to $20,000, could drive undesirable behavior.

Eliminate commissions and you’ll minimize this potential conflict by working with a fee-only advisor. The fee-only advisor can still recommend that you should purchase a product, but she won’t receive a hefty commission for doing so.

4 – Not a fiduciary

You never want to wonder about whose interests your advisor places first: yours or her own.

You also don’t want someone who is a “part-time” fiduciary with some of your accounts or only in certain situations. You need a full-time fiduciary on all your accounts and in all dealings with you.

I know this seems like it should be obvious. As an attorney, you have a fiduciary duty to your clients and your financial advisor should be held to the same standard. However, many advisors are held to a much less stringent suitability standard. So, as opposed to acting in your best interests, the advisor may just act in a way that is deemed suitable for you. (Biglaw Investor: I know this surprises many lawyers who think that all financial advisors must act as a fiduciary.)

5 – Doesn’t understand your profession / works with Eeveryone

You’ve probably seen this on advisors’ materials: “We work with executives, professionals, business owners, entrepreneurs, and women.” Great, that covers most of America’s adult population.

Your advisor needs to understand the financial challenges and potential opportunities attorneys will encounter as their lives and careers progress.

Ask your financial advisor about the issues she sees attorneys in your situation facing. Make sure she mentions a few of the following:

(This list is not exhaustive.)

• Later entry into the workforce;
• High student debt loads;
• No (or rare) 401(k) matching at Biglaw firms;
• Often a downward income adjustment when going in-house, especially from a larger firm;
• Cash flow issues when making partner and transitioning to a draw;
• Tax complexities when transitioning from associate to partner;
• Potentially varying annual compensation as a partner;
• Utilizing deferred compensation plans and other executive-level benefits available to those in senior in-house positions;
• An elevated likelihood of exiting the legal profession or the traditional practice of law; and
• Lifestyle creep – exacerbated by practicing in high-cost-of-living areas. (Biglaw Investor: Also ask the advisor if they’re familiar with Backdoor Roth IRAs and the current state of the student loan refinancing market.)

If you’re a solo practitioner, this list expands with numerous small business owner-specific items.

6 – Checkered past

The Financial Industry Regulatory Authority (FINRA), offers consumers a free tool to research advisors via its BrokerCheck website.

Ideally, you want to avoid advisors with any disclosures on their records. At a bare minimum, stay away from anyone with multiple disclosures. You’re trying to avoid a pattern of bad or questionable behavior.

7 – Leading with a product

I doubt your situation desperately requires a complicated, high-cost, and likely illiquid product. Permanent/cash value life insurance, annuities, and non-traded products will not solve your financial woes. (Biglaw Investor: That’s worth repeating. As lawyers with high student loan debt burden, we’re often targets for complicated products to solve our financial problems. You need a simple solution that you can understand. The hard part is executing the simple strategy.)

If an advisor leads with any of these, end the conversation.

To be clear, you may legitimately need life insurance and/or disability insurance, but it should be a component of a larger discussion. If you’re working with a fee-only planner, you don’t have to wonder if a commission is driving a recommendation.

8 – Lack of credentials

Your advisor should be a Certified Financial Planner™ (CFP®) or a CPA/PFS. The “PFS” stands for Personal Financial Specialist and is granted to CPAs who have passed an additional exam and concentrate on personal financial planning.

Additional designations include:

• Investments – Chartered Financial Analyst (CFA®);
• Taxation – Enrolled Agent (EA);
• Divorce Planning – Certified Divorce Financial Analyst (CDFA); and
• Life Insurance – Chartered Life Underwriter (CLU).

While numerous other designations and certifications exist, you’ll see the above-mentioned ones more often.

I’d shy away from an advisor who hasn’t taken the time or felt it necessary to obtain any designations.

9 – Big promises

Any promises or guarantees surrounding investments or beating the market should sound alarm bells.

A less obvious red flag is overly consistent returns, epically during market drops. Many Ponzi schemes, with Bernie Madoff as a prime example, were famous for eerily stable, too-good-to-be-true, returns.

Remember, risky, growth-oriented assets (think: stocks) will generally drop as broad market equity indices fall. This is normal and should be reflected in some capacity in an advisor’s past performance from 2008 or similar years.

(Biglaw Investor: That’s a great list. Unfortunately, there’s a lot more red flags left, which we’ll cover in part two of the series. In good news, these should arm you in any discussion with a financial advisor. Thanks again to Ryan McPherson for such a detailed write-up.)

Joshua Holt is a former private equity M&A lawyer and the creator of Biglaw Investor. Josh couldn’t find a place where lawyers were talking about money, so he created it himself. Years later, he opened up an insurance agency and created a tool where you can get instant life insurance quotes from hundreds of companies to ensure you’re getting the best price.