Terms to Understand With Financial Advisors
financial adviser/advisor
noun [ C ]
UK/faɪˌnæn.ʃəl ədˈvaɪ.zər/ US/faɪˌnæn.ʃəl ədˈvaɪ.zɚ/
Compare: financial planner
Someone whose job is to help people invest by giving them advice and managing their investments:
A good financial adviser will assess a client’s goals and tolerance for risk before suggesting investment options.
What terms do you need to understand when interviewing financial advisors?
What questions should you ask when interviewing financial advisors?
What are some tips for getting the most out of your appointment with your financial advisor?
Hiring a financial advisor is a crucial decision that can impact your financial future. When looking for an advisor, it's important to do your research and understand some key terms that will help you navigate the financial industry and make informed decisions about your financial future. This can help you find an advisor who understands your unique financial situation, has expertise in the areas that matter most to you and is trustworthy and reliable. Ultimately, the right advisor for you will depend on your specific financial needs and goals. Consider meeting with a few different advisors and asking questions to find the one that's the best fit for you.
Here are some terms you should know:
Financial Planning Standards (Fiduciary vs. Non-Fiduciary)
Financial advisors will fall into one of these two classifications, and it’s important to know which classification your prospective financial advisor adheres to before engaging in a relationship.
Fiduciary – A fiduciary financial advisor has an obligation to put the client’s best interests above their own. Registered Investment Advisors (RIAs) have this fiduciary obligation and register with either the Securities and Exchange Commission (SEC) or state securities regulators which help ensure the RIAs serve your interests as fiduciaries. This means fiduciary advisors are not allowed to collect commissions from the sale of any investment and typically operate on a fee-based system (where the client pays a flat fee, usually an annual, quarterly, or monthly retainer fee) for their services. These fees are paid separately and not taken out of your investment balance or proceeds.
Non-Fiduciary – A non-fiduciary financial advisor often works for institutions that incentivize them for selling investment products, usually by paying commissions to the advisor. They are also only held to the “suitability standard” meaning they may be able to sell you products that may be suitable but not necessarily the lowest cost or best for you.
The Money Guy Show Suitability Standard Analogy: Even though it’s not healthy to eat popcorn, candy, and/or soda, movie theaters can still sell these items because they are suitable for human consumption. They may not kill you right now, but these foods are shown to not be good for you over the long term.
Example: Consider two mutual funds with similar performance. A fiduciary financial advisor must recommend the fund with the lowest fees since that would be in their client’s best interest, however, a non-fiduciary financial advisor can recommend the fund with higher fees since it would still be “suitable”, and it will net the advisor a higher commission.
Note: Per Advice Chaser, be cautious when asking if a financial advisor is a fiduciary financial advisor or is bound by fiduciary standards because if they are not ethical, some might answer yes to this question even if they do not follow fiduciary standards. Be sure to do your own research. Look for referrals and be sure to check BrokerCheck.finra.org as this is a great place to see if an advisor has any complaint against them.
Top 3 Financial Advisor Credentials
CFP – Certified Financial Planners have a minimum education level of a bachelor’s degree and coursework in financial planning with up to 1,000 hours to complete the required coursework and exam, pass a comprehensive one-day (six-hour) exam, and must have at least three years of professional financial planning experience. They must also agree to be bound by the code of ethics or fiduciary responsibility putting the client’s best interest first.
CFA – Chartered Financial Analyst need to hold a bachelor's degree from an accredited institution or have equivalent education or work experience have 48 months of related professional work experience in an investment-related field and pass three required examinations (each exam is six hours and must be taken over several years) and they cover accounting, economics, ethics, finance, and mathematics.
PFS – Personal Financial Specialists are credentialed by the highly regarded American Institute of Certified Public Accountants (AICPA); This professional is a Certified Public Accountant (CPA) with additional expertise in all aspects of financial and wealth management including estate planning, retirement planning, investing, insurance and additional areas of personal financial planning.
These credentials require rigorous study, experience, and high ethical standards, but remember, even though someone might have a lot of initials behind their name, doesn’t necessarily mean they are a good advisor. Be sure to do your own research.
Compensation Models
Fee-Based – These advisors are paid through a combination of fees and commissions. They will usually charge a flat fee (such as an annual, quarterly, or monthly retainer fee) for various financial advising services, and then they can also earn a percentage from the managed portfolios or even commissions from insurance companies and/or brokerages.
Fee-Only – These advisors are compensated directly by the clients they work with. This method of compensation is considered to be the most transparent as it can help ensure your financial planner is acting as a fiduciary (putting the client’s best interests above their own) because they are not being incentivized by outside companies (i.e., insurance companies). This fee can be a retainer fee such as an annual, quarterly, or monthly fee, or even an hourly fee. (Hourly fees are usually for a short-term need that you think will go away soon.)
Commission-Based – These advisors receive payment when they sell a product or service to a client, such as insurance, stocks, or a mutual fund. Their commissions are paid by the companies providing the products that are sold, such as insurance companies, banks, brokerages, and/or other financial institutions.
Other Terms
Assets Under Management (AUM): AUM refers to the total value of the assets that an advisor manages on behalf of their clients.
Securities and Exchange Commission (SEC): The SEC is a government agency responsible for regulating the securities industry, including financial advisors.
Understanding these key terms can help you find an advisor who is right for you. By asking the right questions and doing your research, you can feel confident that you’re making a smart choice for your financial future.
Disclaimer: I am only learning myself, so I cannot guarantee this information is completely accurate, but my hope is that it can give you a good starting point if you are interested in finding a financial advisor as well. Be sure to do your own research and let me know if you have any additional information or corrections to add to this information.
To learn more, check out my Financial Professionals page for additional information.
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