Summary/TL;DR
Great advisors don’t compete on investment performance or portfolio management. In my experience, the biggest thing that differentiates great advisors from average ones is high-quality tax planning. One’s competency here is arguably the strongest indication that they truly know their stuff and will add loads of value to you. Finally, while some of the common certifications (such as the CFP®), can be useful for establishing minimum levels of education, their influence shouldn’t be overweighted. Part two of this series will discuss advisor compensation models.
Introduction
Finding a financial advisor is easy. Just about anywhere in the country, you can drive through your neighborhood and come across multiple different advisory firms. Finding a great advisor, however, is very tricky. The financial services industry is full of shiny objects and fancy jargon that can trick just about anyone (including those who sell them!) into paying hefty sums (much of which remains undisclosed) in exchange for useless products and services.
Furthermore, even amongst the true advisors, skill-sets and competency levels vary widely, making it easy to get overwhelmed. My goal in this short series (comprised of two parts) is to present the most important things to look for in an advisor, as well as things that should prompt red flags. This first part will discuss areas of focus and common advisor certifications, while part two will explore various advisor compensation models.
Areas of Focus and Competency
Perhaps the most important thing to be mindful of when interviewing financial advisors is how they frame their value proposition. What are the key areas that they focus on to improve your financial outlook and that differentiate them from other advisors? This section will focus on how you can listen to what an advisor says that will tell you if they’re truly the “real deal”.
The Folly of Focusing on Investments
Unfortunately, most advisors will compete with one another based on account performance. This is not only futile, as mountains of research have shown that they will underperform passive benchmarks regardless, but is also a huge disservice to clients who won’t receive advice in other areas where professional assistance can truly make a material difference.
If your meeting with a prospective (or your current) advisor involves a lot of charts and graphs showcasing how their portfolios have “outperformed” over the past few years (which I can almost guarantee you is a lie) without a mention of tax, estate, or insurance planning, then you’re in the wrong office. This isn’t to say that the advisor shouldn’t talk about investments at all, only that it should be one of many areas that they have expertise in.
Tax Planning – The True Differentiator
In my experience, the main thing that separates the great advisors from the average ones is tax planning. Great advisors have a firm understanding of the fact that tax planning, when done correctly, has tremendous capacity for making a difference in their client’s financial outlook. One indication that you’re working with a great advisor is they will ask to review your tax return. They will also discuss things like Roth conversions, the social security tax-torpedo, required minimum distributions, tax diversification, tax-loss and tax-gain harvesting, and a host of other tax planning strategies without you even having to ask.
Of course, there are many other areas of focus which great advisors are clued into, such as estate planning, insurance planning, and retirement distribution planning. Tax planning, however, tends to be at least loosely connected to these other areas, which is what makes it so integral to a great financial plan. At the end of the day, a ton of things come back to taxes!
Alphabet Soup (Certifications)
It’s not uncommon for advisors to carry a series of professional certifications or designations, typically displayed as an acronym after their name. There are a dizzying amount of these certifications (I see new ones I’ve never heard of all the time), and knowing which ones, if any, are meaningful can be challenging. This section will review a few of the most common certifications along with their merits. It is by no means intended to be an exhaustive list. Finally, keep in mind that there are plenty of exceptional advisors out there who have no certifications. While the alphabet soup following someone’s name can be helpful for determining what type of training they have had, they are essentially useless for telling one advisor apart from another on more important matters.
Certified Financial Planner (CFP®)
The CERTIFIED FINANCIAL PLANNER™ designation is considered by many to be the “gold standard” of financial planning certifications. It usually takes more than one year to study due to the wide range of subjects that the curriculum covers and also a few other requirements. First, CFP® carriers have to have had at least three years of experience in the financial services industry (as defined by the CFP Board). They also must have at least a bachelor’s degree (in any subject) and have to pass a rigorous examination with a 50% fail rate.
At the end of the day, the CFP® mark is a reliable indicator that an advisor possess at least a minimum threshold of education and experience to be taken seriously.
Chartered Financial Analyst (CFA®)
The CFA® is widely considered to be the most difficult financial designation one can obtain. There are many years of study involved and at least four difficult examinations that I’m aware of. The subject matter of the CFA®, however, is not relevant for finding a good financial planner. It focuses solely on investments and very in-depth financial analysis of a wide range of asset types. While great for working for a hedge fund, it has nothing to do with financial planning.
Chartered Financial Consultant (ChFC®)
The ChFC® certification was started as a competitor to the CFP®. My understanding is that the overlap between the two curriculums is quite large, but the ChFC® has one or two additional courses. Unlike the CFP®, there is no comprehensive exam for the ChFC®.
Conclusion
At the end of the day, the best thing an advisor can do to demonstrate their expertise is to add value to you. Great advisors do this naturally, identifying points of weakness in your current plan and suggesting ways they can help you improve them without even being asked. They don’t sell you products, they don’t tout their portfolio performance, and they don’t dangle carrots over your head by withholding information in exchange for payment.
In addition, most of the common certifications and designations are relatively useless. While some, such as the CFP® and ChFC®, can be helpful for establishing minimum levels of competency, they shouldn’t be overweighted.
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