Helpful miscellaneous articles
regarding our retirement plan and planning.
Like you, I review my retirement nestegg and plan from time to
time. Recently, I went though some continued
education for some credentials I maintain and it occurred to me that we all
could use a review about these issues.
So with your help, we will share and post articles and info that may be
helpful and of interest to many of you in this section.
Choosing a Financial Planner vs. an
Investment Advisor – What’s the Difference?
From 1998 to
2013, the number of Fortune 500 companies offering pensions to their employees
fell from 60% to 24%, according to The Washington
Post. With the
decline of unionism and loss of employee bargaining power, corporate
managements have aggressively replaced pensions with profit-sharing plans,
essentially transferring the risk of retirement planning and investment
management to their employees. It is possible that the Social Security program will be similarly
transformed, making retirees responsible for investing funds through private
accounts. However, the truth is that few people are prepared to manage their
own retirement funds – as Howard Gold writes in MarketWatch, “Most investors have no idea of
what they’re doing.”
In the last
half-century, the financial markets have become increasingly complex with new
products, new markets, and changing tax laws. Technology makes it possible for
investors to remain informed 24-7 about events that may affect their stock
positions and to enter trades from the comfort of their home. At the same time,
they must compete with robo-trading programs that react to news and market
activity faster than any human can. As a consequence, according to
Rosalind Resnick writing in Entrepreneur, even people capable of managing
their own capital should carefully consider whether a go-it-alone approach to
investing makes sense.
Whether due
to a lack of training, interest, or time, many individuals are turning to
professional advisors to help them navigate the perilous waters of personal
finance. In some cases, advice covers the entire spectrum of financial
services, ranging from budgeting, to creating specialized trusts and estate plans. In others, the consultant’s primary
responsibility is limited to a specific need, such as managing a portfolio of
investments or developing effective tax strategies.
Seeking and
finding the perfect advisor is not always easy, especially in an industry
filled with confusing acronyms. According to the Financial Industry Regulatory
Authority (FINRA),
there were more than 160 different professional designations. In addition,
terms such as financial analyst, financial advisor, financial consultant, and
wealth manager are generic titles and can be used by anyone without registering
with securities regulators or meeting educational or experience qualifications.
To add further confusion, many consultants add multiple titles and designations
to their resumes, making it difficult to determine which services they actually
provide.
Do You Need
Financial Planning Advice or Portfolio Management Services?
While the
terms “financial planning” and “investment advice” are often used
interchangeably, they refer to different skill sets. As a consequence, two of
the more popular designations – certified financial planner (CFP) and registered investment advisor
(RIA) – are regulated under different authorities.
In many
ways, a certified financial planner is the financial equivalent to a
primary care physician. The financial planner generally deals with the client’s
total financial health.
As in the
medical field, when a particular condition or concern arises, a specialist is
called upon. In the financial arena, that specialist may be an RIA or an
experienced estate lawyer. Consequently, it is not unusual for clients to
engage the services of a CFP and an RIA simultaneously or sequentially.
Certified
Financial Planner: Financial Planning Advice
According to
the “Standards of Professional Conduct” of the CFP Board, the privately held governing body
that awards the CFP designation, financial planning is defined as “the process
of determining whether and how an individual can meet life goals through the
proper management of financial resources.” Therefore, CFPs typically deal with
numerous aspects of their clients’ finances.
Qualifications
and Educational Requirements
A consultant
holding the CFP designation must have at least a bachelor degree from an
accredited college or university and 6,000 hours of financial planning
experience. He or she must also complete the CFP educational program and pass
the final examination. The examination may be waived if the consultant has a
Ph.D in business or economics, or is a CPA, CLU, CFA, or an attorney.
Description
of Advisory Services
The advisory
process typically includes one or more of the following:
Cash Flow
Analysis and Budgeting. Having a complete understanding of a client’s cash
flow, assets, and liabilities enables the planner to help the client balance
conflicting needs and wants, both short- and long-term. This element of service
might include a multi-year audit of expenditures to ensure that recommendations
are valid.
Insurance
Planning and Risk Management. Analysis and recommendations typically include a
review of the property, life, disability, and health insurance risks and
coverages.
Investment
Planning. CFPs typically advise clients regarding investments in general –
asset selection, allocation, and diversification to fit a client’s risk profile
– or specifically, such as recommending individual stocks and bonds within a
portfolio. Notably, a CFP may also be registered as an investment advisor.
Income Tax
Planning. The burden of taxes can significantly impact short- and long-term
returns of a portfolio, as well as each client’s discretionary income. CFPs
understand income tax fundamentals and calculations including legitimate tax
reduction and postponement techniques.
Retirement
Planning. Preparing for retirement is a requirement of every client. Thus, a
CFP must be cognizant of the different types of retirement plans, the rules and
options of each, and the impact of investment choices on long-term risk and
result. A CFP must understand regulations and rules regarding the taxation of
profits within each plan, as well as distributions from qualified and
non-qualified plans.
Estate
Planning. In addition to advising on wills and trusts, CFPs help their clients
plan for the efficient distribution of their assets at death. A CFP must be
aware of changing state and federal laws regarding marital deductions, charitable giving, and gifting to non-charities.
Registered
Investment Advisor: Portfolio Management Services
An
“investment advisor” is one who provides advice about investments for a
fee. As defined by the Investment
Advisors Act of 1940,
a registered investment advisor is a “person or firm that, for compensation, is
engaged in the act of providing advice, making recommendations, issuing reports
or furnishing analyses on securities, either directly or through publications.”
RIAs have a specific fiduciary duty to their clients, meaning that they have a
legal obligation to provide suitable advice and always act in their clients’
best interest.
Investment
advisors are required to register with the Securities Exchange Commission (SEC) or their respective state’s
securities board, depending upon their size and services offered. In addition,
they are required to have written policies and procedures to comply with the
Advisors Act, and must regularly file reports with clients and the authorities.
Unlike the
CFP designation, “RIA” is not a professional designation, and does not signify
any special training or qualifications. The only qualifications to register as
an RIA are to pass the Series 65 examination or maintain a Series 7 and Series
66 with a broker-dealer firm. Some states waive the Series 65 examination if
the individual holds a CFP, CFA, PFS, or ChFC.
Description
of Advisory Services
According to
the North American
Securities Administrators Association, registered investment advisors provide advice or analysis
about securities either by making direct or indirect recommendations to clients
or by providing research or opinions on securities or securities markets. They
receive compensation in any form for the advice provided.
While many
Wall Street firms have utilized the term “financial planners” due to its
marketing cachet, they are in fact investment advisors whose advice is limited
solely to recommendations about specific securities or the makeup of a security
portfolio. This distinction is important when determining whose services best
fit your needs.
RIAs work
with their clients in a variety of ways. Some advisors simply make
recommendations regarding the purchase or sale of individual securities, while
other advisors operate with full discretion, buying and selling securities for
their clients without prior authorization. In recent years, online-only robo-advisors such as Betterment, FutureAdvisor, and Wealthfront have become popular because of their
low fees and automatic, algorithm-based portfolio strategies. Recognizing that
many investors prefer a personal touch, many robo-advisors have begun to link
with financial planning firms, allowing clients to benefit from a full range of
services, generally at less cost than a traditional asset management firm.
Fees and
Expenses
As market
returns have declined in recent years, investors have become acutely aware of
the burden of management fees upon their returns. A 2% management fee for a
portfolio that grows 10% to 12% per year may be acceptable, but the same fee
during a period of low growth likely would not be welcome.
In addition,
research suggests that many folks would be better served with investments in
unmanaged index funds than managed portfolios of individual stocks. Though in
some cases management fees can be excessive, that doesn’t mean you should
forego portfolio management entirely. Sometimes, the money you spend on
advice is the best money you can spend.
Financial
advisors – whether CFPs or RIAs – may receive compensation in a variety of
ways:
Commissions
on Transactions. Some CFPs may be registered representatives of brokerage
firms, insurance agents or their representatives, or have other arrangements
whereby they receive a commission for each financial product (such as shares of
stock, mutual funds, or an insurance policy) purchased
by their clients.
Fees Based
Upon Account Value. Typical fees range from 0.5% to 2% of an account’s value,
paid on a quarterly basis. Generally, the more assets under management, the
lower percentage of fees charged. The apparent benefit of an asset-based fee is
that the client’s and the advisor’s interests are the same – the fees grow as
the asset balance increases, and they decline if the balance falls.
Unfortunately, in such arrangements, an unscrupulous advisor is just as likely
to recommend high-risk, high-growth investments to generate outsized fees, and
then simply find new clients to replace those who have lost money and
confidence in the advisor.
Hourly
Rates. Some CFPs charge clients based upon hours worked, similar to the
practice of accountants and attorneys. Since advisors in this case are paid
regardless of recommendations made or followed by the client, the advice is
generally considered more objective. Hourly fees are generally based upon the
experience of the advisor and the complexity of the work performed. For
example, A CFP might charge $100 per hour for personal budgeting analysis, and
$300 per hour for investment portfolio advice.
Negotiated
Fee for Service. Clients with specific needs often negotiate a fixed fee for
the completion of certain services. This arrangement generally works best where
there is a specific, tangible deliverable such as a budget, an initial
retirement portfolio, or an estate plan.
Combined
Commissions and Fees. Many advisors, including CFPs who perform a variety of
different services for their clients, receive a combination of fees and
commissions. Just remember that it is important to understand the level and
nature of any compensation – RIAs are required per their fiduciary duty to
alert clients of all fees.
The best
advice when considering whether to hire advisors is to ask how they are paid.
Their answer can enable you to identify possible conflicts of interest. A good
rule of thumb is to never hire an advisor who leaves you uncomfortable or
unsure, or one that isn’t transparent about compensation. It is your money,
after all, and bad advice can cost you dearly.
Suitability
Standard Versus Fiduciary Duty
There is a
significant difference between the two legal standards that apply to financial
advice:
Suitability.
Stockbrokers, registered representatives, and other investment professionals
are required to make investment recommendations to their clients based upon
age, risk tolerance, and financial circumstances. For example, a recommendation
to trade high-risk commodities would generally be unsuitable for a 70-year-old
widow whose investment income was her sole support. At the same time, the same
recommendation to a 30-year-old executive in the prime of his earning years
might be “suitable,” though ill-advised. Advisors do not have a legal or
regulated requirement to educate their clients about the nuances of investing,
nor about the presence of alternative investments. Unfortunately, such a
broad standard often results in the products that pay the highest commissions
and fees being recommended.
Fiduciary Duty. Registered investment advisors are held to a
much higher standard for their recommendations than other advisors. RIAs are
required by law to put their clients’ interest above their own. Any investment
advice must be thorough and complete, and all potential conflicts must be
disclosed to the client. Though CFPs aren’t legally required to act as
fiduciaries to their clients, their professional standards require that they
do.
The “Three C’s” of Choosing an Advisor
Before selecting
the type of advisor to employ, take the time to consider your financial
circumstances and needs. If you need general advice such as budgeting,
investment planning, or tax planning, you would be best served by a certified
financial planner. On the other hand, if you want specific counsel regarding
stock investments or portfolio management, a registered investment advisor
would be a better match. Whatever your needs, be aware that all advisors vary
by expertise, experience, and capabilities.
Consider the following measures of an advisor:
Capability. The right advisor should be both qualified and
experienced. While designations can be misleading, they are generally evidence
of a tested competence and a recognition of rules and policies. Before engaging
an advisor, ask for a minimum of three references from clients of at least two
years’ standing. Contact these references and ask open-ended questions about
what they like and dislike about the advisor, how often they communicated, and
any problems that arose during the relationship. It is essential that you trust
any advisor, so run from any situation where you feel an advisor might be
unethical or lack integrity.
Cost. Understand and document any fee or commission
arrangement. While it is customary and appropriate to pay advisor fees or
commissions, they should be fair in relation to the services rendered. For
example, an investment advisor whose portfolio significantly outperforms the
market as measured by the S&P 500 is likely to receive a higher fee than an
advisor whose performance lags the market. Remember that any fee or commissions
paid negatively affect your total return. For example, if your stock portfolio
is up 5% for the year, but you must pay the advisor a 2% annual management fee,
your net return is 3%.
Compatibility. It is extremely important that your advisor
have a personality and manner that makes you comfortable, as well as the
patience to answer questions until you are satisfied. If possible, visit your
potential advisor several times before engagement. Even a single personal
meeting can help you form a more thorough impression than what a phone
conversation or email exchange can provide. Under no circumstances should you
turn over your financial future to a virtual stranger without testing your
online perceptions with a face-to-face encounter.
Final Word
Balancing the demands of a career and the demands of
creating a secure financial future are difficult. As markets grow more complex
and volatile, more and more people will turn to professional advisors to guide
them. There are thousands of competent, ethical, experienced advisors available
to discriminating investors who need help.
Just as your primary care physician watches over your
general health, the advice of a compatible CFP can help you avoid the pitfalls
of poor planning or execution. At the same time, a registered investment
advisor can maximize your investment return potential while aligning with your
particular risk profile and goals.
~~~~~~~~~
(As
with any of these informative articles, anyone who needs someone to talk to
about
this
very subject contact me and I can direct you to a knowledgeable advisor).
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ Full post disclaimer in left column. PCN Home Page is located at: http://pcn.homestead.com/home01.html
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