When it comes to hiring a financial adviser, heed the first rule of personal finance: "Consumer beware."
Financial consultants wear many hats. Some are accountants. Some are broker/dealers who work for brokerage houses, banks, or insurance companies. Some are independent planners. But however they work, they all require compensation. And for consumers, a key question is how - and by whom - are they paid?
The answers can have big consequences for consumers. If the planner is paid entirely or in part for selling specific products - whether on payroll or on commission - that fact should be known by the consumer. The advice may not necessarily be bad, but you should at least know that the planner has a vested interest.
But what if, like most Americans, you're more inclined to hire a "fee only" planner - one paid only by the consumer? Watch out.
A study just released by the Consumer Federation of America (CFA) and the National Association of Personal Financial Advisors (NAPFA), a trade group for fee-only planners, finds that many planners representing themselves as "fee only" in fact get secret pay.
"What we found was appalling," Barbara Roper, director of investor protection at the CFA, says of the random survey of 288 planners and firms in the Washington, D.C., area.
Two-thirds of planners or offices claimed to offer fee-only services. Of those, 3 out of 5 were earning commissions or other financial incentives from undisclosed third parties, such as mutual-fund companies or insurance firms.
It may not be enough, the study showed, for a customer to ask planners to turn over copies of their Form ADV, a document required by the US Securities and Exchange Commission, for scrutiny. In many cases, information on fee structures was missing or obfuscated on these forms. To get a clearer picture of how the planners were paid, the CFA had to request copies of Schedule F, another detailed SEC form.
The study suggests that many planners, conscious of growing consumer wariness about conflicts of interest, are deliberately "obscuring the commission-based source of much of their income," Ms. Roper says.
Determining how many financial planners there are in the United States isn't easy, given the many different types of planning groups, says Mark Spangler, president of NAPFA, headquartered in Chicago. Mr. Spangler, who works in Seattle, says he has often heard the figure 200,000, but that includes insurance agents and mutual-fund salespeople. The actual number, he reckons, is closer to 30,000. Of these, only about 5,000 are true fee-only planners, he says.
CFA and NAPFA want to identify the "wolves in sheep's clothing" who call themselves fee-only planners but are not, says Tom Grzymala, a financial adviser and NAPFA official in Alexandria, Va. It is uncertain what action may follow, but the group has trademarked the phrase "fee only."
Genuine fee-only planners are usually paid in one of three ways: They charge a flat-fee, are paid hourly, or require compensation based on a percentage of the assets under management.
In some cases, a fee-only planner will cost more than a commission-based planner. Whatever the underlying cost, the fee-only planner is paid for his or her independence from third parties.
Steps to take
So, what should you do to ensure that your adviser isn't getting hidden incentives?
1. Avoid working with financial planners who are not registered at either the state or federal level, say the CFA and the National Institute for Consumer Education, an educational group based at Eastern Michigan University in Ypsilanti. If planners are licensed to sell securities, the state securities agency can provide a copy of their central registration depositories (CRDs), files that contain information about complaints or unauthorized trades.
2. Ask planners for their Form ADV, which spells out their credentials, background, and how they are paid. Compensation details are found on Part 2. Look for the box titled, "Sells products or services other than investment advice." If the box is checked, the planner is not fee-only. If they have lied on the form, you will have grounds for legal action.
3. Remember that the SEC does not always have the resources to verify accuracy of ADV forms. So, you should still be alert when the planner recommends specific products. If you do buy them, it should be because they match your investment needs.
4. Finally, even a true fee-only planner can overcharge you, for instance by padding hours or charging a high percentage fee. Call several planners to compare. Many fee-only planners don't want to work for people with less than $100,000. If your assets are relatively modest, you might prefer using free advice (from your library or investment-company planning kits) or dealing with a commission-based planner.
To get a free brochure on picking a fee-only planner, call NAPFA at 888-FEE-ONLY.