How To Evaluate A Financial Advisor (2024)

Working with a good financial advisor can have a profound impact on your financial life. It can mean the difference between retiring at 55 or working until you are 70. It can affect whether your children go to their dream college or end up graduating with six-figure student loans. It can even help you avoid financial strain on your relationship and keep you happily married.

But how do you evaluate a financial advisor? Most people ask their friends and family for recommendations, but how do you know that who they recommend is qualified? To properly evaluate a financial advisor, you should consider how they are paid, what their qualifications are, their track record and the scope of their practice.

Are They a Fiduciary?

The first thing you will want to know about any financial advisor is whether they are a fiduciary. A fiduciary advisor is required to act in your best interest at all times, regardless of how it affects their compensation. They must disclose any conflicts of interest and provide transparent and detailed information on their fees.

By contrast, non-fiduciary advisors only have to follow a “suitability” standard, meaning any products they recommend simply have to be suitable rather than the best option.

Always Follow the Money

How your financial advisor is paid is another one of the most important things you need to evaluate. Financial advisors are typically compensated through commissions, flat fees or as a percentage of your money invested with them—referred to as assets under management, or AUM. Fiduciary advisors cannot make money from commissions.

If you are unsure how your advisor is being compensated, simply ask them how they make money. If their answers are hesitant or opaque, that is a red flag.

• Commission-based. Commission-based advisors make money when you buy a product like life insurance or mutual funds from them. As a result of this model, these advisors have a financial incentive to steer you toward products that net them the most money—even if that product is not necessarily the right choice for you.
• Fee-only. Fee-only advisors charge hourly fees, annual fees or AUM fees, and they do not earn commissions of any kind. Advisors who are fiduciaries are required to be fee-only. The National Association of Personal Financial Advisors, or NAPFA, says the fee-only compensation structure is the “most transparent and objective method” for an advisor to use.
• Fee-based. Fee-based advisors not only charge an AUM or hourly rate to provide their advice and answer questions, but they also get paid commissions. This makes them a hybrid version of a fee-only and a commission-based financial advisor. Like commission-based advisors, fee-based advisors are not fiduciaries. In addition to being paid by their clients, they also receive commissions from certain products that they recommend.

If your advisor is charging an AUM fee, take some time to do the math. Even a seemingly small 1% to 2% AUM fee can add up to hundreds of thousands of dollars when compounded in your portfolio over a lifetime.

Check Their Credentials

“Financial advisor” may seem like the type of title one has to earn through substantial study and training, but unfortunately, that’s not the case. There is no governing body that regulates the term, so you could be working with someone who has less experience, education and training than your favorite bartender.

It is vital to check the credentials of any advisor who you are considering working with. Ideally, you will find someone with an alphabet soup of qualifications after their name. However, not every credential is created equal, and the credentials you should prioritize depend upon your individual situation and goals.

For example, a CDFA is a certified divorce financial analyst. That qualification may not be especially helpful to the average person, but a CDFA’s skills are relevant if you are trying to map out a pre- or post-divorce financial plan.

Within the realm of financial planning, a certified financial planner, or CFP, is one of the best designations you can look for. A CFP must complete an education program, pass a rigorous exam and gain 4,000 to 6,000 hours of training to qualify. Also, all CFPs are fiduciaries, meaning they have a legal and ethical obligation to serve your best interests.

Professional Organization Membership

In addition to credentials, you should look for advisors who belong to high-quality professional organizations with minimum standards for membership.

The XY Planning Network is composed of fee-only financial planners who are not allowed to earn commissions and must hold a CFP designation.

The Garrett Planning Network includes hourly-based, fee-only fiduciary financial advisors with no investment minimum who have or are working toward a CFP or CPA with a personal financial specialist designation, also known as a PFS.

Also, NAPFA requires all members to function in a fee-only capacity and serve as fiduciaries.

Have They Had Any Regulatory Problems?

It is important to know if your financial advisor has had any regulatory issues in the past, such as complaints from clients or disciplinary actions.

You can view individual broker details through the SEC’s Investment Adviser Search tool. This tool is free to use. It will show a list of the advisor’s registrations and licenses, industry exams that they have successfully passed, details on their past employment, customer disputes and any regulatory or disciplinary events.

If you are unable to find a given advisor on the SEC’s site, you can search state-registered advisors by calling the North American Securities Administrators Association or visiting the NASAA website.

Review Past Performance

Although financial advisors can do much more than manage your investments, it is important to consider how well they will manage them. Past performance is never a guarantee of future results, but it can give you a good idea.

If there is a financial advisor you or a family member have been working with for a while, review your returns over a period of one, five, 10 and 15 years. Compare the performance of your investments to market benchmarks like the S&P 500 or the Russell 2000.

Depending on where you are in your investment plan, your portfolio may not line up with the major indices. But if the performance of your portfolio is significantly lower than the typical benchmarks, ask your advisor to explain why.

It may be that your advisor chose a more aggressive portfolio allocation to help you take advantage of higher returns and higher risks while you are young, which can cause you to experience more significant fluctuations. Or, if you are nearing retirement, your portfolio may be allocated to more conservative investments with lower returns and lower risk, such as bond funds.

If you are considering working with an advisor, ask them to provide examples of their return rates after fees for other clients with a similar risk tolerance.

Determine Their Scope

Some financial advisors will only work with you on limited projects, while others provide more holistic financial planning. For example, AUM or commission-based advisors may not help you with things like deciding how much money to put in your 401(k) every paycheck or which student loans to pay off first.

If you need help optimizing the entirety of your financial life, pick an advisor who is full-service and has experience in multiple areas. At the very least, you will want someone who works with a team that has broad experience.

Over the course of your lifetime you could need help with any or all of these issues:

• Debt management
• Credit card debt
• Student loans
• College savings
• Home buying
• Tax optimization
• Insurance planning
• Legal issues
• Investment properties
• Estate planning
• Charitable giving
• Retirement planning
• Benefits planning
• Elder care
• Disability
• Salary negotiations

Consider which situations you could need assistance with when evaluating a financial advisor. Have they worked with people on these issues before? Do they have people on their team they can refer you to, or do they seek outside help when they need it?