How to Choose a Financial Planner

A widow just shy of her 90th birthday recently asked me to review her investment portfolio. This happens a lot: Much of my practice involves giving second opinions to other financial planners' clients.

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This widow had a reason to worry. She had been sold two expensive annuities — just about the last thing a 90-year-old needs — and the rest of her portfolio consisted mostly of risky stock funds and junk bond funds. The planner was making a fortune as the widow's nest egg dwindled.

R. Kikuo Johnson

What is your financial planner doing with your money?

A natural reaction would be to file this story next to that of Bernie Madoff or other brazen crooks. But that would be too easy. Like every financial planner I know, the widow's adviser really seemed to believe that she was doing her client a great service. In fact, she considered her a dear friend.

My point is this: Bad advice is epidemic in my industry, and it doesn't come only from villainous fraudsters such as Madoff. It also comes from pleasant, empathetic folks who are merely responding predictably to my industry's perverse incentives and self-serving ethical standards.
 
We financial planners are masters at persuading ourselves that what's in our best interest also happens to be the moral thing to do. By and large, we're good people, which is why we can be so convincing — and so potentially dangerous to your money.

Who I am

I spent 20 years in the business world as a corporate finance officer before becoming a personal planner more than a decade ago. I started my practice because I knew that a lot of the advice families got was mediocre or worse, and I hoped that I could help counteract that.
 
That's also why I write very candidly about how this profession works, and what you should know about it before you seek advice from me or any other planner. (This article isn't a plea for business: I have a long waiting list and don't need to advertise.)

For two years I penned these insights anonymously in a column called The Mole in Money magazine; today I write for the website CBS MoneyWatch and elsewhere, often giving an insider's view of my industry and how it treats its clients.

Sad to say, the worst cases often involve older clients. We planners target you because you have the largest nest eggs, and the more money we manage, the bigger our take. Also — and let me be frank here — you often view your money more emotionally than younger people do, because you have so much at stake. And that makes you vulnerable.

What planners want from you

I'm a certified financial planner (CFP) and a member of the Financial Planning Association (FPA). Roughly 70 percent of the FPA's 23,800 members are CFPs; earning the designation typically requires months of study to pass a reasonably tough exam.

About half of the members have been in business at least 15 years. As an organization, we want to establish planning as a true profession, one seen in the same light as medicine, the law and accounting.

But that's not our only motivation: Planners have financial aspirations of our own. We make money by getting it from you. This isn't evil in its own right. But it is a conflict of interest, and it pervades everything we do.

Initials galore

We spend a great deal of effort trying to win your trust. A CFP is a serious designation, but that's not true of all the strings of initials after our names: At least 100 financial designations are in circulation, each meant to convey expertise in something. Some prove only that the planner passed an easy exam.

One organization, representing the Certified Retirement Financial Advisor (CRFA) designation, solicited me in 2007 to obtain both this “prestigious designation” and to sell me the names and contact information for older people who might want to buy an annuity. (CRFA spokesperson Lynda McColl says that the organization is under new leadership and has not sold names since 2007; its current certification requirement consists of a 100-question test.)

Other businesses will anoint us (for a fee) with even loftier distinctions. For instance, I've received an America's Top Financial Planners award from the Consumers' Research Council of America.

Forbes.com found that the council's Washington, D.C., address was a rented mailbox, and its vetting process is questionable, to say the least: To memorialize my honor, I called the 800 number the council gave me and received a $183 acrylic plaque — bearing the name of my dachshund, Max Tailwag’er. After I wrote about this in my MoneyWatch column, the council contacted Forbes.com (but not me) to demand the plaque’s return.

And there’s the email I recently got from AmericasTopAdvisors.com, telling me I was among the top 1 percent of advisers in the United States. Recipients of this honor are chosen via “peer nomination, industry recognition, or significant press mention,” the message said. To earn this accolade, I had only to pay an annual fee of $995 (minus a 20 percent discount).

How we make money drives what we sell

Advisers make money in two main ways. You need to understand which method your planner has chosen, because that helps explain his or her behavior. We either get a commission to sell you a financial product, or we charge an asset-based fee — typically 1 percent annually of the assets you let us manage.

Commissions can range from a recurring annual fee of 1 percent for some kinds of mutual funds to as high as 10 percent for certain annuities. If we sell you a $100,000 annuity with a 10 percent commission, we get a $10,000 check.

You can’t see this commission the way you can see, for example, a real estate broker’s take when you sell a home. The size of the commission is often reflected only in the penalty you pay if you try to get your money back before the insurance company has had time to recoup the commission.

Obviously, a planner who works on commission would want to sell you products that yield the highest commission — typically, load-carrying mutual funds, hedge funds, private investments and a host of insurance investments, ranging from annuities to universal life.

How sales quotas affect you

A commissioned planner at a big financial firm like Merrill Lynch, Wells Fargo Advisors or MorganStanley SmithBarney might also be under pressure to make a sales quota or to sell particular investment products the firm wants to sell, whether or not they’re the best investment for you. This is not to say that all commission-based planners are out to rip you off; they’re not.

And if you don’t have more than $100,000 or so to invest, commission-based planners may be the only ones who will take your business. But the conflict of interest is particularly stark in the commission business.

Fee-based planning

Another model is fee-based financial planning, which has been gaining ground on the commission model. (About one-third of FPA members say they work for fees only, no commissions.) In theory, charging you 1 percent of your assets each year aligns our interests with yours: We have no incentive to sell you a particular investment just because it brings us a higher commission than another, and if your portfolio grows, so does our fee.

But there are still conflicts. It encourages us to capture as much of your money as we can. That’s why few of us will ever tell you to pay off your mortgage: Using $100,000 to discharge a loan rather than investing it could cost us $1,000 a year in fees.

The fee model also limits where we advise you to invest, since we’ll favor putting you in products set up to pay us automatically each quarter. Few planners will tell you about, say, a higher-paying certificate of deposit at a bank, because banks don’t pay planners. You’ll have to find such investments yourself. (DepositAccounts.com and Bankrate.com both let you compare yields for accounts at banks and credit unions.)

Some of us make money from both commissions and fees. One CFP whose work I reviewed made a huge commission when he sold his client an annuity, then charged 1.6 percent annually to “manage” it. Between the commission, planner’s fees and ongoing costs of the annuity, the client was handing over a whopping 5.29 percent annual fee. Still, the CFP Board did not publicly discipline the planner.

The compensation model I follow is comparatively rare: charging by the hour. I chose it because I didn’t trust myself to be nobler than my colleagues at resisting the financial incentives of the other two models. That said, the hourly model isn’t the best choice for everyone.

It’s not cheap: I charge up to $350 an hour. Other hourly planners can be found through the Garrett Planning Network, a group of more than 300 planners who generally charge $180 to $240 an hour. (I am not a member of this network.)

Hourly planners aren’t immune to conflicts, either. I could rack up billable hours, for example, by telling you I have to actively manage your portfolio. Richard Salmen, past FPA national president, has other caveats. For example, he thinks the hourly model might discourage a client from seeking advice. “It would be like seeing the dentist only when you are in pain,” he says.

The FPA is “revenue neutral,” meaning it takes no position on which fee model is the best. Be aware that no model is conflict-free.

How we sell you

All planners know that the quickest way to your money is through your emotions. To get you to sign up, many follow a five-step system. We invite you to talk about your values and get you excited by discussing your goals. We might ask you to describe your “perfect day,” then help you understand the amount of money you’d need to make your future one long string of perfect days.

Finally, we’ll try to close the deal, which means you commit to hiring the planner and promise to implement the planner’s advice. “I can get you to your dreams of spending time with your grandkids if you let me handle your money now,” the planner might say. “Sign here and I’ll get to work!”

In one hour we’ll try to get you wound up enough to sign your entire nest egg over to us. We know that if you walk out of our office without signing, you may realize how manipulative the session was and never return.

But once you sign and buy some product, you may find it will take years to get your money back without penalties. So don’t even think about signing any document during your first meeting with a planner, even if he or she tells you that you can still back out.

Outright deception

And that is among the more ethical methods planners use to sign up clients. Others use outright deception: Any ad that promises wealth without risk or a high “guaranteed” return is almost certainly a scam.

Have you ever seen advertisements for a CD boasting interest rates far above what banks are offering? They are merely bait-and-switch tactics to get you into our office, where we can sell you other products.

When I complained to the Colorado Division of Insurance about such advertisements in my state, I was told that the ads didn’t violate the state’s insurance law. Be particularly cautious about promises made at a free “educational” dinner. Better yet, skip the free meal altogether; you’ll save a lot more money in the long run.

My advice

It may seem as if I’m trying to drive you away from financial planners. I’m not. Focusing on your financial goals and finding a path to realize them is a valuable, even indispensable service. Most of us do that as well as possible. But understand our limitations.

You should also remember that virtually anyone can fill an office with prestigious-looking credentials and call himself or herself a financial planner. “For seniors, it is the financial equivalent of the Wild West,” says Harvard economics professor David Laibson. “Many so-called planners are free of almost all regulatory oversight or constraints.”

Don’t get ambushed: Follow the tips in a sidebar to this article, “10 Ways to Get the Best Money Advice,” and you should be able to find a financial planner you can trust. But never trust an adviser so much that you follow that person blindly.

Allan Roth is a certified financial planner and CPA in Colorado Springs. He writes for CBS MoneyWatch.com.

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