In this podcast I will answer the question: How do I pick a financial advisor? How are financial planners compensates? What certifications or degrees should I look for?
Podcast #9 can be found below. You can also see our video on the same topic.
If you feel like you need support with your finances, there is no shortage of financial advisors. One of the most important things to know is how they are being compensated. Unfortunately, financial investment firms are often very unclear about the cost of their services and investment products. This lack of transparency and concealing of fees is an unfortunate reality. PBS Frontline did a nice story about investments and advisors called the Retirement Gamble. One of their lessons was that commissions and fees can add up to significantly reduce your overall return on investments.
There are many ways investment firms get compensated. They may receive: sales loads, surrender fees, management and administrative fees, 12b-1 fees, transaction fees, redemption fees, brokerage fees, inactivity fees, transfer fees, market impact costs and more. These fees directly reduce the return on your investments – they are costing the investor money. Many financial professional are being compensated for selling products, such as annuities and life insurance, that may not be appropriate for their client.
Four types of common fees for mutual funds are described below.
12B-1 FEE – ongoing ‘hidden’ sales fee
Mutual-fund investors paid about $9.5 billion last year in 12b-1 fees. The 12b-1 is an annual marketing fee used to reward intermediaries for selling a fund’s shares – it is paid by mutual fund companies to the brokers who sell their funds. The 12b-1 fee is considered an operational expense and is included in a fund’s expense ratio (check the expense table in the fund prospectus for the existence and magnitude of a 12b-1). It is generally between 0.25-1% of a fund’s net assets. The fee gets its name from a section in the Investment Company Act of 1940.
This fee is being questions because it is not a disclosed fee and many people are unaware of or don’t really understand these charges, which are subtracted from fund assets.
FRONT-END LOAD – sales charge for buying a fund
Associated with Class A shares of a mutual fund, known as a Sales Charge, this is a fee paid to the brokers that sells the fund. Front-end loads reduce the amount of your investment. For example, if you have $10,000 to invest it in a mutual fund with a 5% front-end load. The $500 sales load you must pay comes off the top and goes to the broker who sold you the fund, and the remaining $9,500 will be invested in the fund. The Maximum sales load is 8 1/2%.
BACK-END LOAD – sales charge for selling a fund
Associated with Class B mutual fund shares, known as a Deferred Sales Charge, this is a fee paid to the brokers that sell the fund when shares are sold. Back-end loads start with a fee about 5 to 6 percent, which incrementally discounts for each year that the investors own the fund’s shares. The rate at which the fee declines is disclosed in the prospectus. B shares have higher annual expense charges. Hence, even though the back-end load decreases with them, the investor is paying a higher annual fee (reducing their investment return) each year.
CLASS C SHARES
Class C mutual fund shares do not have a sales load, such as purchase fees, redemption fees, exchange fees, and account fees. However, Class C shares have the highest annual expense charges – this directly reduces the return you receive on your investments.
Eighty five percent of all financial advisers and financial planners are really just brokers or salesman. Their incentive is to sell you a product that makes them a higher commission, not necessarily a product that maximizes your chances of saving more. Only 15 percent of advisers are fee-only “fiduciaries” — advisers who by law must operate with your best interests in mind.
Fee-only advisors work in a number of different ways, including:
– hourly (you just pay for the time the advisor works for you),
– assets under management (pay a percentage, usually about 1% per year of the assets being managed),
– lump sum (a fixed quarterly or monthly fee depending on the complexity of your situation).
If you just need a check up and some occasional guidance, consider an hourly or short term lump sum arrangement.
Fee-based is not the same as fee-only. Fee-based advisors collect a commission and a fee from their clients. Fee-only advisors do not receive any commissions and do not sell product.
The National Association of Personal Financial Advisors (NAPFA) is the nation’s leading organization of Fee-Only comprehensive financial planning professionals. Since 1983, NAPFA’s ranks have enjoyed steady growth, operating under a strict code of ethics and our widely recognized definition of Fee-Only compensation. NAPFA members are trusted, objective financial advisors for consumers and institutions alike.
Individuals join NAPFA to enhance skills, market services and be a part of a collective, influential voice on matters that affect them and their clients.
Another designation to look for is a CFP (Certified Financial Planner). In addition to investing, a CFP can help you with retirement projections, tax planning, insurance review, estate planning, and education planning. Depending on your situation, this may be important.
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