There are several ways an investor can compensate a provider of financial advice. The important thing to keep in mind is that one form of compensation—whether commission, fee or both—is not inherently better than the other.
Additionally, each form of compensation requires investors to do their homework and decide which model is right for them—remembering that compensation is not, in itself, an indicator of trustworthiness.
Just because an advisor is compensated through commissions does not mean he or she is going to solely recommend investment and insurance products that are going to pay out the biggest commissions. And if advisors are compensated through fees paid by the client, it does not mean they don't have any conflicts of interest. Compensation is certainly one aspect of an advisor's business model that must be taken into consideration, but it is a small part of the bigger disclosure puzzle.
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Disclosure is, simply put, the act of making information known. In the advisory world, that means being completely transparent of all material facts and information that are important in the advisor/client relationship.
You are probably saying to yourself, "Yeah … that makes total sense. Why wouldn't my advisor be willing to divulge this information?" But in my nearly three decades as a financial advisor, I've observed that full and fair disclosure by advisors does not, in fact, always happen. And that is usually to the detriment of their clients.
A good place to start learning about an advisor—if he or she is a registered investment advisor with the Securities and Exchange Commission or a state securities agency—is to review his or her Form ADV Part 2.
This vital document, according to the SEC, requires "investment advisors to prepare narrative brochures written in plain English that contain information such as the types of advisory services offered, the advisor's fee schedule, disciplinary information, conflicts of interest, and the educational and business background of management and key advisory personnel of the advisor."
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While this form is a great place to start, not every advisor has one. That's because those not registered with the SEC or their state—including brokers affiliated with a wire house and insurance agents—are not required to have one. So while having full disclosure in writing is ideal, you need to have a conversation with your advisor, or prospective advisor, to fully understand who she is and how she is going to work for you.
Q&A with your CFP
Here are just a few of the questions I would ask if I were looking for an advisor:
—What financial planning designation(s) or certification(s) do you hold?
—How long have you been offering financial-planning advice to clients?
—What kind of services can I expect?
—Who will work with me from your firm?
—How does the client compensate you, and what do you typically charge?
—Do you have a business affiliation with any company whose products or services you are recommending?
—Are you an owner of, or connected with, any other company whose services or products I will use?
—Do professionals and sales agents to whom you may refer me send business, fees or any other benefits to you?
—Will you provide me with a written disclosure detailing any disciplinary history for you or your firm?
If you have not asked your advisor these questions, you should. The answers to these questions will provide you greater clarity on how advisors operate and what they are going to do for you.
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If you want to access a full list of 35 questions to ask your advisor, the Financial Planning Association developed a free resource that provides investors with those key questions.
How an advisor is compensated—commission, commission and fee, or fee-only—is important, but it is far from the only telltale sign of a truly qualified professional.
It's essential for investors to stop and think about everything that makes an advisor qualified to give financial advice. That's why it's important to be prepared and ask the right questions.
—By Janet Stanzak Special to CNBC.com. Janet Stanzak, a certified financial planner, is the president of Financial Empowerment in Minneapolis. She is also the 2014 President of the Financial Planning Association.