How to Perform Due Diligence on a Financial Advisor

How to Perform Due Diligence on a Financial Advisor

 

In this complex and often confusing financial world, it is essential to have a trusted advisor who genuinely has your best interests at heart. This is precisely where a fiduciary financial advisor enters the picture. But what exactly does it mean to be a fiduciary? And how does it impact your financial health, life and wellbeing?

 

What is a Fiduciary Advisor?

A fiduciary is a professional who’s ethically bound to act in your best interest, putting your needs above their own. This responsibility transcends the financial world, with doctors, lawyers, accountants, and trustees of trusts all being examples of fiduciaries.

When it comes to financial advice, a fiduciary financial planner or advisor must ensure that their advice is accurate and complete to the best of their knowledge and possibly in conjunction with other professional advisors, maybe a lawyer or an accountant. They’re obligated to avoid and disclose any potential conflicts of interest and disclose all fees and or commissions. Moreover, they are required to make investment recommendations that align with your goals, objectives, and risk tolerances.

 

Compensation Structures of Financial Advisors

When evaluating possible advisors, understanding how financial professionals are remunerated should be key to your decision-making. The compensation structure can directly impact the advice you receive and the costs you incur. Here are some common ways financial advisors are compensated:

 

1. Commissions:

Advisors earn a commission for selling certain financial products or executing trades in your account. However, this can often lead to a conflict of interest if the advisor recommends a product that pays a higher commission rather than one that may be a better fit for your financial situation.

2. Fee-Only:

Fee-only advisors charge a flat fee for their services, often a percentage of the assets they manage for you. This model is used by financial advisors such as Private Capital. To understand our fee structure, click here.

3. Fee-Based:

Fee-based advisors earn a combination of fees and commissions. They may charge a fee for financial planning services and earn commissions from selling products or executing trades.

4. Salary:

Some advisors are salaried employees of a financial institution. They may earn bonuses or incentives based on sales targets or other metrics.

 

Do not hesitate to ask your financial advisor how they are remunerated. Check out our article here with useful questions to ask your money manager.

 

Fiduciary vs Non-Fiduciary

If you’re looking for a fiduciary advisor, consider working with an Independent Financial Advisor (IFA). IFAs are not tied to any specific family of funds or investment products, meaning they’re free to recommend the best options for you. They’re not obligated to push their funds or products that offer them back-end incentives. This independence allows them to provide you with objective, customised financial advice.

IFAs are typically fee-only advisors, which means their compensation is transparent and directly aligned with your success – as your wealth grows, so does their fee.

An example of a non-fiduciary advisor would be an advisor being compensated for placing your wealth into one fund over another. This incentive may not be in your best interest. Imagine the institution or company wants advisors to ‘sell’ a certain fund and in return, the advisor receives a commission for every client buying into that fund. What if the fund has higher management fees? The advisor may still invest your wealth into the fund to be paid a commission. This may not be in the best interests of any client

Conflicting interests can arise when financial advisory firms listed on a stock exchange seek to increase their revenue through higher fees payable to their clients, which may not align with the best interests of their clients. This situation can often create a potential conflict of interest where the firm’s goal of maximising profits clashes with its fiduciary duty to act in the best interest of its client. By increasing fees, firms generate more revenue, leading to higher profits and potentially boosting their stock price, which is beneficial to shareholders by way of dividends.

This approach is generally not in the best interest of the client, as higher fees will erode investment returns and reduce the overall value of the client’s portfolio.

 

Navigating the Fee Maze

This approach is generally not in the best interest of the client, as higher fees will erode investment returns and reduce the overall value of the client’s portfolio. Navigating the Fee Maze When working with an advisor, it’s crucial to understand the different fees you may be charged. Some common fees include:

 

1. Management Fee:

This is the fee charged by advisors for managing your investments. It’s usually a percentage of the assets under management.

2. Trading Fees:

These are fees charged every time a trade is executed in your account.

3. Expense Ratios:

These are fees charged by mutual funds or ETFs as a percentage of your investment in the fund

4. Load Fees:

These are sales charges or commissions that you pay when buying or selling mutual funds. (This does lead to an expensive round-trip)

5. Performance Fee:

Some advisors may charge a performance fee, which is a percentage of the investment gains.

 

Finding an advisor, you trust and feel at ease with is vital, but it’s often not enough. Ask yourself why? “Advisors” may well be salespeople with extraordinary aptitude for putting people at ease and promoting themselves, their concepts, and their products. Therefore, whether or not an advisor recommends something that has a potential conflict of interest has little bearing on how they make you feel. This is why before you act on their advice, you should insist on knowing how and what they will be compensated for.

As long as you are aware of the financial structure, commissions are acceptable. The majority of homes, cars, and life insurance plans pay the salesperson a commission. Similar to this, some financial products do exist without “fees,” such as a bank time deposit but that doesn’t mean the banks aren’t profitable.

 

Why should I Work with a Fiduciary?

An essential component of a fiduciary relationship is transparency. A fiduciary advisor should disclose their fees, how they’re compensated, and any potential conflicts of interest. They should also provide regular, comprehensive reports on your investments and be open to answering any questions you may have.

Fiduciary advisors often follow a comprehensive and holistic approach to financial planning, considering various aspects of the client’s financial life, including repatriation planning, tax planning and estate planning. This comprehensive approach helps clients develop a well-rounded financial strategy tailored to their unique circumstances

Make sure your fiduciary advisor is registered to give advice. All financial advisors need to be registered with the SFC in Hong Kong. Click here to see the public register of licensed persons and registered institutions. Check to see if your advisor has any higher qualifications such as Chartered Wealth Manager or Chartered Financial planner.

Understanding how advisors are compensated and to whom their duty is owed is a good first step to finding the right financial advisor, and guiding and helping you achieve your long-term financial goals. Remember, it’s not just about finding an advisor who is knowledgeable and experienced, but one who genuinely has your best interests in mind.