In many professions, like law and medicine, you know exactly what to expect from your providers.

In other words, if you see your Doctor, you expect them to advise you on how to stay healthy or get healthy if you're experiencing an illness or injury. Likewise, if you visit an attorney, they will provide legal advice and help you interpret laws or create contracts.

But when it comes to working with a Financial Advisor, the reality is not so simple.

You may go to a financial advisor expecting to learn ways to improve your financial situation and get on track for early retirement, or even double your money through investing, only to be pitched a complex and costly life insurance or annuity product that you may not need.

What gives?

Why is it that some Financial Advisors seem like pure salespeople, solely focused on pitching a product, while others can be deep experts in their field and will help you design and build a custom financial plan tailored to your unique goals, hopes, and dreams?

The reason why boils down to two unique phenomena in the financial planning industry:

1. (Almost) anyone can call themselves a financial advisor. So while you may rest assured that your Doctor or Lawyer is bound to specific standards of care, advice, and educational achievement, that's not the case for Financial Advisors.
2. Different advisors get compensated in different ways. Warren Buffett's business partner and one of the greatest investing minds of all time, Charlie Munger, said, "Show me the incentive, I'll show you the outcome." When working with an advisor, it is critical to understand how they get compensated when evaluating their advice and recommendations. The way they get paid creates an incentive for them to recommend certain things.

(Almost) Anyone Can Call Themselves A”'Financial Advisor”

For various reasons, the financial planning profession hasn't yet reached the same level of maturity as law, medicine, or even accounting. In other words, you can have zero experience, zero credentials, and zero educational background and still hang up a sign as a Financial Advisor. 

And to make matters more confusing, you don't even have to offer financial advice — you can simply be an insurance salesperson or financial product sales agent.

"It's quite interesting how the world of financial services works," says Leonard Kim of AdvisorCheck. Many people will get hired from companies thinking that they are in fact, a financial advisor. However, when you thoroughly look at what they are hired to do and what services are in their rolodex to offer to their clients, they could be highly skewed in the direction of what a registered insurance broker would provide," Leonard continued.

In contrast, if you want to hold yourself out as a physician, attorney, or accountant, you must fulfill a series of educational, experience, and fiduciary duties before you can legally use those terms to describe your services.

So, just because one of your pickleball buddies says they are a financial advisor does not mean they can help you design a custom financial plan to reach all your goals and more. Instead, it might mean that they have just started a brand new job selling insurance, and they don't actually know much at all about retirement, investing, and tax planning, but they know a list of products that they get paid to sell and a couple of interesting angles that they can use to pitch those products that were covered in their 1-week training.

What is worse is that a lot of people who do end up going forward with a life insurance policy with a financial advisor often get one that is overfunded. 

“Overfunding a life insurance policy is typically something that helps the 1 percenters in society,” says Luke Turner, CFP®, founder of JL Strategic Wealth. “For the other 99 percent of people out there, this typically doesn’t work out for them. What usually happens is most people buy an ineffective investment that is typically not suitable for their financial lifestyle, that more often than not, typically ends in a surrender charge,” Luke continued. 

If you are being told you need to get a whole life insurance policy that pays you out during your retirement years, be wary. 

“The dividend portion of a whole life policy is a portion of the overfunded premium paid back to you,” says Carter McClung, CFP®, CSLP®, a financial planner at Blue Rock Financial Group. “That means if you’re offered a whole life insurance policy as a retirement vehicle, you are paying a hefty premium up front for it that might not make sense, whereas other investment vehicles could make a lot more sense to generate similar types of returns during retirement that are much safer and have a much lower rate of being surrendered before being able to utilize their benefits. A surrendered policy ultimately does not pay a dividend, nor a death benefit, because it gets abandoned completely by the carrier of the policy.” Carter continued. 

That's why it's so important to choose a Financial Advisor who is highly qualified and fully understands your individual financial needs. 

Make sure you know exactly what credentials they have, their investment philosophy, and whether or not they offer comprehensive financial planning services. It's also essential that you feel comfortable with the advisor—you should be able to trust them with your hard-earned money.

One of the best ways to do that is by looking for the CFP® (Certified Financial Planner) designation. 

A CFP® Professional is a financial planning professional who has passed specific education, experience, and industry exam requirements to obtain the credentials of a Certified Financial Planner. And the best part—they've also sworn a fiduciary oath to act in the best interest of their clients at all times—so no product recommendations just to earn a commission. No, a CFP® Professional acts in your best interest to design, build, and deliver financial planning recommendations to help you meet your specific financial goals.

In addition, it’s essential to understand the difference between an RR (Registered Representative) and an IAR (Investment Advisor Representative). 

Essentially, an Investment Advisor Representative is held to a fiduciary standard of care, similar to a CFP® Professional, while a Registered Representative is held to a lesser standard of care, known as the suitability standard. For example, when receiving advice from an Investment Advisor Representative or CFP® Professional, you can rest assured that the advice is always in your best interest, because of the fiduciary standard of care. Alternatively, when working with an RR, they can make recommendations that would be suitable for someone in your similar situation, even if it isn’t exactly in your best interest or the best fit for you. 

To complicate matters further, some advisors can be dually registered as both an Investment Advisor Representative and a Registered Representative — adhering to the fiduciary standard at times and the suitability standard at others. 

If you need help finding a trusted financial advisor, we've got you. We've built a proprietary search tool with over 1 million US Financial Advisors complete with all the specific information you need to know about their experience, credentials, services, compensation structure, and more.

Now, back to Charlie Munger and the power of incentives.

Different Advisors Get Compensated In Different Ways

One of the primary reasons you may have been sold a life insurance product when you wanted a financial plan is because the 'Financial Advisor' you went to see only gets paid when you purchase a financial product. This is known as a "commission-based" Financial Advisor, and they make their money in an interesting way.

Here Are The 3 Advisor Compensation Structures

1. Commission-Based Advisors.

Unlike a lawyer or physician, who would charge you directly for providing legal or medical advice, a commission-based financial advisor typically doesn't charge you anything to offer financial advice. 

Instead, they get a kickback or commission from a third party when they sell you a product. 

And typically, the higher the premium or 'cost' of a financial product, the higher the kickback. So, if your Financial Advisor gets paid on commission and can sell you a really expensive life insurance policy or annuity, they've got an incentive to do so. Of course, that doesn't mean they'll always try and sell you the most expensive products. However, it is important to be aware of the incentives at play and evaluate their advice accordingly.

2. Fee-Based Advisors.

Next, a fee-based advisor is a kind of hybrid model. 

On the one hand, they earn income by charging fees directly from their clients, but on the other, they receive kickbacks from selling certain financial products or recommending specific mutual funds, just like a commission-based advisor. Generally, this is viewed as having less of a conflict of interest than a commission-based advisor, but those conflicts can still arise as your advisor may have strong incentives to steer you toward certain products based on the commission structure.

3. Fee-Only Advisors.

Lastly, in recent years there's been a strong shift towards a fee-only compensation model for Financial Advisors. 

Essentially, a fee-only advisor only gets paid directly by their clients for offering financial advice. 

No third parties, no kickbacks, no commissions. The idea is that by getting paid directly by their clients to do work directly for their clients, advisors can remove many of the conflicts of interest that come from getting paid commissions to sell products. For obvious reasons, many in the industry view this as the optimal compensation structure to align clients' needs with the advice they receive from their Financial Advisor. 

But, it's not without its conflicts.

For example, most fee-only advisors choose to manage their client's investments and charge a percentage fee on the assets they manage. So, a typical fee-only advisor may charge 1% in fees. This means if they manage $1 million dollars for you, they would charge you $10,000 per year. ($1,000,000 x 0.01 = $10,000) 

This is called AUM fees or assets under management fees, and it is the primary way fee-only advisors get paid. 

But, if your advisor gets paid more money by managing more of your investments, then they have a strong incentive to steer you towards investing with them versus alternative investment options like real estate. For example, using the scenario above, if you decide to take half of your $1 million portfolio and buy real estate instead of investing with your advisor, you've just cut your advisor's fee in half to $5,000 per year.

However, within the fee-only compensation model, there's an additional wave of advisors that are shifting toward advice-only or flat-fee models that have nothing to do with assets under management. The premise is simple and direct: you pay a flat annual fee for financial advice based on the complexity of your situation. And for many, your fee is the same whether you want your advisor to manage your investments or not—it's all included in their flat annual fee. This appears to be another step in the right direction to help reduce conflicts of interest.

In the end, it's critical to recognize that the financial planning profession is complex and unique. 

So, when hiring an advisor, you must understand the various forces at play and begin the process with a good understanding of the common pitfalls and risks associated with finding the right advisor. That's why AdvisorCheck can be a useful tool. It helps you verify the credentials, background, and even the fee models of potential advisors before you commit to working with them. With proper due diligence, it's possible to find a financial advisor who meets your needs and charges a fair rate.

With your free membership, you will not only get the best financial resources possible to make sure you are on track, but you can also search for a CERTIFIED FINANCIAL PLANNER™ professional (CFP®) in your area who takes a holistic approach to personal finance with our database of over 1 million US Financial Advisors.

Written by Anders Skagerberg, CFP®

Reviewed by KJ Kim

Fact checked by Billy Quirk

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The information provided in this article was written by the research and analysis team at AdvisorCheck.com to help all consumers in their financial journeys, by providing the resources and the insights to help improve one’s financial health, make it through recessionary and inflationary periods of time, and save their earnings to use them towards building a secure financial future. 

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