Navigating the financial needs of millions of American’s is a daunting task, but one the financial industry is certainly willing to try. According to research group Cerulli Associates, there were roughly 285,000 financial advisors in 2014, vying to manage the $84.9 trillion of America’s net worth.1, 2 So, as you’d expect, the wealth management business is highly competitive and constantly evolving.
What is a Financial Advisor?
Financial advisors (aka financial planners, wealth managers, stockbrokers) are licensed professionals that offer investment advice and services to various clients. They devise investment strategies, execute transactions and offer a myriad of financial products to meet the unique goals of their clients.
Most advisors work for larger, recognizable names but there is a trend towards financial advisors going independently and starting their own firm called Registered Independent Advisors (RIAs). Today’s financial advisor looks nothing like the stock brokers calling hot tips to clients as depicted in the movies. Now, advisors develop comprehensive financial plans encompassing different asset classes, both domestic and international, including equities, fixed income and real estate. Further, today’s advisors offer exposure to alternative investments like hedge funds, commodities, private equity, real estate and insurance.
Additionally, financial advisors are expected to act as fiduciaries for their clients, meaning they put the client’s interests above their own, always. This standard has been in place since the Investment Advisors Act of 1940. In the wake of the 2008 financial crisis, Dodd-Frank Reform Act increased the standards for advisors and brokers. There is some gray area as to which types of advisors fall under this scrutiny. But the trend is clear towards increased regulation of advisors, for the protection of their clients. The trend seems to be heading towards one uniform fiduciary standard.
Who Needs a Financial Advisor?
The demand for financial services is enormous because there are so many financial needs a person encounters over their life. These needs range from banking services, college savings plans, buying a house, marital concerns, retirement planning, tax planning, risk management products and estate planning. With the complexity in meeting all these future needs, many people enlist the services of financial advisors who, if properly licensed, can address these. In the wake of the financial crisis, many people just feel more secure having their investments watched over by a licensed financial advisor.
One example of the role of a financial advisor can be seen with the baby boomers. With persistent low interest rates, it’s difficult to find investments that pay off. Financial advisors can offer, vet and provide access to various structured products, risk-management insurance products like annuities, all designed to provide above-market rate income to the purchaser.
Some may wonder why they need the services of a financial advisor. Some people certainly invest on their own and many invest passively, meaning they replicate a broad index like the S&P 500. Investing in this manner probably doesn’t require professional advice. But with the complexities of the various products, especially for high net worth or accredited clients, is easier to navigate with an advisor. Additionally, certain types of investments require a financial advisor for purchase. Participation in IPOs, private partnerships, many structured products and insurance related investments are examples of products that need to be purchased through advisors.
What are the Required Skills and Credentials of a Financial Advisor?
Financial advisors are highly motivated professionals with an entrepreneurial spirit. They are becoming quite tech savvy and over 80% use social media for their business, according to a study by Putnam Investments.3 Even when they work for a large firm, they, or their group, are their own entity within the organization. The wealth management business weeds out advisors that aren’t meeting production goals and quotas. Younger advisors must be able to handle these stresses and persevere while building a business.
Financial advisors are regulated by FINRA, the Financial Industries Regulatory Authority, and the SEC, Securities and Exchange Commission as well as various state financial and insurance regulatory bodies.
Financial advisors are required to pass various exams designed to make sure an advisor understands the financial markets and how to determine the suitability of the investments or investment strategy for his clients. These licensing exams lean heavily heavy on the ‘Know your Client’ premise when determining the suitability of investments. These unique factors include the client’s financial situation, tax implications, investment objectives, risk tolerance, liquidity needs and any other material information about the client. Passing these exams gives you licenses to sell various investment products.
There are different licenses required to offer different services but the most comprehensive is the General Securities Representative Exam or Series 7.4 A financial advisor will probably continue to obtain additional licenses to expand their business. Many are becoming dual-licensed so they can sell securities and also insurance products including variable annuities (Series 6, Series 65). When selling insurance products, the advisor will also have to obtain a life and health insurance license at the state level.
Financial advisors are also thoroughly background checked and can be verified by any customer or potential customer by using FINRAs ‘broker check’ website feature.5
What is the Compensation like for a Financial Advisor?
Financial advisors are handsomely rewarded for their efforts as the median annual compensation for a financial advisor is $90,000, according to Payscale.com.6 This compensation varies widely, with some financial advisors making many multiples more and some much less. There is a high attrition rate for financial advisors, especially in the first few years. Racquel Oden, head of Merrill Lynch’s advisor strategy and development program says just 35% of new financial advisor trainees at the firm stay on long-term.7 Nevertheless, given the aforementioned compensation figures, a post-crisis rebound in the financial markets and the favorable demographic trend of millions of baby boomers approaching retirement, the financial and insurance industry is expected to growth by 30% through 2018.8
There has been a shift in the way advisors have been compensated over the years, moving towards a more fee-based structure and away from a commission-based structure. There is still the stigma of commission-based compensation structures as ‘sales’ practices that may be at conflict with the client’s interests. Many advisors don’t enjoy this sales stigma either, although some sales are inevitable in the course of business. Gone are the days of high commissions and high turnover stock trading with gouging commission rates. After the security was purchased, and the hefty commission paid, the broker didn’t have much incentive to worry about the stock’s performance within the account.
With the fee-based structure, the theory is that the advisor and client’s interests are better aligned (with the goal of long-term positive returns). Advisors charge what’s referred to as a ‘wrap-fee’, a certain percentage of the assets under management typically around 1% of assets annually for their services. As an example, a financial advisor managing a $1 million dollar portfolio for a client would charge $10,000 annually. (The full amount wouldn’t go to the advisor as he’d have worked out some split with his firm). As client assets grow, so does the advisor’s compensation. If this account gets up to $5 million, the fee becomes $50,000 annually.
Some financial advisors get paid by a mix of these two or also a salary and bonus from the company depending on their experience and performance. Many financial products that are offered to the clients from outside sources, such as mutual funds from fund companies and annuities from insurance companies have different commission structures for the financial advisor. Some clients get frustrated trying to understand how their advisor’s get compensated. The trend is growing towards greater transparency and simplicity with advisor compensation.
Even when they work for a large firm, they, or their group, are their own entity within the organization. Sometimes, advisors feel like they get the short end of the stick in some compensation split agreements and leave to start their own independent firms. To retain top talent, firms are adjusting their compensation packages accordingly.
How do I Become a Financial Advisor?
Wealth management is a very lucrative business and is a growing profit engine for many banks. Consequently, many firms actively pursue financial advisors at designated career events where recruiters meet with interested parties. They are low-key meet and greets, often referred to as ‘open houses’ or ‘opportunity dinners’ where prospects have questions answered and hear from current financial advisors first-hand about the opportunities and challenges they’re likely to face and whether this is the right path for them.
If the idea of being a financial advisor sounds appealing, here are some steps to take. First, you have to decide whether you’re trying to join an established firm or go out on your own as an independent advisor. Becoming an ‘independent’ advisor is a growing trend but if you’re new to the industry you’ll probably want to gain some experience (and clients) before going it alone.
To be hired by an existing firm, you’ll typically need at least a bachelor’s degree and a Master’s degree is preferred. Also important is a demonstrated ability to sell or show an existing network of friends, family and professional contacts to tap. The wealth management business is highly competitive and the majority of financial advisors don’t make it five years in the business. But many firms do provide training, support and development to provide the advisor the best chance of achieving a sustainable business. Sometimes, candidates join established teams as junior partners while they learn the ropes. Finally, you’ll need to prepare for and pass various licensing exams to be able to offer advice and services to the public.