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Checking out an Investment Adviser: Form ADV Part 2

If you’re shopping for fresh parsley, you won’t find it by searching in the freezer aisle.

And yet people do this all the time when it comes to looking for financial professionals — or when recommending them to others.

For instance, on the Bogleheads forum, you’ll often see:

  • People asking about a robo-advisor (e.g., Vanguard Personal Advisor Services) when what they’re looking for is financial planning, or
  • People recommending an advice-only planner (e.g., Mark Zoril or Jon Luskin) to somebody looking for an advisor that will manage their portfolio.

To back up a step, registered investment advisers (RIAs) can be broadly grouped into three categories based on what services they offer:

  • Those that are “advice-only” (i.e., they provide planning but do not actually manage the client’s portfolio),
  • Those that provide investment management only, and
  • Those that provide financial planning as well as investment management.

(To be clear, this is only one way to group such professionals. They can also be grouped based on how they charge: hourly, flat fee, percentage of assets, etc. Or they can be grouped based on expertise; to draw a medical analogy, some financial professionals are specialists with deep expertise in a sub-field of financial planning, whereas other professionals are more akin to general practitioners.)

Before considering a specific advisor (or recommending a specific advisor to somebody else), it’s important to know what services are being sought. Are we looking for just investment management? Are we looking for just financial planning? Or are we looking for both? Any of those three options is perfectly valid, but you must know the answer, otherwise our parsley shopper is going to end up in the freezer aisle looking at a bunch of tasty treats but very few herbs.

Once you do know what you’re looking for, how do you know which category a given advisory practice falls into? You read the firm’s Form ADV Part 2 (a.k.a. “Part 2 Brochure”).

What’s Form ADV Part 2?

Form ADV is a form that investment advisers have to file with the SEC. Part 2 of the form contains most of the important information that you’d want to know about an investment adviser. For example, you can see:

  • How the adviser charges for their services (hourly, fee-for-service, percentage of assets under management, etc.),
  • How much the adviser charges for their services (e.g., if it’s hourly, what is the hourly rate?),
  • What services the adviser offers (e.g., if you’re paying 1% per year, are you getting comprehensive financial planning? Or is it just portfolio management, and you would have to pay extra for other financial planning services?), and
  • The adviser’s investment philosophy (i.e., how they pick investments and how they allocate between those investments).

What’s nice about this form is that it’s a way to get the relevant information quickly, without having to filter through a bunch of sales talk (as you would often have to do if you visited the adviser’s website), and without having to give the adviser your contact information.

For instance, if you’re wondering whether PlanVision provides investment management, their Form ADV Part 2 has this very clear statement: “PLANVISION’s services are limited to providing investment advice only and not asset management services to Clients.”

And if you’re wondering whether Vanguard Personal Advisor Services provides comprehensive financial planning, you can find this statement in their Form ADV Part 2: “The Services are not intended to provide comprehensive tax advice or financial planning with respect to every aspect of your financial situation.” Elsewhere it states more bluntly, “We don’t provide tax advice.” (Vanguard PAS is basically portfolio management, plus a basic level of advice relating mostly to the portfolio.)

How to Find an RIA’s Form ADV Part 2

Downloading an RIA’s Form ADV Part 2 is easy:

  1. Go to the SEC’s Investment Adviser Search website.
  2. Look up the adviser by firm name.
  3. Click “more details” then “Part 2 Brochures.”
  4. If necessary, click the link for the most recent brochure filed.

Looking up a registered investment adviser’s Form ADV Part 2 should certainly not be the only research you do on an adviser. But it’s an excellent first step to quickly check for things that would eliminate the adviser from consideration (e.g., they don’t offer the service you’re seeking, they have an important conflict of interests, their fees are too high, they have a minimum asset level that you don’t meet, or they have an investment philosophy that’s markedly different from your own).

What is Comprehensive Financial Planning?

A reader writes in, asking:

“I’m currently ‘in the market’ for a financial planner. I’m looking at many different options, because I’m still a little unsure about exactly what I’m looking for. One phrase that I keep seeing is ‘comprehensive financial plan’ or other similar wording. What exactly would that include? On the one hand comprehensive sounds good. I don’t want anything important left out. But I also worry about the possibility of overpaying for services that I don’t really need.”

Financial planning includes several sub-topics. The following list is from the AICPA’s Statement on Standards in Personal Financial Planning Services. (Different sources have slightly different lists of sub-topics. For example, some omit elder planning or charitable planning.)

  1. Cash flow planning
  2. Risk management and insurance planning
  3. Retirement planning
  4. Investment planning
  5. Estate, gift, and wealth transfer planning
  6. Elder planning
  7. Charitable planning
  8. Education planning
  9. Tax planning

Of course, for a given household at a given time, not all of those topics will be equally important.

But, whether you’re doing your own planning or working with a professional, those are the topics that should be addressed on an ongoing basis — unless there’s a clear reason to exclude certain topics. (For example, if you have no kids, no plans for kids, no student loans, and no plans to go back to school, you have no need for education planning.)

The truth is, there’s no way for one person to have a deep level of expertise in all of those topics, even if the person is a full-time professional with a ton of letters behind his/her name. There’s simply too much material.

Ideally, the financial planning field would work like the medical field in this regard.

For instance, there are outpatient dermatology practices that do what they do, and they’re good at it. But nobody at such a practice is going to perform your colonoscopy. And you know that without even needing to ask.

And there are big hospital systems. They have radiology, oncology, anesthesiology, you name it. But it’s not one single professional doing all of those things.

And with regard to the individual physicians, there are specialists with clear areas of expertise. And there are primary care physicians who know something about all of the various specialties, but they recognize the limits of their expertise and they regularly refer out to specialists as necessary.

Ideally financial planning would function similarly.

There would be broad financial planning practices with a team of professionals with expertise in various areas, with the goal of keeping everything “in house.” And there would be smaller practices, specializing in various areas and regularly referring to each other.

And financial planners (and financial planning practices) would make it clear that they do offer this and they don’t offer that.

What makes me nervous are the solo practitioners who offer “comprehensive financial planning” and rarely refer out to other professionals. I do not understand how a person can in good faith assert that they have deep expertise in all of the above topics.

Why Do Advisors Recommend Complex Portfolios?

A reader writes in, asking:

“After talking to a few investment advisors who I’m considering using, as well as reading articles and books written by other advisors, it really appears to me that advisors create portfolios that are more complex than is really necessary. Do you see that as well? And if so, why do you think that’s the case?”

I do agree that many advisors tend toward complex portfolios, but I will also note that there are some who like to keep things simple. For example, most of the advisors from the Garrett Planning Network with whom I’ve spoken are fans of very basic “total market” index fund or ETF portfolios. The same goes for various advisors from the Bogleheads community, such as Allan Roth, Rick Ferri, and Jon Luskin.

But let me back up a step first. There’s isn’t necessarily anything wrong with a complex portfolio. The primary drawback of portfolios with many moving pieces is simply that they’re more work to manage. But if you already know that you intend to hire an advisor to manage the portfolio for you anyway, that’s a non-issue.

I think there are three possible reasons for the preference for complex portfolios among advisors.

The most positive possible reason is that advisors are in fact better informed than DIY investors, and their preference for more complex portfolios is simply the result of better information. Frankly, I have my doubts. I’m unconvinced that a sliced and diced portfolio with 7-10 different funds is meaningfully better than a simple three-fund portfolio.

Then there’s a more neutral reason — one based on simple human nature. As people who were drawn to working in the financial services industry, it’s likely that advisors think portfolio construction is neat. It’s fun. So they have a natural inclination toward portfolios with many different holdings.

Finally, there’s a more negative/cynical explanation. It has to do with marketing.

By showing you a complicated portfolio and the research behind it, an advisor looks smart — or at least, that’s how many prospective clients would see it. Compare that to, for example, the opposite end of the spectrum: if an advisor told you they were going to put your money into a target-date fund, many people’s natural response would be “well then why am I even hiring you?”

And presenting you with a complicated portfolio is almost a no-lose proposition from the perspective of the advisor. If it helps with the sales process, it means more clients and more revenue. And the additional complexity is not a major drawback for a full-time professional with portfolio management software.

And the complexity provides a degree of client “stickiness.” That is, if you’re already somebody who is inclined to have an advisor manage the portfolio for you, the more complicated the management of the portfolio appears to be, the less likely you are to want to switch to a DIY approach at some point.

Do You Need a Financial Planner?

A common refrain in the realm of DIY personal finance is that by the time you know enough about investing to be able to pick the right type of advisor, you likely don’t need an advisor.

If we’re only talking about investing, I think that’s true. The more you learn about investing, the more you realize that a very simple approach (i.e., a portfolio with a few low-cost index funds or ETFs) is quite possibly the best approach. Or, if it isn’t the best approach, it’s at least close.

And no, you probably don’t need professional help to manage a simple index fund portfolio, especially if you’re still in your “accumulation” stage. (Though even then, a person might still choose to delegate such responsibilities.)

The financial planning industry grew out of the stock brokerage industry, so many people still think of financial planners as “people who give investment advice.” But investing is only one piece of personal financial planning. And, frankly, it’s the easiest piece.

Insurance planning can be complicated. With life insurance, simpler is generally better. But there’s plenty of complexity involved with choosing a health or disability policy. And if you already own a deferred variable annuity and you’re trying to figure out what to do with it, there’s nothing simple about that decision. Professional assistance may be valuable.

And then you’ve got tax planning. I’ve worked in the tax field for ~15 years, and I’m still regularly learning about a new tax law, learning about some state tax law that I haven’t had to know about before, re-learning about an existing law that I haven’t had to deal with recently, or learning about the interaction of two pieces of tax law.* It’s complicated. And the more I learn, the more I realize the depth and breadth of what I still don’t know.

Estate planning is similar. For some people, it’s not so bad — get your basic documents in order, and you’re all set. For other people (e.g., combined families, or people trying to provide for a disabled loved one after their own death) it can get complicated in a hurry. Guidance from an experienced estate planning attorney (e.g., Bruce Steiner) or a financial planner who deals with estate-related topics (e.g., Elliott Appel) could provide a better financial outcome as well as considerable peace of mind.

With regard to student loans, the rules for public service loan forgiveness can be bewildering. If that’s a path that could be available for you, advice from somebody like Ryan Frailich who deeply knows those rules could be extremely valuable.

Running a simple portfolio is indeed simple. But financial planning involves a lot more than just running a portfolio. In fact, it involves so much more that there’s no way for one person to be an expert in all of it — even if it’s their full-time job and they have decades of experience. If/when one of those more complicated situations becomes relevant to your household, requesting professional assistance isn’t some sort of failure. It’s a prudent decision, to minimize the likelihood of a mistake undoing the smart decisions you’ve already made.

*Among tax professionals, the words “quick question” (or “simple return”) are self-contained jokes/punchlines. Almost everybody thinks they have a quick question. What makes things complicated isn’t so much any one particular provision in the law (unless it’s the QBI deduction). What makes things complicated is the interactions between multiple provisions. There are many tax topics/situations that are individually very common (e.g., dealing with a particular deduction or credit, the sale of a home, sale of a business, the way long-term capital gains and qualified dividends are taxed, etc.). But each household has a handful of different things from that menu that happen to be applicable to them. And the possible combinations are endless. So even if a tax professional has worked with each of these individual topics many times, this may well be the first time he or she has dealt with this specific combination and the ramifications thereof.

Professional Financial Advice: How Much Should You Pay?

In the realm of financial planning, advisors are often encouraged to use “value-based” pricing — and to determine the value of their services by comparing the results the client would get with those services to the results the client would get without those services. For example, an annual advisory fee equal to 1% of your assets under management is reasonable if the financial planning and portfolio management services provided for that fee can collectively improve your results by more than that amount. (And Vanguard’s “Advisor Alpha” research or David Blanchett and Paul Kaplan’s “Gamma” research is often used to make this case.)

But that only makes sense if this financial professional is the only financial professional with whom you could work.

If you’re at the Toyota dealership, considering purchasing a RAV4, the decision you’re making isn’t “Toyota RAV4 as compared to walking everywhere.” You’re evaluating the RAV4 against other vehicles.

It does make sense to first ask the question: do I want to buy a vehicle? Depending on your mobility, where you live, and so on, you may be able to save a lot of money by walking, biking, and using public transportation. Similarly, not paying for financial advice can be perfectly prudent for lots of people in various stages of their lives.

But for a particular vehicle to be the right one to purchase, it has to not only improve your life relative to no vehicle, it has to improve your life relative to the other vehicles you could purchase.

The same goes for financial advice. Even if a financial professional could, for example, improve your results by $20,000 per year relative to not working with a financial professional (and that’s a tall order to fill), that doesn’t mean that any price less than $20,000 per year is a good deal. You might be able to find an equally qualified professional who can provide the same service for less.

There Are Substitutes

Since starting this blog in 2008, I have had the pleasure of meeting and corresponding with lots of super smart financial professionals. But I have never met a single one whom I thought to be the only person who could handle a particular financial planning situation.

And to be clear, that’s 100% true for me as well. I believe I do a good job advising clients about retirement tax planning, Social Security, and a few other topics. But Jim Blankenship, for example, knows at least as much about those topics as I do. And so do plenty of other professionals who don’t happen to write a blog or books.

Many parts of financial planning are complicated. But they’re not that complicated. There’s nothing for which you need a one-in-a-million genius-level IQ. No matter which area(s) of financial planning you want help with, there are more than a few people qualified to help.

What Services Do You Want?

When considering working with a financial professional, the first step should be to ask yourself what services you want.

A critical question here is whether you want advice (i.e., financial planning), portfolio management (i.e., somebody who will actually place the buy/sell orders for you, to keep your portfolio at its intended allocation), or both.

If all you want is portfolio management, you can get it very cheaply through Vanguard or other robo-advisors. (Or you can get a very basic version by simply using an all-in-one fund.)

If all you want is advice, you would likely appreciate working with an “advice-only” professional (i.e., one who does not even provide portfolio management, and who will therefore not be trying to sell you such services).

If you want both advice and portfolio management, that’s where the financial planning firms that charge based on assets under management might be a good fit. But even then, not necessarily. There are flat-fee firms as well (e.g., Bason Asset Management, which charges a flat $5,100 per year as of this writing). And depending on the size of your portfolio, a flat fee could be a lot less than an asset-based fee.

Typical Costs

For advisors charging hourly, a 2020 Kitces Research survey found that the median cost for hourly financial planning was $250. A 2020 survey from Envestnet/MoneyGuide found the hourly average was $257. (I’ll be interested to see the extent to which these fees change in the next iteration of the surveys, given the inflation over the course of 2021.)

For firms charging a flat retainer fee, the Kitces Research survey found that the median annual amount was $4,000.

As far as asset-based fees for financial planning combined with portfolio management, the Kitces Research survey found that “median fees were 1.0% of [assets under management] up to $1 million. The median fee then dropped to roughly 0.9% at $2 million and 0.8% at $5 million.” The Envestnet/MoneyGuide survey found a mean asset-based fee of 1.04%.

More Than Just Costs

The point here isn’t to automatically choose the advisor who can provide the rock-bottom cost. You want to be aware of costs — and check to see if there’s an equally-good option that costs much less. But in many cases the advisor who turns out to be the best fit for your needs will not be the very least expensive option.

It’s important to determine whether this particular advisor has the particular expertise you’re seeking. Do they often work with people in circumstances similar to yours? For instance, Jon Luskin works with DIY investors. Meg Bartelt focuses on working with women in tech. Cody Garrett works with families with “FIRE” goals. Sotirios Keros works especially with healthcare professionals.

And there are other questions about the firm that could be important. For instance, some people may prefer to work with a solo advisor, while others may prefer to work with a larger team, such as the hourly-only firm Timothy Financial. A team can likely provide deep expertise on a broader range of topics than an individual can. In addition, a team can provide better accessibility. (If a solo advisor is on vacation, the firm is on vacation. If one person in a team firm is on vacation, the team is still operating.)

And there are subjective considerations as well: does this person/team feel like a good fit? Do you trust them? Do they communicate in a way that makes sense to you, or does it feel like they’re speaking another language?

Financial Advisor Licenses and Designations

A reader writes in, asking:

“I’m looking into using a financial advisor for the first time as I near retirement. I know I’m supposed to look for a ‘fee only fiduciary’ but am lost as to the titles…RIA, CFP, CFA, etc. I am not sure the pros and cons of each. Perhaps you could elaborate in an article?”

The first thing that confuses (and surprises) many people is that the term financial advisor doesn’t have any legal meaning at all. Basically anybody can refer to themselves as a financial advisor. A person who refers to himself or herself as a financial advisor might, from a regulatory perspective, actually be any of a few different things: an investment adviser representative, an insurance agent, a registered representative, or none of the above.

Registered Investment Adviser (RIA)

A registered investment adviser (RIA) is an entity (either a person or a business) that provides investment advice for a fee. A investment adviser representative (IAR) is a person who works for an RIA and provides advice on behalf of the RIA. For example, Wealth Logic, LLC is a registered investment adviser, and Allan Roth is an investment adviser representative who provides advice on behalf of the firm. Similarly, Jon Luskin, LLC is an RIA, while Jon Luskin (i.e., the actual person) is an IAR who provides advice on behalf of the firm.

Registered investment advisers (and representatives thereof) have a fiduciary duty to their clients. That is, they’re required by law to put the client’s interests ahead of their own. Unfortunately, the reality is that there are some RIAs who do not actually live up to a fiduciary standard. So a certain level of self-education is still necessary, in order for you to be able to understand what the advisor is recommending and why.

Another noteworthy point here is that you don’t actually have to be an RIA (or representative of one) in order to provide investment advice. For example, if you’re a cardiologist and your sibling comes to you asking for investment advice, you’re perfectly allowed to provide that advice.

The general rule is that anybody who is in the business of providing investment advice in exchange for compensation must be an RIA (or IAR). But there are exceptions even to that.

Registered Representative

A registered representative (also known as a broker or stockbroker) is somebody who sells securities on behalf of a broker-dealer (i.e., a brokerage firm). Registered representatives are generally paid a commission. They do not (usually) have to be RIAs because the advice is considered to be solely incidental to the business as a broker (i.e., the business of selling securities).

Registered representatives are held only to a “suitability” standard. That is, they are not required to put the client’s interests first. The only thing that is required is that they must have reason to think that the product they are selling is “suitable” for the client. And if history is a guide, all sorts of garbage can be considered suitable.

When you see, “securities offered by….” on a website or other piece of marketing material, you know that you’re dealing with a registered representative.

Certified Financial Planner (CFP)

The certified financial planner (CFP) designation is not actually a license. The entity that provides this designation (Certified Financial Planner Board of Standards, Inc, generally just referred to as the “CFP Board”) is a private entity rather than a governmental entity.

From a legal standpoint, all this designation means is that the person is allowed to use the registered trademark “CFP professional” to describe himself/herself and use the registered trademark “CFP” letters after their name.

So from a legal standpoint, this designation is not important at all. That is, there’s no service that you might want for which it’s legally necessary for the service provider to be a CFP. However, it is relevant information from a credibility standpoint, because it means that the person a) has passed an exam that covers quite a bit of financial planning material and b) has a meaningful amount of experience providing one or more financial planning services.

Certified Public Accountant (CPA)

The certified public accountant (CPA) designation is a license (at the state level). But, roughly speaking, the only things that CPAs are allowed to do which other people are not allowed to do are:

  1. Provide auditing (or similar) services, and
  2. Use the “CPA” letters.

So, as with the CFP designation, if you’re looking for personal financial services, it’s unlikely that you need somebody who is a CPA. But, as with the CFP designation, the CPA designation can be quite relevant, as it means that the person has a certain level of expertise with tax and other financial topics.

The personal financial specialist (PFS) credential is an additional designation (through the AICPA) that CPAs can get, which is akin to the CFP credential in that it means that the person has passed a test about personal financial planning and has a certain amount of experience with financial planning. But as with the CFP designation, it’s not a license from a governmental entity. It just means you’re allowed to use certain letters after your name.

Chartered Financial Analyst (CFA)

The chartered financial analyst (CFA) designation is akin to the CFP designation in that it is not a license to practice, but rather a designation from a private entity. So again it’s a situation where there’s no service for which you would need somebody who is a CFA, but it is a useful indication of a person’s experience and expertise.

Whereas the CFP area of focus is overall personal financial planning, the CFA curriculum and exams focus much more specifically and deeply on the investment side of things.

What Type of Professional is Right for You?

An important point to understand is that somebody can work in more than one of the above roles. For example, it’s common to see people who are both IARs and registered representatives. That is, they provide advice for a fee, and they also sell products for a commission. And that person might have one or more of the CPA/CFP/CFA designations — or none of them.

Are you looking for overall financial planning? Then you probably want to work with somebody who is an RIA (or representative thereof). The CFP designation (or the CPA/PFS designation) would be great to see. But it isn’t entirely necessary. For example, you might find a CFA who has also developed the necessary expertise in taxation, retirement planning, etc.

Are you looking specifically for somebody to do a certain type of tax planning for you? Then a CPA would likely be a good fit. But a CFP could be a great choice as well, if they happen to specialize in that particular area.

And of course in some related areas — estate planning, for instance — the best professional to work with is probably an attorney.

And finally, just because somebody has the right designation(s) doesn’t mean they’re a good fit for what you need. Compensation matters as well. For instance, if you’re looking for a one-time engagement, you will want to find a professional who usually works in such a manner, rather than a professional who prefers to work with clients who have ongoing needs and who are happy to pay an ongoing annual fee.

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