How to pick a financial adviser

While many Morningstar readers are tried and true do-it-yourself investors, there may come a time when you consider turning to a financial professional. Though Morningstar is all for keeping costs to a minimum, there are occasions when it makes sense to hire a professional, such as if you no longer have the time to manage your own investments, face a complicated tax situation, or simply want a second opinion.

Paying a financial planner an ongoing fee to handle every aspect of your financial plan can make sense if you're extremely time-pressed or if your finances are particularly complicated. Ditto if you're very rich. Paying for ongoing financial advice (and hand-holding) may also be worth it if you've had trouble sticking with your investment plan through the market's many ups and downs. The best advisers earn their keep many times over by saving investors from their own worst tendencies to buy high and sell low.

For most other investors, however, it's not that difficult to create a sensible investment plan on your own, and this lesson from our Learning Centre can help you do that.

If you do decide to seek out a financial advisers, below are some explanations of the tyes of advisers, the services they offer, and some tips for finding the right adviser for you.

Types of advisers
Financial advice is available from a wide variety of sources in the UK and all recognised providers are regulated by the Financial Services Authority (FSA).

Financial advisers can be categorised into two basic groups: tied advisers and independent advisers.

Tied advisers either work for one company and can only give advice on the financial products that company provides, or they offer advice from a range of companies (these are termed multi-tied advisers). Tied advisers are remunerated on a commission basis by the financial companies whose products they sell. This group includes advisers from banks, building societies, etc.

Independent financial advisers (IFAs) are not tied to any particular company and can give advice on the full range of financial products, although some advisers will specialise in particular areas, i.e. an accountant will likely be strongest on tax issues. IFAs can still be remunerated by commission on the products that they sell but must also offer you the option of paying a fee for their advice instead.

Fee structures
Fee only: The adviser is compensated solely by the client. Fee-only advisers can charge in a variety of ways. The fee can be a percentage of assets or a flat or hourly rate. The adviser is not selling any investment product and is not being directly compensated for recommending specific investments. If you want a one-time checkup, rather than full management of your investments, it makes sense to find someone who charges per session or per hour. If you want ongoing portfolio advice, it may be more cost effective to find someone who charges a percentage of your assets. When the compensation is a percentage of your assets, your adviser's financial interests are aligned with yours--when your portfolio's value increases, your adviser earns more money; when it decreases, your adviser earns less.

Commission: The adviser is compensated by selling you products, such as funds or an insurance policy. The adviser's pay is not tied to the performance of your portfolio. This may be the cheapest option, but there are potential conflicts of interest since the adviser is paid based on which securities you purchase and not based on how well your portfolio performs.

A combination of fee and commission: Advisors who are paid this way sometimes call it 'fee-based' compensation, which should not be confused term with 'fee only'. Under this structure, advisers still receive compensation from selling you particular products.

The fee-only option offers two big benefits. First, the adviser's investment recommendations are not driven by a commission. Second, it is more transparent--you will receive a bill and know exactly how much you paid for the services. With a commission-based adviser, you do not know how much the adviser has earned from you and how commissions affected your investment recommendations. Note, however, that the FSA has laid out changes that it intends to make regarding the labelling of advice and remuneration practices, which includes increased fee transparency and a ban on advisers receiving commission. These proposals will not come into effect until 2012 and are therefore subject to change before then. The FSA's consultation paper can be accessed here.

What can an adviser do for me?
Financial advisers can help with advice on just about any aspect of your personal finances, including mortgages, pensions, tax, life insurance and investments.

Before dispensing any advice, an adviser will build a picture of your financial situation by conducting a fact-finding interview.

This will focus on:

1. Your current financial situation: earnings, outgoings, dependants, income tax rate, how much you can afford to put aside etc.

2. Your financial goals: what you are seeking to achieve with the investments you make and when you want to achieve them. For example, if you are saving to pay for a child to go to university then you have a fairly specific time constraint and also a rough idea of the amount of money you will need to have saved.

3. Your appetite for risk: what level of financial loss are you willing to accept in exchange for the possibility of a higher return?

Once the adviser has all of this information they will create a financial solution that is tailored to your needs. It is therefore important that you give them accurate information on you finances and goals.

Benefits of using an adviser
Financial advisers are investment professionals who have access to a huge amount of information on financial products and have sophisticated tools at their disposal to help analyse this information and find the appropriate financial products for you.

Tips for choosing an adviser
Is the investor tied/multi-tied or independent?

As mentioned above, the type of adviser will determine the range of products available for them to recommend to you.

What qualifications do they hold?

As with any profession, areas of expertise vary. It is important to find an adviser that can offer the appropriate advice on the products you are interested in.

How is the advice paid for?

Is the adviser paid on a commission basis from the products they recommend or do they charge a fee or a combination of both?

Ask around

If a friend, family member or colleague has had financial advice that they think is good they may be able to recommend an adviser, although it is important to consider that your financial needs may be different to theirs.