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5 Things Your Financial Advisor is Not Telling You

The financial industry is not known for transparency. It can be difficult to find the answers to simple questions, such as how your financial advisor is paid and whether he or she is required to work in your best interest. But if you educate yourself, you can better understand what to look out for when thinking about working with a financial advisor. Here are five things you should know about your financial advisor:

Know how your financial advisor is paid. One of the first questions you should ask your advisor is, "How do you get paid?" The vast majority of the financial industry is commission-based, meaning that advisors are paid a sales commission for the products they are selling.

The three major compensation models are:

-- Commission: Financial commissions are paid by mutual funds, insurance companies and brokerages to the registered representatives who sell their products.

-- Fee-only: Fee-only advisors are paid directly and only by their clients. They receive no commissions and aren't paid via marketing dollars. Their fees can be hourly, a retainer or a percentage of assets under management. According to the Bureau of Labor Statistics, there are 249,400 personal financial advisors. The largest body of fee-only financial advisors, the National Association of Personal Financial Advisors, has only 2,400 members.

-- Fee-based: This hybrid approach allows advisors to choose how they get paid. They can charge fees or a percentage of assets under management for some of the funds they manage, but also accept commissions for other products such as insurance policies.

The most transparent business model is fee-only financial advisors. Since they only receive compensation and fees directly from their clients, there is no incentive to recommend high-cost investments and they are not limited to products and solutions that pay commissions. To find a fee-only advisor, consider the National Association of Personal Financial Advisors, Garrett Planning Network and XY Planning Network.

Understand any conflicts of interest. Most financial advisors have some form of conflict of interest. For commissioned and fee-based advisors, there is an incentive to steer clients to products that pay the highest commission or fee. For fee-only advisors, their compensation could be reduced if a portion of the client's assets are used to pay down debt or if they load up the plan and charge more hours.

Ask your advisor directly if he has any conflicts of interest. Continue the discussion by asking if she has a process to ensure that the conflicts are accounted for and the best recommendations are being made.

Know the difference between the fiduciary standard and the suitability rule. There are currently two standards for accountability in the financial service industry, and they are the suitability rule and the fiduciary standard.

-- The fiduciary standard legally requires the advisor to put their client's interests above their own.

-- The suitability rule asserts that the broker-dealer has to reasonably believe that recommendations are suitable for clients.

When you consider hiring a financial professional, the advisor's motivation and the standard they are held accountable to are important. Suitability treats the transaction as a sales process, and any advice is incidental to the transaction. The fiduciary standard legally requires the advisor to act in your best interest. The weight of making good decisions to reach financial independence is too important not to ensure that your professional advisor is motivated to see you reach success.

Ask about investment strategies and philosophies. Since the majority of the financial industry is pushing products, it makes sense that the focus has been shifted to the sizzle of performance. However, if you boil down the reason you invest, it should be to reach long-term financial goals like retirement and paying for college. The investments are only a tool to help reach the goal, and investing can be a very emotional and long journey.

A good financial plan will leverage diversification to smooth out the bumpy emotional ride of long-term goals. All advisors want to see their portfolios perform well, but reaching goals is the primary objective. Taking unnecessary risk or not accounting for all of the other variables that go into a complete plan can derail the likelihood of success.

Don't put too much weight into fancy titles. A study by the government's Consumer Financial Protection Bureau found more than 50 senior specialist titles on the market. Many of these are not worth the paper they are printed on and only serve to confuse the public. According to the study, "the titles and acronyms for the different designations are often similar or nearly identical to other designations, making it difficult for consumers to distinguish between different designations' qualifications or legitimacy."

Hire a financial planner who has at least one of the four major designations. These designations include certified financial planner, certified public accountant / personal financial specialist, chartered financial analyst and chartered financial consultant.

These five points of discussion should go a long way to creating a good conversation with your prospective or current financial professional. Becoming an educated consumer will help you make the most of the process and increase your probability of long-term success.

Brian Preston and Bo Hanson are fee-only financial planners who host the podcast, "The Money-Guy Show".