Is Your Trusted Financial Advisor Working for You? (Part I)
It is not uncommon to hear in investment conversations about someone’s trusted advisor who takes good care of them. However, within the investing landscape a glaring dilemma exists with these individuals understanding. The compensation system and the exclusion of the fiduciary role of your advisor can run counter to your interests. And, it is well documented in the literature that when the incentive system of your advisor runs counter to your interest, often their behavior follows…leaving your trusted advisor not so trusted.
Many of us assume all advisors are similar. And, once you feel you have found someone you can trust then you believe you have the winning combination for success. However, not all advisors are the same. In fact, how your advisor gets paid can likely communicate to you how well they can be trusted and how likely they will work on your behalf.
The vast majority of financial advisors are sales people. This method of client interface has been very effective for the “Wall Street” firms. These very likeable and apparently trustworthy people concentrate on distributing the products and services of the firm they work for that designed them to generate a profit and to be easily sold. I might also add I think these sales peoples’ relationships are genuine, but they don’t make decisions beyond the sales execution and often don’t have the financial knowledge to understand the investment structure that best benefits a client’s interest. It is quite common for these sales people to be well liked. It is why they took up the vocation of sales in the first place. And, those who don’t leave potential clients with this warm and fuzzy feeling and don’t get the new business get thrown out of this, often described, ruthless industry quite quickly. But, in no way is this particular sales structure good for you.
So, even though you feel like you can trust your advisor, it is important to understand how your advisor is paid and how that system incentivizes their behavior. We will discuss the incentive systems, the complexities of them and what is most likely to work best for you in our next posting, “Is Your Trusted Financial Advisor Working for You?” (Part II)
Is Your Trusted Financial Advisor Working for You? (Part II) - August 12, 2015
There are multiple ways advisors get paid by their clients. The public investing community isn’t usually aware because most advisors try to look like the independent fiduciary that is representing your best interest and are vague about methods of compensation. And, frankly, unless your advisor discloses this to you, you will likely never know the full extent of the compensation picture. So, it is important to ask your advisor how they are paid and what fees you pay.
For clarity I have divided the compensation system into two types of payment: (1) Fee-only and (2) Fee Based. Fee only advisors get paid directly by you in a variety of forms. But, they will disclose that fee to you and that is the only fee they receive for their services. Fee-only advisors are generally considered the most transparent and the most likely to best represent your interest because conflict of interest is minimized.
On the other hand, Fee Based Advisors may not disclose their compensation or only some of it; which is why many clients don’t know what they are paying or only know about the fees charged on your statements. Additional fees could be in an ongoing insurance commission, an investment fee that the fund kicks back to the advisor (12b-1), spreads in the transaction of an investment (compensation typically gained in bond trades from differences in price your advisor firm transacts and purchases or sells to you for), or commission on the sale of an investment. Financial services clients paying advisors through Fee Based methods will find the method of compensation very convoluted, but more importantly, likely are bringing in an incentive system to the advisor that no longer includes looking out for the client’s best interest because they are bringing other compensatory relationships into the equation.
And, even more confusing is many Fee-Based advisors, and some calling themselves Fee-Only advisors, complicate these compensation methods by collecting fees from a combination of payment types, a sort of wolf in a sheep’s clothing. Some might call themselves a Fee-Only Registered Investment Advisor (RIA) firm and charge a fee like a fee only advisor, all seeming very trust worthy. But, the actual employees of the firm might also work for another employer, typically a brokerage firm or insurance company, where they receive additional income from these other forms of compensation and therefore, as employees, are not a Fee-Only advisor. The usual scenario occurs when a dually employed advisor also works for a brokerage firm and/or an insurance agent, selling you questionable insurance contracts or putting you in investments into expensive vehicles which provides these advisors additional income, or provides them a commission on the spread of a sale.
Hopefully this is not the case for you? Unfortunately, it is likely happening more often than not, which makes one question the often overheard statement of one’s trusted advisor.
It is clear, if you are going to use an advisor, which is poignantly clear in the research of client benefits, that utilizing a “real” Fee-Only Advisor and Advisor Representative is the most beneficial choice for your financial goals and health.
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