You have a trained professional giving you advice, allocating your assets, and shielding you from making mistakes with your money. Most of us think that’s what a financial advisor does.
Having been a financial advisor and spent the majority of my career in financial services I can say that’s unfortunately not always the case; and more often than not, it’s the opposite.
As we’ve discussed in previous posts, there are two basic types of financial advisors: fee-only and commission based.
Fee-only means your advisor charges a percentage of the money you give him or her to manage. Under that arrangement, they’re legally required to place your financial interests ahead of their own. These are the good guys!
Commission based means your advisor charges you a certain amount of money for every transaction. These amounts can be small—like a $6.95 charge every time you want to buy a stock. Or they can be obscene—like a $5,000 sales fee on a $50,000 variable annuity! These are the bad guys.
To be fair, they’re not bad people. They’re just not people you want to trust with your money because at the end of the day they have no obligation to do what’s in your best financial interest.
As a reminder, the fiduciary duty of a fee-only advisor is a simple concept to grasp: if two investment options are available, both expecting to generate let’s say 7% returns each year, the advisor must select the option that is least expensive to you. On the other hand, a commission based advisor can select the option that pays the advisor the most, regardless of the cost to you!
Broadly speaking, there are four places where you’ll find a financial advisor: Wall Street and regional powerhouses; banks; insurance companies; and independent RIAs.
Wall Street firms and the regional powerhouses are what you’d expect them to be. Aggressive sales, strict minimums, and proprietary products that are pushed across the board. Financial advisors working for these companies can be fee-only or commission based. They have incredibly high attrition rates and the advice you receive will be largely formulaic to fit whatever model their firm developed.
Banks often have a financial advisor in a branch that works for the bank’s affiliated brokerage business. They are almost always commission based as they trawl the branch’s client list, looking for customers who may have CDs ready to mature so they can call and pitch a mutual fund with a 5% sales load (commission paid to the advisor). You pretty much only get a call from them when there’s potential for a transaction, and not to just check in on your financial health.
Insurance company financial advisors serve one purpose: to sell the insurance company’s products, which include life policies, annuities, and some mutual funds. These are the classic sales “advisors” that can make 6 to 10% off your initial investment in commissions while also earning the insurance company up to 4% in management fees on your money each year!
Finally, we have Registered Investment Advisors (RIAs). These are typically fee-only financial advisors that owe their clients a fiduciary duty. These advisors tend not to have conflicts of interest seen at Wall Street firms since they don’t have any proprietary products they’re trying to push. They also don’t have affiliated insurance or banking products to sell, so they’re less concerned with commissions. They have the most freedom and flexibility to give financial advice that actually benefits you, the client.
If you’re unsure – just ask! Pick up the phone and call your advisor. Ask him or her the following: “Do you owe me a fiduciary duty in every transaction?” ... “Do you have any conflicts of interest with proprietary products when providing me with investment recommendations?” ... “Do you earn a flat fee or a commission from my money and investments?”
The ideal responses should be, in order:
“Yes. No. Flat fee.”
It’s that simple.
An advisor with nothing to hide will answer honestly and proudly. These are the people you want looking after your money.
An advisor that doesn’t want you to know they just made a $10,000 commission on your $100,000 variable annuity will skirt the question and try to distract you with claims about guaranteed income, safety, and other red herrings. If that’s the response, take your money and run! Well, make sure you read the fine print on your annuity surrender penalty charges first.
I don’t mean to harp on commission focused advisors, too much. They’re not necessarily malicious and in some instances, they may even think they’re helping you achieve your financial goals. If you feel your commission generating advisor is, in fact, doing what’s best for you, talk through your options with him, get a second (or third) opinion, and then make a decision.
Of all the financial advisors out there, a fee-only RIA is the one most likely to give you non-conflicting, balanced, and objectively helpful advice. The challenge, however, is that it’s also the toughest kind of advisor to be.
To be an RIA is expensive. It’s risky. It’s like climbing a mountain to get started. The options for software and business partners are limited to a large field of players with little difference between them, all of which are interested in making as much money off the RIA as humanly possible.
This, unfortunately, means that an RIA is stuck working with antiquated custodians still charging commissions on trades and software vendors charging an arm and a leg for sub-par service. Because of these limitations, both in time and money, the advisor can only do so much for her clients.
Fortunately, there’s hope. Altruist plans to give fee-only RIAs the tools they need to help advisors focus on their clients, and not on the noise. If your financial advisor uses Altruist, you’ll know that you’ll never be charged a commission, you’ll never incur a software fee, and the advice you receive will never be biased by some Wall Street custodian.
This is financial advice as it should be—benefiting you first, not your advisor.