Does My Financial Advisor Work For Me Or His Brokerage Firm?

Well, it depends. Most financial advisors don't actually sit on your side of the table. This goes against the common perception that a financial advisor will always recommend the best solutions, like a doctor would. Industry regulations permit financial advisors to operate under two very different sets of rules. This allows an advisor to act in your best interest when that's the marketing message needed in order to be hired. It also allows the advisor to quickly abandon honoring their fiduciary relationship in order to earn investment, insurance, and annuity commissions usually not in your best interest.

In this blog post I'll give two common examples of how a "fee-based" financial advisor promotes a false sense of trust, then bends the rules to earn additional compensation selling expensive products. I'll then provide a brief summary of how an advisor should conduct themselves to minimize conflicts of interest. At the end of the post you'll be able to confidently answer the question "does my financial advisor work for me or his brokerage firm?".

Let's Start With Two Important Definitions

Fee-Based Advisors: Think of Edward Jones, Morgan Stanley, or MassMutual. Individuals giving investment and financial planning advice that work for these companies have the ability to earn commissions from product sales. They can also charge their clients a fee for financial plans and certain types of investment accounts.

Fee-Only Advisors: Think of, well, no one you've ever heard of. According to Financial Planning Magazine, the top 3 Fee-Only firms are Oxford Financial Group, Rockefeller & Co, and Shepherd Kaplan. Note: Financial Planning Magazine ranks them solely on the total amount of assets they manage. They don't assess the quality of advice. Fee-Only firms like these are structured as Registered Investment Advisors (a business entity, not a human), or RIAs for short. RIAs are legally required to act in a client's best interest 100% of the time. If even a potential conflict of interest arises, an advisor working for an fee-only firm must disclose it, and work to mitigate that conflict as best they can.

An Example Of How Fee-Based Advisors Bend The Rules

You receive a referral to work with a financial advisor because some sort of financial problem arises. Perhaps you got divorced, changed jobs, or simply feel like it's too much to manage on your own. After a free meet & greet, you decide they're likeable enough to earn your business. What really appealed to you was that they can offer a financial plan to help organize everything.

After paying an upfront fee, anywhere from a few hundred dollars to several thousand, you get to the "review meeting". During this meeting the focus is on restructuring the investment accounts the advisor can manage, ie., not your 401(k) plan. You'll probably also be sold insurance policies like life, disability, and long term care.

What happened to looking at your investment allocation as a whole and making the necessary adjustments across all accounts? What about shopping the entire insurance marketplace for highly rated, low cost policies? What about detail regarding how much you should save for each of your unique goals in the types of accounts that make the most sense? Social Security planning? Ok I'll stop now.

Under the pretense of a financial plan, your values and goals may have only received light attention, while the majority of the advisor's work was designed to sell you things. The problem with this scenario is your real issues may not have fully been analyzed, and the products you ended up with probably provided only a marginal benefit. Meanwhile, the financial advisor made thousands on the planning fee and recommended products.

Another Extremely Common Example

Let's say you don't want a financial plan. This thinking isn't logical, as everyone can benefit from a plan, but that's not the point of this post. In this example, you hire an advisor to manage your investment accounts. They recommend multiple investment strategies to help you reach your goals. Sounds good, right?

You're set up with 3 different accounts; a brokerage account to earn commissions on certain investment products, an investment advisory account (called any number of things depending on which firm you work with) where you pay an annual fee such as 1%, and an annuity account.

The three-pronged account approach is appealing, since it's sold as diversification. That's always good, right? Well, now you're paying extra account fees the brokerage firm keeps, high costs with annuities and insurance products, an advisory fee that is split between the advisor and their firm, and difficult to find 12b-1 fees baked into the already hidden cost of your mutual funds. Only the account fee and the advisory fee is detailed on your statements. The other costs are completely hidden unless you know exactly where to look for them.

What Actually Happened In These Two Examples

The advisor sold you on strategies, services, and products intended to be in your best interest. However, in both scenarios the trusted advisor quickly abandoned their fiduciary role to sell you items not 100% in your best interest. This perfectly legal arrangement merely requires the advisor to believe the products are "suitable". Most investments and insurance products are suitable, but few are the very best for you. Unfortunately, products deemed suitable can be complicated and expensive. Many times they're actually proprietary products that you could have obtained at a lower cost elsewhere.

The above phenomenon is why your financial advisor doesn't work for you, even though that's what they'd have you believe. Every single fee-based advisor doesn't always sit on your side of the table for the simple fact they sell you products. Conflicts quickly arise because their brokerage firm may limit what products they can offer you. Or, if the advisor says "we have choice and flexibility since we can select from the best carriers", there still exists a very real threat the advisor may recommend a product that pays a higher commission versus a lower cost option. Who knows whether the fancy features of the more expensive product are actually worth it, you or the advisor? That's a slippery slope!

How A Financial Advisor Should Behave

First, they should not sell products, period. This puts them on your side of the table, where they can truly look out for your best interest.

Second, they should help protect you from excessive cost, not add to it. There's nothing wrong with compensating your financial advisor thousands each year (depending on complexity). However, attention to costs that could otherwise be avoided should be a priority.

Last, they should offer and commit to analyzing all aspects of your financial life. This means reading about and explaining your workplace benefits like group life and disability insurance, explaining how you can use the available funds in your 401(k) to create an appropriate investment asset allocation, how to most efficiently reduce debt, how much to save for each of your goals (and in what types of accounts), how much cash you should keep at the bank, and last, hold you accountable to updating your beneficiaries and legal docs like wills. This list is a minimum starting point for what this author constitutes a comprehensive financial plan.

Final Thoughts

Realize that everything I've said I've witnessed as I've played for both the fee-based and fee-only teams. Just this year, I can think of 4 separate individuals that were sold stuff outside of anything remotely resembling a fiduciary relationship. This lack of real advice will end up costing hundreds of thousands of dollars if they don't adjust.

The status quo for financial advice seriously lacks a moral compass. Ethics in my industry are glossed over at best. Ultimately it's the unsuspecting clients who trust their money with advisors who are taken advantage of. It's in your best interest to understand how and by who your financial advisor is being compensated. Working with a fee-only financial advisor could mean as much as few extra hundred thousand during your retirement years.

#fiduciary