Jason Flurry, CFP
Are you working with the right kind of financial advisor?
How to understand the differences and choose the best one for your financial future.
I’ve been a financial advisor for 25 years and during that time I’ve seen a little bit of everything from clients, from the financial markets, and from the wide variety of financial advisors who are out there providing financial advice. I’ll save some of the client stories and market stories for another time, but today I’m going to show you how to understand the differences between different types of financial advisors and how to choose the best one for your financial future.
Let’s start with the big picture first. Numerous studies have shown that the majority of Americans age 50 and over use a financial advisor. That’s interesting, but by itself it doesn’t provide a lot of insight into what kind of financial advice they’re actually getting. That’s because the term financial advisor has become so broad, it’s like saying over 50% of people drive cars, on their own homes, or take vacations. There’s a huge variance between cars, homes and vacations and it’s the same with financial advisors. I even saw where according to the Wall Street Journal there are more than 200 different designations for financial advisors including financial consultants, wealth managers, investment consultants, investment managers, wealth advisors, and the even more exclusive sounding private wealth advisors.
These are all just different ways of financial professionals trying to say “Hey, I’m respectable. You can trust me.” But here’s the thing you really need to understand about all of these folks. Regardless of their title, the fact is that 90% of the roughly 300,000+ financial advisors in America are actually nothing more than just brokers. They’re paid to deliver financial services to their customers in return for a transaction fee or a commission.
At this point you may be asking yourself, “Okay, I get it. That’s a lot of brokers. But why is that so important?”
It’s important because of the way brokers are compensated. Brokers have a vested interest in selling people expensive investment products, which might include actively managed mutual funds, variable annuities, and managed accounts, sometimes called “wrap accounts,” where some third-party manager makes investment decisions independent of the broker or that broker’s firm.
Of course, there’s nothing wrong with being a broker or using a broker. I started my career as a broker and worked in that environment for 5 years before becoming an independent advisor, which I’ll talk more about in a few minutes. But being a broker or working with a broker can be fine as long as you understand how things are set up.
See, no matter what the advisor’s title is or what the perceived arrangement is between the client and their advisor, any relationship with a broker, your relationship with a broker, is founded exclusively on transactions and transaction fees. The more transactions brokers can generate, the more money they and their firm can make. That’s good for them, but it doesn’t necessarily mean that you will also make money in that arrangement.
Making it rain There’s a lot of pressure to be a good broker because most major firms require brokers to produce at least $500,000 in sales commissions every year. If that broker doesn’t hit those sales marks, the percentage of their take-home pay from those commissions gets cut. And, if their level of production stays down for too long, their job gets cut too.
Recognizing how the financial services business model works for most financial companies shows you that, regardless of how fancy the advisor’s title sounds, in most cases they are merely salespeople under intense pressure to generate revenues just like any other salesperson working for any other company.
When I first started in the business as a broker 25 years ago I worked under this model and grew very frustrated with it. It seemed that everyone in the financial services industry, including the brokerage firms themselves, were always saying, “Put the client first.” But with this kind of arrangement in place, it’s impossible to ever put the client first because with each transaction the house always wins. The broker always wins too. But you, the client, may or may not win, because you’re last in the relationship.
So, if the house and the broker get paid regardless of whether client make money, does this mean they’re being dishonest in their dealings with clients? Not at all. Some of my good friends are brokers and they do great work for their clients. But, no matter how nice they are and how much integrity they have, because they’re brokers, they still work for the house. And remember, the house always wins!
If you’re working with a broker, there’s a good chance your broker is a very nice, hard-working, and sincere person who has a high level of integrity. But, there’s also a very good chance he’s selling only what he’s been trained to sell or what he has access to within the brokerage firm’s platform. Even in situations where there’s no proprietary house brand, like you see with companies like Fidelity and Vanguard, there are usually “preferred” mutual fund families and other more frequently recommended investment options ingrained into the culture of most banks and brokerage firms.
It’s also standard operating procedure for most brokerage firms to have their cooks eating their own cooking. In other words, you might find that your broker uses some of the same investment products he recommends to you in his own accounts because he’s been convinced they’re good. And that’s because that’s what he’s been trained to think, so it’s normal to expect that kind of advisor’s personal investment experience to mirror many of their recommendations.
No matter how good an investment option may be though, you have to also assume that whatever he’s selling will benefit the house first. Sophisticated investors know this and even reported in a recent survey that 42% of them think their broker is more concerned with selling products than with helping them meet their goals. Is that what you want from your trusted advisor?
Know where you stand I’ve learned over the years that almost everything is possible in the financial services industry as long as it’s disclosed. That doesn’t make it right or even ethical, but it does make it legal. And, while a lot of financial services firms and brokerage firms do good works, every year many of them are penalized for pushing the boundaries too far, making dumb mistakes that hurt their clients, and making bad decisions that result in their brokers or management teams engaging in illegal activity. Other companies in different industries do the same things, so I want to make it clear that I’m not here to just criticize financial firms just because they employ brokers. These companies are doing what they’re trained to do.
They’re designed to maximize profits for their shareholders.
The problem here is you’re not a shareholder. You’re a customer and you rank far down the list compared to everyone else. The companies want to take care of their shareholders first. They want to take care of their brokers and themselves next. And then, and only then, do you ever show up as a client – you know, the one who was supposed to be first in everybody’s mind originally…
Don’t get me wrong. It’s not that everybody in the financial services business is out to get you. But the sad fact is the incentives many of these companies use to drive sales for everyone upstream from you can create conflicts of interest that interfere with your ability to build true, lasting wealth. The financial companies aren’t necessarily bad because of the way they motivate their sales reps. The whole financial system is broken and I hate to see people get ripped off by those who they thought were looking out for their best interest. These folks come to the end of their financial lives and find that the money that they counted on is not there for them when they need it most. And by then, it’s too late to do anything about it. They’re just stuck. In my opinion, retirement should be all about having freedom and flexibility, not being a slave to your finances because your broker’s good intentions didn’t pan out for you as both of you had planned. What do you think?
It’s critical that you understand how to protect yourself from being taken advantage of and that you learn how the system works against you so you can counter it. After all, if you don’t understand the incentives of your advisor, you’re liable to discover that you’ve done wonders for their financial future while potentially lowering or even wrecking your own.
What’s the alternative? I’ve talked a lot about brokers here because they make up roughly 90% of everyone who’s out there providing financial advice. Now let’s talk about the alternative. Are there advisers who are required by law to solely operate in your best interest and not their own?
Fortunately, the answer is yes.
They’re called independent Registered Investment Advisors. And, unlike brokers who, regardless of their title, are paid a fee or commission for selling products, Registered Investment Advisors are not incentivized to sell some items more than others because they get bigger commissions or because it makes the brokerage firm more money. Registered Investment Advisors have a completely different approach to providing advice and holistic services to their clients that’s based on designing strategies around that client’s goals, resources, and timelines.
Many brokers work for enormous Wall Street banks, investment management firms, brokerage firms, or insurance companies – like the kinds of names you see splashed on sports arenas – but Registered Investment Advisor firms are typically much smaller and independent from banks, brokerage firms, insurance companies, and mutual fund companies. They have a vested interest in getting to know you at a deeper level than brokers do, since they’re interested in more than just making transactions.
Registered Investment Advisors also have a higher standard to uphold when it comes to caring for clients. To give you an idea of how this actually works, let me go back and revisit the broker model again.
Here’s an important question you may have never thought to ask: How do you know if the product your broker is recommending is actually the best one for you?
You don’t. Because it doesn’t have to be. Let me explain.
Brokers don’t have to recommend the best products for you. All they’re obligated to do when making recommendations to you is follow what’s known as the “suitability standard,” which means they must simply believe that any recommendation they make is suitable for that particular client. Yes, you read that correctly. A broker’s investment recommendations don’t have to be filtered by what’s best for you, they only have to be suitable for your situation. And here’s the rest of the story. The broker and his or her firm gets to make that suitability determination.
In my opinion, suitability is an extremely low bar to clear. After all, do you dream of marrying a suitable person or dream of sending your kids to a suitable college? Of course not! But to brokers, which means to 90% of people who call themselves financial advisors, suitable is good enough. No wonder so many people fall short of reaching their financial goals... including those who work with so called “financial advisors.” Their best interest gets lost in things like suitability and their advisor’s conflicts of interest. Instead of getting the best of what they really have in mind and deserve for their financial future, their financial results are far too often mediocre at best.
Now let’s go back to Registered Investment Advisors so I can show you the difference in their standard. Like doctors or lawyers, Registered Investment Advisors, or RIA’s as they’re often referred to, have what’s known as a fiduciary duty to uphold when working with you. In other words, they have a legal obligation to act only in your best interest at all times, which is what most people think they’re getting when they decide to work with a financial advisor.
After all, wouldn’t you expect anybody who’s handling your finances to have to put your needs first ahead of their own? Of course. It’s common sense, right? But in the strange twilight zone of the financial services industry, unfortunately this common sense idea is anything but common practice.
No one would ever choose a financial advisor who doesn’t have to put their needs and best interest first if they truly understood how things worked, right? Unfortunately, most people do exactly this as they work with their financial advisor because they’re completely unaware of where they stand in the relationship. They just don’t know better and it can cost them a fortune.
Follow the money So you’re probably asking yourself, “If the RIA model is so superior to what most financial firms offer, why aren’t there more RIA’s in the business?” The most obvious reason is because a broker tends to earn a lot more money through all those commissions and fees he earns from selling financial products than he could as a RIA. For successful broker in a good commission payout bracket, working under a commission model can be extremely lucrative.
By contrast, the RIA firm doesn’t accept sales commissions. Instead, Registered Investment Advisors typically charge a flat fee for financial advice or percentage of the assets they manage for you. It’s a very clean, transparent model because you know exactly what you’re being charged. There are no hidden fees or commissions creating conflicts of interest or awkward situations for you or your advisor. And you know that a person working as a Registered Investment Advisor is being paid for advice and service, not for recommending overpriced products and in-house brands filled with fees and kickbacks.
If the advice the RIA provides is good and if the level of service they deliver to their clients is valuable, they can still do very well financially too. In order for them to win though, you have to win first. By building a comprehensive plan and managing that plan based on a percentage, the firm’s revenue is closely tied to the success of that plan’s outcome, not the transactions that go into implementing it. That puts you and your advisor on the same side of the table and it creates a mutually beneficial partnership you simply can’t get from most other financial advisors.
Brokers in disguise In closing, let me mention one more category of financial advisors. I’ve covered a lot about brokers and compared their way of doing business to Registered Investment Advisors. There’s one more type of advisor you need to be aware of so you don’t get taken advantage of. This type of advisor is both a broker AND a Registered Investment Advisor. They’re usually referred to as dually registered advisors and they make up the vast majority of independent advisors you find in your community.
These advisors are registered both as fiduciaries and as brokers. And here’s the problem with that. One moment they play the part of an independent advisor reassuring you that they abide by the fiduciary standard I described earlier that provides you with conflict-free advice for nothing but a fee. Then a moment later they switch hats without telling you and act as a broker earning commissions by selling you some of their own products or someone else’s where they have a fee sharing arrangement.
And check this part out.
When that switch happens and they take on the role of being a broker, they no longer have to abide by the fiduciary rules or standards RIA’s do. In other words, they’re sometimes obliged to serve your best interest and sometimes not. And to make matters worse, with a dually registered advisor, both situations are allowed to be used interchangeably, so you never know which one they’re being in the moment.
This doesn’t sound legal, I know, but I can assure you it is – and far more common that most people realize. It’s just another one of those gray areas in the law that people don’t know about and they get taken advantage of because of it.
A true Registered Investment Advisor will provide conflict free, comprehensive investment advice based on your goals, not on which products are needed to help you meet those goals. In my office we also provide services that help you with your investments, review your mortgage information, discuss ways to potentially help you save thousands in taxes, and review your life insurance to make sure you’re covered at a level that is proper for your family. We do all of this for our clients for a very small annual fee, which is usually 1% or less for most families. It’s the cleanest, most transparent, and most advantageous model we can offer for our clients and we never play the role of broker because it’s simply not in our client’s best interest for us to do so.
Choose wisely Fortunately, you can work with anyone you like and trust when it comes to planning for life’s most important financial milestones. But, like I said earlier, even though just about everything is possible as long as it’s disclosed, not everything is profitable for you as you’re trying to build the best financial life possible. Now that you understand the differences between financial advisors, you can make a better, more informed decision on which type of advisor is the best fit for you and your family. Choose wisely and let me know if you have any questions on how to make a good decision when it comes to choosing the right kind of financial advisor.