Hiring a financial advisor is a very smart move to make. Studies show that those who use a financial advisor get better results over time and are more likely to achieve their financial goals.
Once you hire an advisor, you don’t have to worry about every little detail and you can just manage the big picture. This saves you time and stress. However, there is one thing you should never delegate, and that’s monitoring the advisor and the fees they charge you.
17 Billion Reasons to Be Careful
There are a number of reasons why you should never delegate the management of your financial professional. In fact, I will give you 17 billion:
A recent White House Council of Economic Advisers (CEA) report states that “conflicted advice” about investments is estimated to cost Americans $17 billion per year.
Yes, that number does tend to get our attention, doesn’t it?
What is “conflicted advice”?
You may not have heard the term conflicted advice but many of you may be paying for it, unfortunately. How does it work? Let’s say you go to a financial professional for help. Non-conflicted advice would look like this: the provider recommends the lowest cost method to achieve your goals, allowing you to keep as much of your returns as possible. “Conflicted Advice” is where the advisor recommends the appropriate type of investments for you (“suitable investments”), but picks higher cost alternatives that pay him or her bigger commissions. While you may still end up with suitable investments, part of your money goes to pay commissions to that advisor, so you earn less. Over time, even small differences can compound into very significant numbers (hence the $17 billion per year).
Paying too much in fees can ultimately make the difference between a comfortable retirement and one where you feel stressed about money.
“Fiduciary” vs. “Suitability”
These two words determine the difference between getting true advice or conflicted advice. They sound complicated but fortunately the concept is surprisingly simple. Knowing the difference between these words is vital, and is part of what can keep your portion of that $17 billion in your pocket each year.
Imagine you’re fresh out of college, dealing with limited resources and need a solution for your transportation needs. Let’s say you have a family friend who is a CPA. You ask her for a recommendation, and she tells you to buy the cheapest used car you can find with low mileage and a remaining warranty. Or she may tell you to seek out a carpool arrangement and delay buying a car as long as possible. To get another opinion, you walk into a Ford dealership and ask an “automobile consultant” there that very same question. While she might send you away recommending that you look at other options, she needs to make a living and doesn’t get paid anything to tell you that. Instead she will more likely recommend a lower price Ford car, but still a new car which will put you thousands of dollars in debt. In the first example, you’re getting unbiased advice. At the Ford dealer, you’re getting a product recommendation.
The CPA family friend is like a fiduciary. She’s interested in providing you the best advice and doesn’t profit from whatever you choose (instead you will pay a fiduciary a fee for the advice, however). The Ford salesperson is paid a commission on every sale, but only if she makes one. She’s not an advisor, she’s a product salesperson, recommending “suitable” choices.
True Advisor or Product Salesperson?
When it comes to dealing with your money, you are usually best served by a true advisor. They will be held to a fiduciary standard, meaning they are legally required to hold your interests above their own at all times. So they must always make recommendations that put your interests first and they may not steer you into choices that benefit them first. If there is any conflict of interest, they must disclose it to you in writing before you make a decision.
The product salesperson is held to a totally different legal standard, called suitability. These advisors who don’t have a fiduciary duty to you are simply required by law to recommend “suitable” investments. So as long as they recommend an appropriate investment to you, that’s fine, even if it means they choose one that over time will cost you a lot more.
With suitability, these professionals technically work for someone else, not you. They work for brokerage firms or sometimes insurance companies. They get paid through commissions. Their loyalty legally is to their employer, not to you. It is fact that these individuals report to someone else, which causes the inherent conflict. They may have sales quotas or other pressures which force them to act. This “conflicted” advice is what generates that $17 billion per year. While there are of course many honest and ethical product salespeople out there, unfortunately they report to their own employers. And, the onus is then on you to monitor everything.
Here’s another problem: it can be really hard to tell the difference between true “fiduciary” advisors and “suitability” advisors.
The Easiest Way to Find Out
With many creative titles out there, finding out who is a fiduciary and who is not is much harder than it seems. With billions of dollars at stake, large Wall Street firms put a lot of advertising dollars into making sure that fact is not clear. Further muddying the waters, some fiduciaries may also be “dual registered” so they potentially can also act as a product salesperson part of the time.
Fortunately, there’s an easy way to cut through all this confusion. Simply ask the advisor you’re considering to sign a Fiduciary Oath promising to always put your interests ahead of theirs. If they don’t agree to sign it, you’ll know right away you’re likely dealing with a product salesperson.
Now, obviously there are both types of advisors out there so there is a role for everyone. While the fiduciary standard usually provides most benefits to investors who are looking for a full-service solution, there are certain times when the suitability standard might be a better choice. Maybe you know what you want and you’ve determined it’s cheaper to just pay a commission than fees for full service.
But the vital ingredient here is that you know exactly what you are getting. So make sure you educate yourself so you can make an informed decision.
Fortunately there are some independent advisor rating agencies that can also help you find out who is a fiduciary. Paladin Registry is one. Free to consumers, this firm vets and rates advisors. It also provides a free matching service to match you with local, fiduciary advisors who may fit your needs. They only accept fiduciary advisors.
The Future May Be Clearer
One recent development may make a lot of this easier. There’s a new regulation that was sponsored by the Obama administration that, if it becomes in effect as planned, will require anyone working with a retirement plan to act as a fiduciary. We’ll know more soon if and when this regulation will go into effect. Even if it does go into effect, however, it doesn’t apply to non-retirement accounts. So you still will need to monitor who is watching your money.
But in the meantime, you now have a couple quick ways to determine who you are talking to. This will help increase your confidence as you look for, and manage, your financial advisor.
Jeanne Klimowski is Founder of Wavelength Financial Content Inc., a provider of employee financial wellness programs and digital content for financial advisors.