In The Physician Philosopher’s Guide to Personal Finance, one of the chapters is on conflict of interest. Why? Because conflicted financial advice is one of the biggest reasons that physicians make financial mistakes. In the process of writing that chapter, I had the opportunity to hear a WCI podcast episode. In this episode, he interviews Sarah Catherine Gutierrez, a financial advisor, who spells it all out. And it really got me fired up about how to avoid conflicts of interest and what a good financial advisor looks like.
So, today’s post will be about separating the wheat from the chaff. More specifically, here are eight ways that you can tell if a financial advisor has a major conflict of interest. In knowing them, you can seek better financial advice or at least mitigate the conflicts that exist.
Number 1. They sell commission-based products
It’s pretty regular advice these days that you shouldn’t mix investments and insurance.
Why then would you use a fee-based financial advisor who works for an insurance company? Their job is to sell insurance products and to make money from the commission they get when they sell it to you. That’s called a conflict of interest.
No matter how good of a person they are, it is going to be extremely hard for them not to sell you their products. In fact, this happened to me and it isthe reason I can’t get personal disability insurance to this day… and he was the brother of a medical school classmate of mine.
So, the first rule of spotting bad financial advice is when the financial advisor is trying to sell you a product. Often, this will come in the form of a free lunch/dinner/coffee. The follow-up will involve products. Just say no.
Who then should you buy disability/life insurance from? A recommended independent insurance agent that can get you quotes from multiple companies and find what’s best for you.
Number 2. Advisors who operate under an Assets Under Management Model
When you pay someone for a service you usually have a very concrete idea of what that service will cost you. For example, before someone replaces your water heater they are going to give you an estimate and tell you what the expected bill is. Right? That’s honest, and that’s fair.
With an Assets Under Management (AUM) model where you pay financial advisors a percentage of your assets each year. You never directly cut them a check. It is swept out of your assets unbeknownst to you every quarter. At 1%, which is the industry standard, that is going to cost you a boatload (A boatload = millions of dollars).
For example, at 1%, of your $3 million dollar IRA in retirement a 1% AUM will cost you $30,000 per year. Compound that on 6% interest for thirty years and you’ll begin to get an idea of how big of a number AUM costs you.
A financial advisor working under the AUM model needs to find 50 people who all have 500,000 in assets to manage. At 1% that’s a $250,000 annual salary. If those 50 have a million, its $500,000, which is more than a lot of doctors make. So, don’t feel bad when you break free from this system.
One of the biggest reasons this rubs me the wrong way is that there is an alternative to this. It’s a really good system that isn’t morally reprehensible. It’s called fee-only flat hourly rate advising where you pay by the hour or for a specifically priced product. More on that in the “take home” below.
Number 3. The advisor tries to sell you whole-life insurance
See number 1 above. Don’t mix insurance and investing. I mention this separately because it gets pitched to physicians all the time. It is shocking how many people fall for this stuff.
If you want to read more on this, WCI has written a bunch of posts on it. I am not going to repeat what he says, but you can trust that it’s a bad idea for the vast majority of people.
For further reading:
The point is… whole life insurance, which goes by many names (permanent insurance, cash value insurance, cash value policy, etc), is bad for the overwhelming majority of doctors. If someone is mixing investments with insurance, it’s probably whole-life insurance with a new name.
Number 4. A SEP-IRA is brought up without mentioning a Backdoor Roth IRA
If you have a side hustle and you are making 1099 money, a financial advisor may tell you to open up a SEP-IRA also known as a Simplified Employee Pension – Individual Retirement Account.
This is one of the options you have when you have self-owned (employer) side hustle income. The other is a solo-401K. While a solo-401K takes a little more work to set up, it has one major benefit for a high income earner that cannot be overlooked.
A solo-401K still allows you to participate in a backdoor Roth IRA. A SEP-IRA does not. Well, that’s not entirely true. You can do it, but you are going to get slammed by the pro-rata rule.
Suggesting a SEP-IRA without discussing this consequence is bad financial advice that an advisor working directly with physicians should know about.
Further Reading: If you have never performed a Backdoor Roth IRA, click here to find a Backdoor Roth IRA tutorial for your first backdoor Roth at Vanguard.
Number 5. Investing over paying down debt
If you ask a financial advisor who is working under the AUM model whether you should hammer away at your debt or invest money, the conflicted advisor is more likely to tell you to invest and “earn more in the market.” After all, historical returns in the market average 10% and your loans are only at 4%!
With an AUM advisor, it would be impossible to tell their motive for the advice. Is it really math? Or is it that investing gives them more assets to manage and increases their take home pay?
By the way, this conflict can present itself in multiple ways. Essentially, any money that doesn’t go towards your assets under management is a conflict. Should you pay off your student loans early? What about your mortgage? Should you take social security before age 70?
All of these questions present possible conflicts of interest for the fee-based AUM financial advisor.
Number 6. They recommend an IRA over a 403B/401K
AUM advisors do not typically get paid for “managing” retirement accounts at your employer. So, that 1% AUM does not typically include money in your 401K/403B. It also doesn’t include money in your 457.
Naturally, if you change jobs and ask your AUM advisor whether you should roll your money into your next employer’s 403B/401K or into an IRA… they are going to tell you to put it in the IRA.
Why? Well, because they would manage the IRA and then take 1% from that pile of money, too. It’s conflicted advice. The only time this advice would even be worth considering is if your future employer’s retirement options are terrible (really high expense ratio actively managed funds).
If you change employers and they tell you to roll it into an IRA, you better think twice.
Number 7. You don’t know how they are getting paid (see number 2 above)
Unless an advisor is provided by your employer and you can be sure that they have none of the other conflicts mentioned in this list, you can bet dollars for doughnuts that they are working under an AUM model. I’ve seen AUM rates as high as 2% in scenarios where physicians thought they were getting financial advice for free.
Run for the hills.
Number 8. They prefer actively managed funds over index funds
Whether you should invest in actively managed funds versus passively managed index funds is an academic question. It has been answered.
The answer is that index funds are King. They outperform actively managed funds more than 90% of the time over a 15 year period. So, you better have a really good reason not to invest in passively funded index funds (i.e. you aren’t offered one at work). The data is so solid on them that any advisor who councils otherwise would be pretty foolish to think otherwise.
I realize that this is a controversial topic to some, but if your advisor is putting you into actively managed funds there is a good chance they are loaded funds or funds that provide them a commission.
You’ll see a theme here in that it is likely a conflict of interest for them.
Take Home: Avoiding Conflicts of Interest?
As I always tell my kids, “If you are going to do something, do it right or don’t do it at all.”
Fortunately, there is a better way when it comes to financial advising! It is called gold-standard financial advising. It involves the four following criteria:
- Extensive working with people like you (i.e. doctors)
This is the model of good financial advising and one that I can get behind. For the record, I am such a fan that I am pitching this kind of adivsing to you, if you need it.
Let the official record show that I am not against financial advisors. I am against financial advisors who have a large conflict of interest. If you need one, ask the right advisors..or don’t ask at all.
What do you think? Are AUM financial advisors and advisors working off of commission a terrible idea? Do you have one? What’s your excuse. Leave a comment below.