Disclosure: Justin is a fee-only financial planner at Quantifi Planning and he is a paid advertiser on this site.
Where does my advisor have conflicts of interest?This question has never been more important, especially for physicians. When it comes to picking a financial advisor, there’s no such thing as conflict-free advice. Sadly, even the word “fiduciary”(the highest standard of ethical obligation for a financial advisor) doesn’t mean what it used to, as there is little uniform enforcement and understanding of this term today. India, Australia, the UK and others have created a much more transparent and consumer-centric environment for financial advice with a series of reforms that have “been built around the idea that advisors giving advice shouldn’t also be earning commissions” on that advice. The US continues to lag behind other nations in reforming the financial advice industry. It also continues to be very difficult for a consumer to discern when an advisor is dispensing fiduciary advice and when they are acting as a commissioned product salesperson. While congress continues to try to sort out appropriate rules for financial services in America (the recent legislation in early June left much to be desired), it’s important for you to understand where advisor conflicts exist and to what extent they may impact the advice you receive.
Knowledge Is PowerFinance is an industry where massive informational asymmetries persist between advisors and clients. Physicians are often on the wrong end of this information see-saw when compared to the financial institutions with whom they work. At the poker table of life, financial companies frequently hold all the cards. I’ve seen that many doctors don’t know what they’re getting when they hire a “financial advisor” (most residencies give only barebones direction on this important topic, if any) and are financially vulnerable because of this asymmetry. Would you ask a pharma drug rep for medical advice? Or would you get legal counsel from an attorney who also represents the opposing party? Probably not. The same consideration should be given when hiring an advisor. Now, I believe that the overwhelming majority of financial advisors deeply desire to serve their clients well. However, many operate in business models that require them to, at times, work against their own financial interests to do this. To be an informed consumer, you should understand your advisor’s business model and understand where these conflicts exist. Conflicts of interest may substantively change the recommendations you receive, and not for the better.
Choosing a Good Financial PlannerThere has been a considerable amount written on this blog and others about how to choose a financial planner. I propose that for my physician friends who want to hire an advisor, a good advisor will:
- Have requisite technical competency (experience with cases like yours, plus a rigorous certification like the CFP®).
- Operate in a fee only model (strict separation of advice and product, i.e. no commissions)
- Charge a fair and transparent price for advice rendered.
How Your Advisor Gets Paid & Your Advisor’s IncentiveEVERY model has conflicts of interest. Yet, they vary in number and degree. Some are much less conflicted than others. It is helpful to understand the conflicts of interest across all of the different business models. The fact is, your advisor makes MORE if they tell you to do one thing, and LESS if they tell you to do another. In a perfect world, an advisor gets paid more over time to have you do things that are aligned with your longer term goals (like growing your net worth), rather than getting paid more to, say, have you sign on the dotted line to purchase a financial product. The below chart outlines some common financial planning actions/considerations and attempts to disclose conflicts of interest as they exist. I define a conflict of interest as a situation in which the advisor has to recommend something that takes money out of her own pocket in order to give you the right advice.
The Basics of Financial Advisory ModelsFirst, let’s define some terms with some of the most popular fee models, listed below:
- Hourly – paid by the hour at a flat hourly rate. (i.e. Hours x Rate = total fee)
- Flat Fee – all financial planning and investment management provided for one flat fee that does not go up or down based on assets managed (i.e. $10,000 per year for all services)
- Flat Fee Based On Net Worth – a tiered variant of the flat fee model, where a higher net worth equals a higher fee. Fee goes up with an increasing net worth.
- % income + % Net Worth – a tiered variant of the flat fee model, incorporating both income and net worth. Fee goes up with an increasing income or net worth.
- % of Assets Under Management (AUM) – a model where the advisory fee goes up as assets directly managed by the advisor goes up.
- % AUM + Commission – A variant of the above where the advisor may also earn commissions on certain investment products or insurance policies in addition to a fee on managed assets.
Some Things Are Worth Mentioning Twice
- If you’re looking for financial planning and investment help, you should start by looking at fee only planners (check out NAPFA or XYPN for lists of fee-only advisors). This fee model simply has way less conflicts of interest because they can’t earn commissions.
- The vast majority of advisors are NOT FEE ONLY. At the end of 2018 there were over 311,000 professionals in America calling themselves a financial advisor. It’s unclear how many of these are truly fee only, but NAPFA membership (a readily available proxy for the fee only planner population) counts about 3,000 members at the end of 2018. This is about 1% of all planners. It’s clear that fee only planners are a tiny minority.
- The above list is not exhaustive from a fee-model standpoint (there are over a dozen). For any advisor you hire, make sure you understand all of the ways in which they may receive compensation and how this may impact the advice they render.
- Many financial products currently can’t be accessed without a commission. Any time you get a life insurance, disability insurance, annuity, or some other financial products, a commission will be involved. This isn’t a bad thing (it’s the way the industry has functioned for decades) but having a fee-only advisor facilitate the purchase of these types of products is a way to get an objective second look.
- There are many great advisors out there in fee + commission business models, who operate ethically and appropriately and serve their clients well. It is not my intention to demonize the +95% of advisors in America who operate in this model, but rather to help consumers be informed about potential conflicts.
TPP’s ThoughtsThe fact that the word “fiduciary” even exists bothers me. Can you imagine a doctor who wasn’t trained to put the patient first? Would such a training program ever exist? As Justin points out, the definition of the word is debated. When it comes to money, though, the need for a financial advisor operating as a fiduciary is not. Justin’s last point is spot on. In fact, that is the advice I give to people who want to hire a financial advisor. I teach them to ask “How do you get paid?” This is a very different question from “How do I pay you?” This will help you understand how your financial advisor gets paid. If you “follow the money” you can sort out of a lot of the conflicts of interest.
What did you think about Justin’s post? Do you understand better how your financial advisor gets paid? What conflicts have you noticed in the models you have worked with? Leave a comment below.