Most Financial Advisers Don’t Put You First

This is the second article in the Mind Your Decisions “week of skepticism.” All this week I am discussing misguided or crooked financial advice. The general theme is to be more careful about advice from people who sell you products or don’t consider strategic implications. See the first article on buying used products.

Fact 1: Unprepared people ask financial advisers for investment advice.

Fact 2: Most financial advisers make money by selling high commission products.

Anyone else see an incentive problem?

Here’s what I imagine normally happens. You hire an adviser to work for you, and instead of working for you, they are working for themselves and selling you high-profit products. They can be sure you don’t know better. Think about it. If you did know better, you wouldn’t be asking them for advice in the first place.

What makes financial advice uniquely bad?

Incentives alone do not cause misbehavior, and that’s very important. We rely on more knowledgeable people to help us all the time—like doctors, dentists, and psychologists. These groups are not perfect; they can also take advantage of us by billing for unnecessary work. And there are bad apples do cheat. But I think by and large, we the public tend to trust doctors, dentists, and psychologists. That’s not something I’d say about financial advisers. What gives?

There’s one very important feature to the good groups: they are all legally bound to have their client’s best interest. Medical professionals have patient confidentiality agreements. The client is supposed to be king.

This is amazingly not the case for many people who call themselves “financial advisers.” There’s an excellent article on this point. It’s written by the registered investment adviser Scott Burns, of AssetBuilder (read the article). My newsletter readers already know about his great articles.

The article discusses what people mean when they call themselves “financial advisers.” Here is what a close look at the numbers suggests:

In other words, of all the people who may call themselves financial advisers, about 5 percent are registered investment advisers alone.

This is an important fact. A registered investment adviser is the only person in this group who has a sworn fiduciary duty to put your interest first [emphasis mine]. The others provide what is deemed “suitable” investments. Micro print contract documents may even tell you that your interest and the interest of their firm may not always be the same.

Scott Burns is a registered investment adviser himself, so this is where he might talk about how people should only trust him.

Of course, that would be self-serving, and what I love is that he admits that. He’s willing to accept that registered investment advisers might not be better:

Will getting your advice through a registered investment adviser guarantee better investment advice?

No. But it will guarantee a fiduciary relationship. That’s one where the adviser has sworn to put your interest first at all times, one where making a sale isn’t what stands between him and a top-producer trip to Hawaii. Unfortunately, many registered investment advisers are nearly as expensive as the legacy distribution system. As a consequence, your long-term after-expenses return can be much reduced.

Ultimately, he proposes a solution that I agree with:

What’s the solution?

Self-education. Learn enough to use the independent investor distribution system— the mutual fund firms and discount brokerage firms that can cut your investment expenses by 90 percent.

Here’s my one-sentence summary of this whole topic. Great personal finances can be yours, if you mind your decisions.

My own strategy based on self-education (yours may differ of course).

1. Write goals to motivate finances.
2. Track where money is going.
3. Save to get higher value.
4. Spend where you want to, not where others do.
5. Be mindful of incentives. Think strategically.