Where Are You Getting Your Financial Advice?

I was watching a cable news channel late Friday afternoon when I saw a commercial that caught my attention. The commercial had a middle-aged couple riding in a car talking about how Washington was trying to make it harder for them to have access to financial advice. It stated that the government was trying to make it more expensive and less accessible for Americans to receive financial advice. What the commercial was referring to is the push from the White House to place fiduciary requirements on brokerage firms.

A Financial Advisor at a brokerage firm has somewhat of a misnomer. The term stockbroker has become taboo because of the images of Jordan Belfort and Gordon Gekko that have been portrayed in Hollywood and the real world events that provided basis for their stories. Life imitates art and vice versa. In the movies The Wolf of Wall Street and Wall Street, stockbrokers are portrayed as self-serving greed mongers. Not someone you’d want to trust your hard-earned savings with. While the movies are highly dramatized, there is some truth to them. I don’t say this to suggest that all Financial Advisors at brokerage firms are greedy, selfish crooks. In fact, I’d hold the opinion that a vast majority of the representatives at brokerage firms are good, trustworthy individuals.

On the other hand, though, I think it needs to be said that the business model of a brokerage firm is riddled with an inherent conflict of interest. A representative at a brokerage firm (stockbroker, Financial Advisor, Registered Representative-all semantics) has only a duty to make suitable recommendations. Not recommendations in a client’s best interest. The two are not the same.

To illustrate a hypothetical example, imagine you had $100,000 in a CD at Bank X that pays you 1% for 5 years that you entered 2 years ago. You’ve been receiving $1000/year in interest for the past 2 years. Let’s say since that time, perhaps the interest rate environment changed, and today someone could buy a CD at Bank X for 2 years paying 5%. If you had to pay a 1% penalty to break your existing CD, you will still be better off to pay the penalty and collect 5% interest over the next 2 years in the shorter term, higher yielding CD. It would not be a profitable move for Bank X, in fact, I’m certain a Bank X employee would be forbidden from recommending this to you by Bank X. Bank X would rather pay you 1%, the cost of them holding your money is cheaper at 1% than at 5%. If the banker at Bank X were held to a fiduciary standard, they would have to act in your best interest and move your money to the shorter-term, higher yielding option. But by suitability standard, if there is nothing unsuitable about your money being held for the next 3 years in your original 5 year CD, their duty would have been met. Again, this is strictly a hypothetical example to show how not being held to a fiduciary standard can impact you individually.

In that example, I used a bank but it can occur in an investment setting as well. If your broker is recommending you invest $100,000 in Mutual Fund A (mutual funds are widely used in the financial services industry), they are only required to ensure that the mutual fund investment is consistent with your risk tolerances, your investment timeline and your financial situation. They are not required to make sure it is the most cost-effective option available to you, as long as the fund they recommended was suitable. Let’s say your $100,000 investment in Mutual Fund A would cost you 3.5% in upfront sales charges and annual management charges of 1.5% (not unrealistic). But let’s also say that Mutual Fund Z could be purchased without a sales charge and had management expenses of 0.25% (again not unrealistic). And the investment management, performance, and risk profile of both funds were about the same. A broker does not have the obligation to recommend Mutual Fund Z over Mutual Fund A in this example, or even tell you that Mutual Fund Z exists. It should be pointed out that in this hypothetical example, the broker would be earning a commission of roughly $3000 by having you purchase Mutual Fund A and no commission to purchase Mutual Fund Z. While working with an Investment Advisor Representative at an SEC Registered Investment Advisor, the representative would be bound by the fiduciary duty to act in your best interest and recommend the lower expense option. You’d likely pay an annual advisory fee to the advisor, but in all likely the total cost would be less than the management fees of the hypothetical Mutual Fund A, with no upfront commission paid to a broker.

But we can’t blame the personable broker that you interface with. Chances are they’re a great person with great morals, and they likely think they’re doing well by you. The honest ones. There are some less than honest ones out there too. The blame is on the industry, on the firms. Their structure and business model is to blame. In the hypothetical example above, the brokerage firm probably wouldn’t even have a selling agreement with Mutual Fund Z’s management company. It wouldn’t be profitable to them. On top of that, many of the largest brokerage firms have their own house brand of mutual fund that competes with all of the other funds out there. They don’t want to be held to a standard that would require them to recommend the outside brand which doesn’t make them as much money. And your nice-guy “advisor” is non-the-wiser. He or she is simply working with the tools available to them. But make no mistake, they are not advisors. They are Financial Advisors by title only. They are the sales force. They are brokers.

And as far as this commercial that I’d seen, who are we to believe made this commercial? It had some organization that I didn’t catch the name of at the end of the commercial, but I’m sure it was paid for by Merrill Lynch, Morgan Stanley, UBS, Wells Fargo, Edward Jones…among others collectively. And if they’re spending money on ads for a cable news network, I’m sure they’re spending money in Washington to protect their interest. They know that if the rules change and tighten around them, it threatens their business model. It does not threaten the interest of consumers as they suggest. They’d like you to believe that their way of doing business is the only way and getting in the way of that means Americans won’t have access to financial advice. Not True. Regardless of what comes from this debate in Washington, I think it would be in your best interest to seek advice from a professional advisor that is happy to put your best interest first and is held by a fiduciary standard to do so. It’s preposterous to suggest that making an advisor accountable to acting in a client’s best will limit the public’s access to good personal advice.