For an investor at any stage of life, there’s always a lot to learn. However, for those of us who prefer to use a financial advisor, we fortunately don’t have to learn all the gritty details. Studies show that those who use a professional advisor get better results over time.
But there’s something we should never delegate, and that is monitoring our service providers and the fees we pay.
Why is this important?
There are a number of reasons. In fact, I can 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. That’s right – PER YEAR.
What is “conflicted advice?”
Let’s say you go to a financial professional for advice. Non-conflicted advice would look like this: the provider recommends the lowest cost method for achieving your goals, allowing you to keep as much of your returns as possible. “Conflicted Advice” would be where the advisor recommends suitable investments but picks higher cost alternatives that pay him larger commissions. While you may still get what you need, part of your money goes to pay those commissions to the advisor, so you earn less. Over time, small differences can compound into 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 are constantly worrying about money.
“Fiduciary” vs. “Suitability”
Two weird words, I know, but stay with me here: the definitions follow, and 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 per year in your pocket.
Imagine you’re fresh out of college, have limited funds and need a transportation solution. You have a family friend who’s 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 Chevy dealer and ask an “automobile consultant” there the 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 to tell you that. Instead she will more likely recommend a lower price Chevy, but still a new car which puts you thousands of dollars in debt. In the first example, you’re getting unbiased advice. At the Chevy 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 your choice (instead you will pay a fiduciary a fee for the advice, however). The Chevy salesperson is paid a commission on every sale, only if she makes one. She’s not an advisor, she’s a product salesperson, recommending “suitable” choices.
True Advisor or Product Salesperson?
A true advisor is held to a fiduciary standard, meaning they are legally required to hold our interests above their own. So they must always make recommendations that put our interests first, and may not steer us to choices that benefit them first. If there is any conflict of interest, they must disclose it to us in writing before we make a decision.
The product salesperson is held to a different legal standard (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 in fees.
With suitability, these professionals technically work for someone else, not you (perhaps a brokerage firm, insurance company, etc.). They get paid through commissions. While the salesperson may be the most honest person you’ll meet, he doesn’t eat if he doesn’t sell enough. The fact is that he reports to someone else – besides you, which causes inherent conflict. This “conflicted” advice is what generates that $17 billion per year. While there are many honest and ethical product salespeople out there, unfortunately the onus is on you to monitor everything.
The problem is, it can be really hard to tell the difference between true “fiduciary” advisors and “suitability” advisors.
The Easiest Way to Find Out
Finding out who is a fiduciary and who is not can be difficult, as there are many creative titles and names out there. To make it worse, even some fiduciaries may be “dual registered” so they potentially can also act as salespersons part of the time. Fortunately, there’s an easy solution to cutting through this confusion. Simply ask your prospective (or current) advisor if they will sign a Fiduciary Oath promising to put your interests ahead of theirs. The beauty of the Oath is that if the person won’t 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. While a fiduciary financial advisor usually provides most benefits to investors who are looking for a full-service solution, there are 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.
But the vital ingredient here is education—you need to know what you’re buying so you can make an informed decision, and manage the advisor accordingly.
So now you have a quick method to determine who you are talking to. Unfortunately, this is just a first step in protecting yourself when selecting an investment advisor. There’s much more, which I plan to share in future blogs. In the meantime, remembering these two words will definitely improve your vocabulary, and confidence, as an investor.