You’ve spent decades building towards financial freedom. If you’re basing critical financial decisions on the advice you’re receiving, it’s worth knowing why that advice was given to you. A popular question has popped up in the last decade. It goes something like this, “Is the average person worse off after working with a financial advisor?” As piercing as that question is, it speaks volumes on the difference between good and bad advice.
The answer to this question can determine the value of the advice you’re receiving. More poignantly, it can tell you why your advisor recommended what he recommended. Historically, there are three basic ways a “financial advisor” can structure themselves.
Broker-This means your advisor is paid based on which product(s) he sells you.
Hybrid-both a Broker and a Registered Investment Advisor-This means your advisor can tell you he or she is a fiduciary. At times, they are. At other times, they are not—they can sell you specific financial products that pay them a commission. Note: They are not required to disclose when they act as a broker and when they act as a fiduciary.
Registered Investment Advisor (RIA)-This means your advisor is required to act as a fiduciary at all times. A fee-only RIA does not accept commissions or kickbacks. Simply put, this advisor is legally bound to act in your best interests at all times.
A couple of years ago, my wife and I found out I was diagnosed with cancer. There isn’t necessarily a great time to find out you have cancer. But I can assure you that two weeks after your wife has a third child (the oldest of which just turned four), is not the ideal time. Fortunately, it was treatable and even curable. As you can imagine, the treatment was not fun, but it was effective.
Now imagine that a doctor diagnoses you with a similar disease. It’s curable. Things are looking good. As long as you have excellent care, you’ll get right back to normal. The only thing standing between you and excellent health is a trustworthy doctor to give you the advice and treatment plan you need.
If your doctor was under the Broker model that many financial advisors use, imagine the consequences. Your doctor would have several different treatment options, all of which would pay him a different commission. Let’s say these options pay the doctor somewhere between $500 and $50,000. Now to make it even more similar to financial advice, let’s imagine that the treatments paying the doctor $500 are widely recognized as the best course of action. They stand up under academic scrutiny. There are mountains of evidence that they are far more effective, and less harmful (!), than the treatments that would pay the doctor tens of thousands of dollars. But your doctor is a broker. He is not interested in a $500 commission. He wants, even needs, a commission that is several times that amount. And the $50,000 treatment might kind of work anyway, so what’s the big deal? Not to mention, there are thousands of others all over America that have been selling the $50,000 treatment for decades! It can’t be that bad, right?
Now let’s imagine that your doctor is #2-a hybrid. He is both a fiduciary and a broker all at the same time. Back to the doctor analogy, he or she can tell you with a straight face that they’re under the Hippocratic Oath. They can tell you they’re going to act in your best interests. But, your doctor is also licensed to sell medical treatments that are far more harmful and can collect the commission from them. Your doctor doesn’t disclose to you exactly when he’s acting as a broker and when he’s a fiduciary. How are you supposed to know when he’s working in your best interests vs. his own?
Note: The majority of Americans working with a financial advisor today are working with a hybrid. In many cases, the client doesn’t even know their advisor is also a broker.
What if there was a better way? What if you could simply pay your doctor a fee. Pay him for his expertise. Pay him to plan a course of treatment that was not just one of 10 different options that could be legally construed as “suitable.” You would pay him to give you the treatment plan that was in your best interests. One that was catered specifically to you and no one else. And would it end up being the $500 option or the $50,000 option? Well, your doctor wouldn’t have any vested interest in the cost. He’s not going to see a penny from the treatment; he’s already paid by you. So, he is free to pick the treatment option that is academically sound and has the best odds of getting you exactly what you need. Did we just solve health care?
Why is this better for you? It means your advisor has to take responsibility for the advice he or she gives. When you work with a fee-only fiduciary, the advisor isn’t settling for one of 20 options that could be construed as “suitable.” The fee-only advisor is searching for the one option that is in your best interests. The fee-only advisor is not holding themselves out to the public as advice-givers while appearing before courtrooms claiming they’re not in the advice business. The fee-only advisor hasn’t lobbied Congress for the last decade to ensure they can continue operating this way.
How does this play itself out with your finances?
John Bogle, the founder of Vanguard, famously said that in investing you don’t get what you pay for. You get what you don’t pay for. Here are the most common ways that bad advice can impact your portfolio.
Annuities and Cash Value Life Insurance. Annuities have become somewhat of an expletive in the financial world. While annuities can have an academically-defensible place in a financial plan, the ones that typically get sold do not. The difference between an expensive insurance policy and one that most Americans need is often several hundred dollars each month. However, that understates the real impact. Being a financial planner, I love compound interest. I could rewrite the above sentence to say: the difference between an expensive insurance policy and one that most Americans need is millions of dollars throughout your life.
If you have either of these products, it’s essential to assess how to transition them to a much lower cost alternative without triggering a large tax bill.
Mutual Funds. Mutual funds have been at the heart of how brokers operate for decades. The general idea behind a broker throughout history was that an investor has no access to information or investments themselves. So, the broker gives them access to the world of the markets, often through mutual funds. There are two fundamental problems with this. The first is that it’s not 1975 anymore. Because of the smartphone, a 20-year-old in Bangladesh can open his phone and purchase an ETF just as quickly as the highest-paid analyst at Goldman Sachs. The second problem is how the typical advisor picks the funds they put their clients in. There are almost 10,000 different mutual funds today. A broker may be structured to put their clients in the funds that pay more to the broker’s parent company. A fiduciary advisor isn’t paid by any mutual fund company. Therefore, they can approach the investment selection process from an entirely different angle. A fiduciary advisor is free to select whatever makes the most sense for the family they’re serving. They can build the portfolio in an evidence-based academically-defensible way. Several investment firms have made excellent strides at bringing low-cost ETF’s to the average investor.
Market Strategies. I have good news and bad news. The bad news is that you can’t time the market. You cannot trust a particular strategy to protect you in turbulent times while making lots of money in good times. I wish it weren’t so, but that’s the truth. The hope that you can time the market or find some magical strategy is so strong, though, that there continues to be a vast number of advisors and firms that offer this. It sounds innocent enough, but investing your assets into a strategy like this can be devastating. One simple google search “cost of missing the ten best days in the market” can quickly teach you how destructive this is. Read more about our investment philosophy here.
One of the primary jobs of a financial planner is to guide your decision making. When you make the right decisions, you compound your returns in a positive way for decades. Wrong decisions can both destroy your returns and increase your tax bill. Ensuring that the advice you get is structured to help you instead of your advisor is a wise first step.