One of the best analogies to working with a financial advisor is working with a car salesman. Most people assume financial advisors have a legal obligation to always act in their clients’ best interests. But the vast majority of advisors have not been under the fiduciary standard.

It’s the equivalent of going to a Lexus dealership and expecting the salesman to give you unbiased advice on which car to buy. Even if a Honda, Acura, or Infiniti at another dealership is far better for you, that salesman is going to sell you a Lexus–that’s the only way they get paid. A huge portion of financial advisors operate in a similar environment. But unlike the car industry, you have a choice to get advice that is legally tied to your best interests instead of a sales commission. As we’ve written before, working with a fee-only fiduciary is a great first step.

If you’re going to work with a financial advisor, it’s critical to ask foundational questions like the following. I’ve added what the answer should be in parenthesis.

  • Are you a fiduciary at all times, and can you state that in writing? (Answer should be: Yes)
  • Does your firm receive kickbacks or commissions for investing my money into specific investment or insurance products? (No, never.)
  • Are you personally paid different amounts of money based on the products or portfolios you sell me? (No.)
  • Are you fee-only or fee-based? (Fee-only)
  • What am I getting for the fees I’m paying? (Depends on your needs: investment management only or IM + significant tax/estate/retirement planning)
  • Which company has custody of my investment account?

Let’s focus on the last point. Simply put, your advisor should not be an employee of the same company that houses your investment accounts. For example, suppose your advisor works for Investment Company X. In that case, your investment accounts should NOT be at Investment Company X. This is why Brownlee Wealth Management uses TD Ameritrade and Fidelity as custodians to hold client accounts we manage. BWM is the advisor managing the account. TDA or Fidelity is the investment company that holds the accounts.

Why is this so important?

Remove Conflicts of Interest

The biggest reason you need separation between advice and your assets is to remove conflicts of interest.

An advisor at a brokerage firm has a serious incentive to put your money in their parent company’s products. Even if a firm claims they are “open architecture” (meaning they can sell any fund company’s products), you’re still not in the clear by any means.

This is because brokerage firms will still stagger the compensation for their advisors based on the most expensive products. So, for example, an expensive annuity from another company will likely still be pushed by a brokerage advisor because the other annuity company pays a kickback to the advisor’s company to sell it. This is “open architecture,” but it can still be terrible for you. The above example is also true for expensive mutual funds.

To give you an idea of just how tilted it can be, let’s take an advisor at a brokerage firm that can sell Vanguard index funds to you. Even though they are not bound only to their parent company’s funds, they are almost always paid many multiples more not to put you in Vanguard index funds. So, suppose a client with $2Million wants this advisor to manage their portfolio. In that case, the advisor could make $10,000 per year (with the parent company likely making an additional $10-$20,000 per year) if the advisor puts them in an expensive managed portfolio full of expensive funds. Those expensive funds pay the brokerage firm kickbacks (or the costly funds may be managed by the same brokerage firm–double-dipping).

The advisor would make next to nothing to build the client a portfolio with low-cost Vanguard index funds in the above example. There are now mountains of data and decades of history that show that the client will likely make less money in the expensive portfolio full of costly funds. If the main objective is the client getting the best portfolio, the Vanguard funds would be the likely choice. But remember, if your advisor works for the same company that your investment accounts are held at, you’re probably not going to get the best choice. The advisor is paid a lot to make choices that benefit the parent company ahead of you.

As Upton Sinclair said, “It is difficult to get a man to understand something when his salary depends on not understanding it.” It’s like needing a Honda and expecting to get that diagnosis from a salesperson at the Lexus dealership.

Avoid Getting Scammed

Most people are somewhat nervous and skeptical when hiring an advisor because of this fear. Managing money is no joke. It’s a big deal. Taking measures to ensure that you are working with someone who will not steal your money, a fiduciary advisor, is certainly a precaution worth taking.

One of the best ways to avoid a scam is to learn from one of the biggest scams in recent history, Bernie Madoff. More than a decade ago, Madoff made headline news for months after stealing billions of client dollars through a Ponzi scheme.

This happened because the advisor (Madoff) was also the owner of the brokerage firm that held client accounts.

If you work with a fee-only, fiduciary advisor who manages your account at a separate institution like TD Ameritrade, Charles Schwab, or Fidelity, it is drastically more difficult for anything like this to happen. 

Madoff could alter client statements and move money out of client accounts without clients knowing what was happening. However, if Madoff would have held his client assets at TDA or Fidelity, it would have been virtually impossible for him to do this.

In fact, Bernie Madoff admitted this exact point in an interview

“Brokerages and advisers should have independent custodians and the government should have forced me to have an independent custodian. Client funds should be held by independent custodians. If they had, I would have been caught long ago. If I had had an inspection by the SEC, they would have looked at the custodian accounts and seen the funds on my books did not match the funds in the accounts, and I would have been caught.”

Unfortunately, situations like this on a smaller scale still happen. Just a couple of years ago, a Merrill Lynch advisor was caught stealing millions from clients over a nine-year period. A Morgan Stanley advisor stole even more over a 12 year period. I could spend several more paragraphs linking to articles of similar broker misconduct, but I’ll spare the time and effort. If you want to read more, you can find more examples in this Bob Veres article.

Simply put: if you need professional financial advice, you want to make sure you’re protected. It’s important to know how to select a good advisor. While I do think it’s important to work with someone heavily specialized in your situation (someone who has worked with several others who have similar assets and tax complexities), at least look for these two things:

  • The advisor needs to be a fee-only fiduciary. Not a broker, not a hybrid, not fee-based. Fee-only.
  • The advisor needs to custody assets at a separate institution. Example: Brownlee Wealth Management is a Registered Investment Advisor managing client accounts at Fidelity and TD Ameritrade.