“Show me the incentives and I will show you the outcome.” - Charlie Munger, Berkshire Hathaway
Of the roughly 310,000 financial advisors in America, how many of them do you think are required to act in their clients’ best interests? All of them? The vast majority?
Less than 10 percent of all financial advisors in the United States are required to follow the fiduciary standard, a standard legally requiring financial advisors to put your interests ahead of their own.1
Think about that for a second – over 90 percent of advisors, the people millions of Americans trust to manage their entire life’s savings, are not legally required to do what’s in their clients’ best interests. In 2019, in the wealthiest country in the world, these are the facts.
This may be a dry subject, but it’s critically important for everyone to understand the difference between a fiduciary and a non-fiduciary. Non-fiduciary financial professionals can recommend products that generate bonuses, prizes, and commissions for them, but may end up costing you significantly more in fees. It’s estimated that non-fiduciary advice costs investors up to $17 billion per year.2
The Investment Advisors Act of 1940 was enacted to regulate advisors who give financial-related advice to others, and in turn, receive compensation for that advice. Under today’s laws, only independent Registered Investment Advisors (RIAs) are required to act in a fiduciary capacity.
Conversely, financial advisors working for broker-dealer firms are held to a suitability standard. The same can be said for financial advisors working for insurance companies. The suitability standard does not require advisers to put their clients' best interests before their own, nor must they avoid conflicts of interest.
When faced with two comparable investments, one of which has a higher commission, a fiduciary is legally unable to recommend the higher cost investment because paying more in fees isn't in the client's best interest. An advisor held to the suitability standard could recommend the more expensive product, provided it's "suitable" for the client.
Most non-fiduciary financial advisors are good people, but their incentive system is often misaligned with a client’s best interest. The compensation structure of a broker is typically a tangled matrix that has nothing to do with client outcomes and everything to do with generating more revenue than last year.
In 2018, an article from the Wall Street Journal described how sales incentives created conflict between Wells Fargo Wealth Management’s brokers and the firm’s clients. As stated in the article:
"Wells Fargo financial advisers pushed clients into products that generated additional fees and often moved client assets between different products or investing platforms to generate more revenue and bigger bonuses."
"Wells Fargo often mandated client quotas for riskier alternative investments, such as private equity and hedge funds, regardless of whether they were appropriate."
"Among employees, 2015 became known as “the year of the annuity” because advisers would push clients into these higher-fee products to meet their revenue targets. Some advisers would redeem clients from annuities that had large surrender charges and place them into another product with annual fees of 1% to 1.5%"
These types of practices are applicable to more brokerage firms than just Wells Fargo. They happen every day with different products and different sales incentives.
While most people aren’t receiving fiduciary advice, here’s what you can do to ensure you’re receiving advice aligned with your best interests:
It never hurts to ask your advisor if they are a fiduciary.
2. Ensure your advisor is interested in more than just your portfolio
A financial advisor should cover all aspects of your financial situation – taxes, estate planning, college funding, health expenses, social security, insurance, savings, debt, etc.
3. Request to see your advisor’s ADV
An ADV is a disclosure document outlining an advisor’s business practices and may be helpful to better understand things like fees and other compensation arrangements.
Financial advisors help people with complex financial situations who want a relationship with someone that intimately knows them, understands them, and will fight to see their goals and objectives met in the future.
Fortunately for consumers, an increasing number of advisors are leaving the brokerage world each year in favor of the independent, fiduciary model.
Your financial advisor should have skin in the game and be a partner in your outcomes – they win when you win.
Sources:
1. Robbins, Tony. “Who can you really trust?” Tony Robbins, Robbins Research International, https://www.tonyrobbins.com/podcasts/who-can-really-trust/
2. “Fiduciary 101 How to protect your retirement savings.” NAPFA, https://www.napfa.org/financial-planning/fiduciary-101