If you have a financial advisor, you probably like and trust him or her. Otherwise, why would you be taking their advice? In many cases the advice you get from your financial advisor will be good, helpful and trustworthy.
But in other cases, maybe not so much.
Unfortunately, there are two dirty little secrets about financial advisors. First, the titles financial advisor, financial analyst, financial consultant, financial planner, investment consultant and wealth manager are generic terms and can be used by any investment professional who may or may not be the proud possessor of any specific credential. In other words, the term financial advisor is basically meaningless. While we certainly hope this isn’t the case, your financial advisor could actually know as much about stock picking as a gerbil.
The second, dirty little secret of financial advisors is that he or she may receive a commission on the investment vehicles you purchase, which means he or she may stand to make money off of you and that’s called a conflict of interest. To put this another way, sometimes financial advisors are actually incentivized to not work in your best interest. The best example of this is probably annuities. Annuities can be very complicated investment instruments that have high fees and are really only for certain types of portfolios. However, some financial advisors push them hard for one simple reason – the commission. As an example of this, if you were to invest $80,000 in one particular annuity, your financial analyst might earn a commission as high as $4000. So when she or he advises you to buy an annuity it might because it’s in your financial analyst’s best interest and not yours at all. Some of the companies that sell annuities even offer financial advisors big perks such as free vacations in castles or villas to further incentivize them.
It’s not illegal … at least not yet
Believe it or not there’s nothing illegal – at least at this time – about a financial advisor putting her or his interests ahead of yours. Plus, it’s very hard to know when good, old Bob – your financial advisor – is suggesting an investment vehicle that will be great for you or him. You have to trust Bob or you wouldn’t be paying him for his advice, right?
If she or he is a fiduciary
Where you can trust your financial advisor almost unequivocally is if he or she is a fiduciary. When this is the case, your financial advisor must by law avoid conflicts of interest and operate with full transparency. And if there is a conflict of interest – such as the annuity thing described above – the financial advisor must disclose it. In addition, a financial advisor who is a fiduciary has what’s called a “duty to care” and must monitor continually not just your investments but also your changing financial situation.
A gold mine for financial services companies
If you’re fortunate your company offers a 401(k) and if you’re even more fortunate your company provides matching funds. But just because you have a 401(k) doesn’t mean that you’re not at risk for losing money. The problem is that 401(k)s can be virtual gold mines for financial service companies. Don’t get us wrong. We believe whatever company is administering your 401(k) deserves compensation for the services it provides. However, in some cases you can get killed with fees. Some companies charge trustee fees, transactional fees, legal fees, bookkeeping fees, finders’ fees and on and on. While these fees may not seem like much at the time they will add up considerably due to compounding interest and totally eat into your retirement savings.
Here’s an example of this. Let’s suppose your investments grow at the rate of 7% per year thanks to compounding interest and the fund manager charges you 2% per year. Over 50 years that 2% fee will also compound and the difference between what you will earn versus what you would have earned without that 2% fee is actually staggering. In fact, you will have lost almost 2/3rd of what you would’ve had.
Most 401(k) plans offer two options. The first is low-cost index funds, which simply try to match the average returns of the stock market. Or for a higher fee you can get what’s known as an an “activelt managed fund”. This is where you have experts who do the stock picking for you, attempting to beat the market. Unfortunately, even the smartest Wall Street experts find it difficult to to this on a consistent basis. Here’s what might be the funniest but saddest example of this. A group of financial experts took on a stock picking challenge versus a cat named Orlando. The cat made its stock picks by throwing its toy mouse at a list of companies. The returns on investments chosen by Orlando were nearly 11% while the returns on the investments chosen by the pros were just 3.5%.
Here’s a short video with more detailed information about this stock picking challenge and about Orlando,
There is increasing evidence that this was no anomaly. In fact, one study found that 66% of fund managers could not match S&P results. There’s a third dirty little secret of active financial advisors, which is that many of them actually own index funds themselves.
There is a law pending that next year all financial advisors must be fiduciaries. Unfortunately, the financial services industry has attacked it with four different lawsuits to get the law struck down. In the meantime, if you have a financial advisor it would be a really good to ask if she or he is a fiduciary. Second if you have a 401(k) your best bet would be to invest in low-cost index funds and then just leave them alone. Finally, if your 401(k) Includes fees higher than 1%, you might want to have a talk with your employer. Failing that, you might open an IRA with a company such as Vanguard that has very low fees and then, once again, invest only in low-cost index funds.