BEHAVIOR MANAGEMENT: Working with an Advisor - PLANNING FOR ACTION - Simple Money: A No-Nonsense Guide to Personal Finance - Tim Maurer

Simple Money: A No-Nonsense Guide to Personal Finance - Tim Maurer (2016)

Part V. PLANNING FOR ACTION

Chapter 20. BEHAVIOR MANAGEMENT: Working with an Advisor

WHY do I need to read this chapter?

If personal finance was merely the study of money within the context of life, then all you’d need to do is act on the wisdom of the many experts represented in this book (and elsewhere) and be on your way. But as we learned in chapter 1, personal finance is more personal than it is finance. It’s actually the study of life within the context of money.

Personal finance is more about behavior management than money management. That’s why I, and many other financial advisors, actually have our own financial advisors. Yes, a great advisor may tell us something we aren’t aware of, but more often than not, they’ll simply remind us of what we already know and nudge us in the right direction.

The challenge, for you as a consumer, is finding a true advisor. Someone who is a practitioner of a trade, not merely a salesperson. Someone who is educated, credentialed, and experienced. Someone who acts in your best interest at all times.

Would you believe that the majority of financial services professionals are not legally obligated to act in your best interest at all times? Indeed, many of the most recognizable companies, firms that often represent the financial industry as a whole in the minds of many investors, have fought hard to keep their employees from having to make such a pledge.

Please allow me to help you decipher whether you’re working with a salesperson or a professional. In order to do so, you need to know both how advisors are compensated and a bit about how they are regulated.

How Advisors Are Compensated

Three primary compensation methods drive the industry—commission-only, fee-only, and fee-based. What you’ll find is that an advisor’s compensation model drives his or her recommendations. And too often, the Elephant squashes the Rider (chap. 3).

The first, and at one time the only, compensation regime in the financial industry was the commission model. In this model, a stock broker or insurance agent would sell a stock, bond, mutual fund, annuity, or insurance policy and receive a commission, typically a cut of your initial investment or premium payment. The driving force of the client interaction between commission-based financial professionals and their customers was not advice but transactions. That was the only way the “advisor” got paid.

Commissions for the sale of products are still alive and well today. This is in part because the majority of financial services professionals work for the very companies that create the investment, insurance, and banking products. This isn’t tolerated in other professions, like medicine (thankfully). Would you, after all, seek the advice of a doctor employed by a pharmaceutical company? Would you question the prescription written for you if you knew the physician was paid more to prescribe that medication over others? But this is still how many in the financial industry are compensated.

On the other end of the compensation continuum, we have fee-only advisors, who are compensated only by their clients. Even within this camp, there are numerous ways a client might pay an advisor. Some advisors charge on an hourly basis, like an accountant. Others charge a retainer, like an attorney. But most fee-only advisors charge clients based on the amount of assets they help manage, where the financial planning and investment fees are combined.

I much prefer fees to commissions. It places the advisor on the same side as the client, not a financial product. This compensation model, however, still isn’t perfect. Hourly advisors have an incentive to stretch meetings or engagements, retainer or flat-fee advisors have an incentive to spend the least time possible on each client, and advisors who are compensated by “assets under management” are incentivized to keep as much as possible of their clients’ net worth under management, where they can charge a fee.

The third compensation method is currently the most popular—fee-based. The biggest problem with this compensation label is its ambiguity. As it connotes, an advisor receives some of his or her compensation from fees, and some from commissions. It’s hard to know exactly where the conflicts of interest are when you don’t know exactly how the advisor is getting paid, which leads me to a very important point.

The ideal situation calls for no conflict of interest between client and advisor, but the best we’re able to achieve in reality is low conflict. Everyone is biased in any circumstance where they have a financial stake in another’s decision. Doctors, lawyers, educators, pastors, and plumbers—each have a conflict of interest. The goal is to ensure that all parties fully disclose their conflicts and limit them to the greatest degree possible. That’s where regulators come in. And while the next section certainly may not be the most exciting in the book, I implore that it might be one of the more important.

How Advisors Are Regulated

Because of conflict abuse, regulatory bodies have sprung up to create legal standards by which financial professionals operate.

The lowest level of care is the same standard used by the local big box store—caveat emptor, or buyer beware. While insurance products are regulated by each state, most insurance policies and fixed (as well as indexed) annuities are sold on this primitive basis. It’s your responsibility—not the agent’s—to determine whether or not a product is right for you. The agent is representing the product. The exclusion in the insurance world is for products that have the label “variable.” Variable life insurance and annuity products require that the selling agent step up one notch to the brokerage industry’s standard—suitability.

The suitability standard requires every broker transacting in stocks, bonds, mutual funds, or any other security regulated by FINRA (the Financial Industry Regulatory Authority) to sell only products that could reasonably be considered suitable for the client at the time of sale. According to Barbara Roper, the director of investor protection at the Consumer Federation of America, “You can satisfy the suitability standard by recommending the least suitable of the suitable options, as long as it falls within the general suitability test. And you don’t have to disclose your conflicts of interest.”1 She continues, “You don’t have to appropriately manage your conflicts of interest or minimize your conflicts of interest.”2

Sounds reassuring, doesn’t it?

The highest standard—the fiduciary standard—was established by yet another regulating body, the SEC. The Securities and Exchange Commission was created as part of the Investment Advisors Act of 1940, in the wake of the financial destruction of the Great Depression. A fiduciary must place his or her interest after that of the client’s. Clients have to be put first.

Why doesn’t everyone holding themselves out as some sort of financial professional, consultant, planner, specialist, or advisor have to act in the best interest of his or her clients? That’s a great question to ask your prospective advisor. How are you compensated and how are you regulated? Which hat are you wearing?

If the individual is truly operating in a fee-only capacity, they must be acting as a fiduciary. But keep in mind that someone who sells only life insurance and fixed annuities is likely wearing only the caveat emptor hat, while someone who sells only variable insurance products and market securities is probably wearing the suitability hat. What makes the fee-based realm especially complex, from a regulatory perspective, is that someone might be acting as a fiduciary advisor at one moment, a suitability broker the next, and then a caveat emptor salesperson—all in the very same meeting.

Now, let’s be clear. Just because someone is held to a fiduciary standard doesn’t mean he’s a fiduciary in principle. (I know some of those.) Conversely, someone who only sells insurance, while not held to a fiduciary standard, may be a genuine fiduciary, in the non-legal sense, through and through. (I know some of those as well.)

That said, if you had an opportunity to work with one of three advisors—and each had the same level of experience, education, and expertise—but only one of them was wearing the fiduciary hat, who would you pick? Well, I can assure you that you have this choice, if you know how to look.

Minimum Requirements for an Advisor

When you hire a financial advisor, you’re the boss. So I recommend applying these minimum requirements in your search:

Your advisor should be an experienced fiduciary who provides evidence of expertise in a field in which they are educated and credentialed.

I Hope …

Those are minimum requirements, but you deserve better.

Specifically, don’t expect anything less than a planner who listens more than they talk, who puts you at the center of their universe in every conversation, and who will place themselves in your shoes to understand your values and priorities, your goals, and your calling.

And why stop there?

I hope you also find an advisor who encourages you to maintain a healthy level of cash and who helps you along your path to being debt free.

I hope your advisor is part of the newer school of investors who construct portfolios based on evidence (not opinion) and create asset allocations based on your willingness, ability, and need to take risk.

I hope your advisor has a broader view of retirement—that is, financial independence—and is comfortable helping you engineer Act Two of your three-act play.

I hope your advisor sees insurance decisions through the lens of risk management, helping you eliminate, reduce, and assume risk before you transfer it, and only then through the most cost-effective measures.

I hope your advisor will help you find the best home for your next dollar, even if it means not making a commission or accepting a fee.

But most of all, I hope you understand that no advisor, productivity system, app, investment, job, insurance product, financial plan, or book can give you what you really need. All those things are only vehicles on your road to Enough. The final vehicle we’ll explore is designed to truly simplify all the work you’ve done to this point in a summary financial plan consisting of only a single piece of paper.

Simple Money Advisor Summary

1. Because personal finance is more personal than it is finance, a financial advisor is needed more for behavior management than money management.

2. There are three primary compensation models for advisors—commission-only, fee-only, and fee-based. Each of them has their own biases, but fee-only advisors offer the least conflicts of interest.

3. There are three primary regulatory models—insurance agents operate under a caveat emptor (buyer beware) standard, investment brokers operate under a suitability standard, and registered investment advisors (RIAs) operate under a fiduciary standard. Only the fiduciary is obligated to act at all times in the best interest of their clients.

4. The minimum requirements for any financial advisor you hire: Your advisor should be an experienced fiduciary who provides evidence of expertise in a field in which they are educated and credentialed.