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Jan 31 2011

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Is it easy to make a fortune as a financial advisor?


Daniel Solin suggests, in his book, The Smartest Investment Book You’ll Ever Read,  that the average financial advisor/broker in the U.S. makes more money than the average primary care doctor.  He puts the average compensation at $105,000 U.S.

But is the scale of effectiveness as it relates to compensation inversely proportional?

Most people who have studied investing know who John Bogle is.  Founder of one of the two largest fund companies on Earth, you’d think he’d be worth billions.  But he isn’t. 

Abigail Johnson, however, whose family owns the “for-profit” financial firm, Fidelity Investments, is one of the richest 22 people in the United States.

Bogle could have had more money than Abigail Johnson, but he chose not to.  Instead of founding an investment company selling mutual funds that—after all taxes and fees—were nearly all mathematically destined to lose to benchmark indexes, he opted for Enough  ….a fitting title for one of his recent books on money and life.

John Bogle opted for a salary instead of ownership in Vanguard.  And he set a precedent, whereby the owners of Vanguard are its investors.  As a non-profit organization, net proceeds (from fund fees) that exceed the company’s expenses find their way towards lowering the management fees of Vanguard’s funds. 

This Brings Me Back To Financial Advisors

To make the most money for themselves, it’s a good idea for them to charge advisor’s fees or wrap fees on top of regular mutual fund costs.

But the excess profit for the advisor comes out of the investor’s pocket.

Finding funds that charge sales fees or back end loads ensures that advisors make a lot more money

But the excess profit for the advisor comes at the client’s expense

Buying actively managed mutual funds with high, hidden trailer fees ensures a lot more money for an advisor

But the client pays for those added dollars as well

Here’s the Dilemma:

We know that the average advisor chooses actively managed funds for their clients, and in many cases, wrap fees and sales fees add to their own payload.  But we know that low cost indexes save money in taxes, fees, and statistically ensure the highest returns for investors….while lowering an advisor’s pay haul.

The dilemma is real.  Is it easy to make a fortune as a financial advisor, if you know that you have to trick or sell your client into buying high cost products?  How is the average client going to know anyway?

Considering that the average person isn’t as financially literate as they should be, they rarely know how to measure their own investment performance.  Very few people, for instance, even know how they’ve performed relative to a benchmark comparison, as Robert Wasilewski, at RW Investments explains: …read more.

So if the average person doesn’t understand the conflict of interest within the industry, and they have no concept of how to measure their success, as investors, then doesn’t that create a massive challenge for the average financial advisor?  Should they make more money for themselves, at the expense of the clients who trust them?

Perhaps we can’t all be as altruistic as John Bogle.

Or is that a cop-out?


About the author

andrew hallam

I'm a freelance finance writer, lucky enough to have been nominated as a finalist for two Canadian National Publishing Awards. I'm also the author of Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School, a book explaining how I became a millionaire on a teacher's salary, while still in my 30s. Working to empower people financially, I'm available to motivate and inspire people on basic retirement planning and index investing. I'm happy to comment on your questions, first, please read the Terms of Use.

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24 comments

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  1. avatar
    The Biz of Life

    I've talked to a lot of financial advisors over the years, haven't done business with any of them. I always felt like I understood more about investing and risk management than they did. But there was no question they were experts on how they were compensated and most steered their clients toward the investments that put the most money in their own pockets.

  2. avatar
    Andrew Hallam

    @The Biz of Life

    Hey Biz,

    That has to be really tough if you learn too much (as an advisor) and have to face a moral dilemma. I'm not surprised that you know a lot more about investing than the advisors you've met.

    My friend's daughter got a degree in Finance and learned nothing about investments in the process—but she got a job at a Canadian brokerage selling investment products. And after a year, she grew dissilusioned. She's a great kid, and she took it upon herself to learn more about what she was selling, and of course, she came across books and studies on indexed investing. She now hates her job and is looking for something else. There's a great quote that goes something like this: "A man won't learn something if his livelihood depends on him not knowing it."

  3. avatar
    DIY Investor

    The answer is yes, especially if you've got a good smile and are a fast talker. Pick up on the buzz words, get some charts with some fancy graphics and you are on your way. One thing is, many advisors don't do like your friend's daughter and "…learn more about what she was selling".

    I admit when I was on the institution side I was paid way more than I was worth. Once the economies of scale aspect of the business dawned on me I saw the possibilities – and I was on the periphery!

    If you want to make money and have no conscience I recommend selling variable annuities with a interest payment guarantee and get lists of people on the verge of retirement – maybe also scour the obituaries. As soon as a good market downturn comes it will be like selling mouthwash (actually Listerine was huge when it first came out – you can imagine).

  4. avatar
    lovely leverage

    I took finance as a business concentration in university. I remember once my finance professor told us that he hope none of his students end up selling mutual funds, because he doesn't want us to take advantage of others.

    I think it's good to seek advice from professionals. But often, we rely too much on professionals which deprives us of learning anything on our own. Therefore, (financial) education is lost in the process.

  5. avatar
    Andrew Hallam

    @DIY Investor

    Hey Robert,

    The fact that there are people like you out there really does give me a lot of hope. I know that you could make considerably more money for yourself if you were more "conventional" as an advisor, by selling actively managed funds and variable annuities. At some point, it would be worthwhile for somebody to compile a collection of people like you, and publish that collection. You're a rare breed. But at the same time, you're going to inspire others.

  6. avatar
    Andrew Hallam

    @lovely leverage

    LL,

    Your finance professor sounds like an ethical, well-informed person. Where did you go to school? Did you learn about index funds and the specifics of mutual funds when you were studying finance at university?

  7. avatar
    lovely leverage

    Hi Andrew,

    I went to Sprott School of Business in Ottawa. we studied a lot of empirical studies, research papers, and back-dated investment models for different time periods, some focused on passive v.s. active fund management. Most studies supported the passive index approach for stocks, however bond fund management is slightly a different story, mostly because key interest rates can be somewhat protected in advance by macro indicators.

  8. avatar
    Andrew Hallam

    @lovely leverage

    LL,

    It sounds like a great school. But I'm so curious about the lean towards active management for bonds. I know that on the retail end, active bond funds perform far worse, as an aggregate, when compared to passive bond funds. The discrepancy on the bond front is far higher than on the equity front. But perhaps that's just at the retail level.

  9. avatar
    Echo

    Advisors get dumped on pretty good in the PF blogosphere but I think the institutions themselves are to blame (meaning Bogle absolutely got it right). Most advisors probably started off wanting to genuinely help people with their finances but they can only use the tools they are given on the job. And if their performance evaluation and bonus depends on how much they sold of the company fund of the day, what are they supposed to do?

    My mom worked as a financial planner for 25 years and witnessed first-hand how the industry was changing. She didn't want to sell people high MER mutual funds anymore than she wanted to convince seniors who had paid off their mortgage to "tap into their home equity" to take their dream vacation or buy an RV. Eventually she had enough and quit, but many don't have that option.

  10. avatar
    lovely leverage

    Yes. you are right. On the aggregate level passive bond funds outperform active bond funds. What I was indicating was that on the individual level, some bond managers have been found to outperform their benchmark on a consistent basis which can be tested with a statistical difference. Unlike stock fund managers, the high performers of this year does not mean they will be high performers in the preceding years. Therefore, tracking the lead fund manager in bonds is more important compared to stocks. This relates back to my last comment about the ability of some individuals being able to analyze marco factors consistently; resulting in better predictions of interest rate movements to create alpha in the fund.

  11. avatar
    Andrew Hallam

    @Echo

    Hey Echo,

    You bring up an amazingly valid point. When taking the CFP course for financial planners, you take a couple of relatively short academic courses (especially compared to a college degree program) and then you have to work for a member of the industry for a period of time before you get certified. What then? There's rarely an option to sell low cost products, when most of the industry itself profits from the mainstream, higher cost instruments. And that's the industry that feeds you and certifies you. By then, you can find yourself in a bit of a jam: recognizing that you need to pay your mortgage, feed your kids etc. Your mom, as you mentioned, was lucky to have an option. I'm really glad you brought this up.

  12. avatar
    Andrew Hallam

    @lovely leverage

    Hey LL,

    From what I have read, there also seems to be a reversion to the mean with active bond fund managers as well. Is it the idea that, especially relative to the returns, the expense ratios are so high? Even if a bond manager beats his/her benchmark, they have an expense ratio that's proportionately higher than the typical equity fund (relative to expected long term returns). So do you think it's the fees that drag down the outperformers? They could still be outperforming, of course, pre-fee. But for the retail investor, it's the "post-fee" return that counts. What do you think?

  13. avatar
    Think Dividends

    I like how the institutions assign fancy titles to these people like "adivsor" or "planner" when in reality they are "sales people" with "sales targets".

  14. avatar
    Andrew Hallam

    @Think Dividends

    Hey Think Dividends,

    It can be even funnier when you see lofty titles like, "Vice President of Investment Operations" or "Senior Investment Specialist". Those titles seem to get handed out like bad coffee at a convention.

  15. avatar
    lovely leverage

    Hi Andrew,

    I completely agree that the after fees and after taxes performance is what should be examined. High management and trading fees stack against the fund's performance. For retail investors, we are better off not gambling on the lead fund manager always out beating the benchmark plus management expense and trading fees. There is an interesting conflict of interest, that the brokerage will reimburse the firm for some of the trading fees as "soft dollar" so there is an incentive to over trade in the funds. Therefore, in my opinion it will always be safer to invest in low cost index funds.

  16. avatar
    Andrew Hallam

    You're so right LL,

    Soft dollar fees and trading costs don't get published as part of the expense ratio. In the end, the fees all add up, don't they?

  17. avatar
    101 Centavos

    Financial advice unfortunately is an industry where the opportunities for malfeasance are high. Customers who are likely to engage a financial adviser are ipso facto not very knowledgeable about finance and investments, and therefore less likely to question investment recommendations.

  18. avatar
    Andrew Hallam

    @101 Centavos

    You're right Centavos,

    I guess there's always room for a fee only advisor: someone you pay a set dollar amount each year to provide advice. That's the route I'd recommend for many people. But many advisors advertise themselves as such ( as low cost advisors) and they're everything but. It's tough for the average person, no doubt. The industry attracts people who have a gift for the gab. And they can be pretty persuasive.

  19. avatar
    Underfloor Heating

    What does anybody know about being a financial advisor or planner? do you have to get a degree for it or is there just a class for it specificaly? Thanks….

  20. avatar
    Andrew Hallam

    @Underfloor Heating

    The academic studying period can be as little as 3 weeks for an American Series 7 certification or for the Canadian Securities certfication. If you study for one of these, full time, it doesn't typically take longer than 3 weeks. The full academic component of the CFP designation takes less than 6 months (of full-time study). Then you have to work at a brokerage/financial institution of sorts for one year, I believe, before you can earn the certification.

    But you can get a license to sell mutual funds with a simple 3 week course behind you.

  21. avatar
    Patrick Smith

    In Canada, the requirements to earn your CFP designation were updated in 2010. Now there is a series of 4 courses that allow you to write the FPE1 exam. When passed, you become a Registered Candidate for the CFP. After passing the Capstone course and acccumulating 1 year of experience, you become eligible to write the FPE2 exam. Once that is passed and you have another 2 years of experience, you can finally apply for your CFP designation.

    With respect to Qualifying Work Experience, you do not necessarily have to work for a brokerage/financial institution. You can accumulate this experience as a self-employed planner as you build your book. This poses a dilemma: more freedom but less or no guidance.

    I'm trying to figure out how to accumulate the experience without having to compromise what I believe in yet want to learn from someone experienced. Perhaps hiring a business coach is the answer?

    But yes, getting licensed for following is a pretty quick exercise:

    Product – Licensing Body – Course

    Insurance – FSCO – LLQP

    Mutual Funds – MFDA – IFIC or CSC

    Securities (Stocks & ETFs) – IIROC – CSC

    Patrick Smith
    http://holisticfinancial.ca

  22. avatar
    Andrew Hallam

    @Patrick Smith

    Thanks for the updated information Patrick. Some of my friends have ended up with the same dilemma as you, not wanting to sell unfair products to clients as they gain their qualification experience. But they have either had to bite the bullet or abandon the idea. Good luck with your decision. It would be great to get another good guy out there for the long term, even if you have to start out on the dark side to get qualified. And if you can avoid the dark side, fantastic. I wish you really well.

  23. avatar
    Doug

    Hi Andrew, love your book and will be recommending it to everyone. One sore point I have with the book, though, is your low opinions of CFP. As an engineer and MBA personally going through the CFP program to earn my certificate, I can attest that the requirements are much more than " a couple classes and a year in a brokerage". To earn a CFP, one must

    Already have a college degree

    Complete the 6 college level classes (plus pre-reqs if needed) which prepare you to serve your clients on a broad level- much more than just investments.

    Pass a 10 hour exam which has about a 60% pass rate

    Pass a background investigation

    Work in the industry for 6000 hours.

    On investing, I am a total beviever in MPT and agree 100% that nobody needs active funds. With a fiduciary standard, there is no choice but to design a diversified portfolio using index funds. Anything else is not in the clients best interest. My own portfolio is invested in 4 Vanguard funds and my total all in cost is roughly .15%, estimating my cost of turnover at .05%. I'll keep about 95% of what the market gives me over 40 years.

    A good CFP will be helping families as their fee only "personal CFO", going well beyond their portfolio design and to ensure they save enough and keep enough to meet their goals. "it isn't what you earn, it's what you keep"

    There are bad apples in every profession, but all planners are not as evil as you portray them. But to repeat, your book is a great read. Right up there with Bogle, Roth, Swedroe and Malkiel.

    1. avatar
      Andrew Hallam

      Hi Doug,

      It's great to hear from one of the good guys. And I know that the industry standards are changing all the time. That's good.

      I did mention some great advisory groups in my book who do what you plan to do: Assetbuilder, RW Investments, to name a couple.

      I shudder at the ratio of investment advisors like you, compared to the others who don't have the fiduciary standards they're supposed to have. You're in the minority, unfortunately. But I'm really glad you're out there!

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