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Oct 02 2011

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The Toughest Part About Being a Financial Advisor





If a person advises people on money matters long enough, they eventually hit a cross-roads.

Many of them recognize that they’re not serving their clients as well as they could, and they’re faced with a dilemma:

A. Continue to invest their clients’ money in inefficient investment products (actively managed mutual funds).

 Or

B. Opt to change course, and create low-cost, low-taxed portfolios of index funds for their clients.

First of all, let me explain why this becomes such a tough decision.

When getting certified to become a financial advisor (even to earn the lowly Series 7 certification) it’s generally required that a budding investment professional work for a financial service company.  In most cases, without employment in a money management firm, the qualification isn’t valid. 

Sadly, many great, well-meaning people start off on the wrong track right away:  selling high cost products like variable annuities and actively managed funds, which pad the coffers of the companies they work for, rather than serve their clients in the best possible way.

The advisor has three choices: 




  1. He or she could quit their jobs (which are often very high-paying) or
  2. They could take a tremendous risk to open their own business, where they would build portfolios of low-cost indexed funds for their clients, or
  3. They could find work at a limited number of upstanding investment firms that put clients’ interests first.

Before getting too judgmental, and assuming that any moral creature would choose to quit, rather than sell inefficient products (while lying about their efficiency to clients) we have to examine the complicated webbing of entrapment, as well as the human rationalizations that take place.

  • First, the advisor asks herself if the client will make money with the products they are selling.  Over a lifetime, if the markets cooperate, the answer would be yes.
  • Second, the advisor asks herself if the client is better off with these products than if they weren’t investing at all.  Again, the answer would likely be yes.
  • Third, the advisor asks herself whether she is willing to take a substantial pay cut so her clients can make more money.  After all, the least efficient investment products for clients tend to be the most lucrative investment products for advisors.

I hammer the people who sell inefficient investment products in my book, Millionaire Teacher.  I hammer them for virtually ensuring that a client who (over an investment lifetime) may otherwise end up building a portfolio of $1 million, only builds a portfolio worth $600,000 – thanks to the self-serving decisions made by the financial advisor that the client thought he could trust.

Having said that, I’m not alone, of course. 

Daniel Solin, a leading Securities Arbitration lawyer suggests a client could have a case for fraud if the advisor doesn’t tell the client that there’s overwhelming statistical evidence suggesting that low-cost indexed portfolios outperform actively managed portfolios (especially after taxes). Not disclosing this information, he suggests, could represent a breach of fiduciary duty (Rule 10[b]-5).

What do you think? When advisors realize how inefficient their actively managed products are, is it unethical for advisors not to tell their clients?

What are your thoughts?

 

 





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.

Permanent link to this article: http://andrewhallam.com/2011/10/the-toughest-part-about-being-a-financial-advisor/

1 comment

  1. avatar
    A CFP Observer

    Well said and 100% on target for the segment of the financial services industry that is compensated by commissions.

    I hold the CFP designation and have worked in financial services for over 10 years. I started out working for an insurance company, moved to an annuity company and then went to work for a bank. It’s worth noting that each of these companies had an "ethics" training program that was consistent with the high ideals of the CFP board and in sync with the oath to "put the client first" that is required each time one renews his certification.

    At the insurance company, the property and casualty side was pretty free from conflicts of interest, but the Life Insurance side was another story. I began looking for another job when the agency owner started pressuring me to meet with people who had high value, older whole life policies to try to encourage them to switch their cash values to Universal Life policies with higher death benefits. This put the client in a riskier product but generated a new commission schedule for the agency.

    The annuity company marketed primarily to colleges and K-12 school employees as one of the choices in their 403b plans. They also offered a wide range of financial products and services besides their highly profitable variable annuity. I left that company when I was told that my annual goals would include selling at least $3 million (net) new variable annuities. I couldn't understand how I could provide decent financial planning with that kind of pressure hanging over my head. It was approaching the planning process with the solution and then trying to make the facts and needs fit that solution.

    I had hoped joining the bank would free me from such shenanigans, but the bank wasn't much better. While they didn't have a signature proprietary product to push, they were shameless in pushing higher commissioned products. The difference between a senior advisor and a just plain advisor isn't any metric that a client would expect. It’s nothing like an exemplary track record, experience, training or education. It's based solely on the level of commissions generated for the bank. A senior advisor that generates a boatload of commissions is awarded with the title. One of my co-workers was a senior advisor and he used to brag that he never spent more than half an hour with a client. This was a guy who held a CFP designation and had taken an oath to put the client’s interest before his own or his companies! It's simply impossible to go through the planning process in half an hour, yet this person was held out as the model for all of us to emulate.

    I left the bank thinking I’d set up my own fee-only practice where I could do the right thing. That was in early 2008. Unfortunately the ensuing market meltdown pretty much made it too challenging for a start up.

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