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).


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?