Who’s Looking Out for You? Understand How Your Advisor Gets Paid
What would you say if I told you that the company your financial advisor works for received revenue sharing payments of approximately $164,000,000 in 2012 from offering certain mutual funds, 529 plan programs, and insurance products? And that virtually all transactions related to these financial products involve product partners that pay revenue sharing to that company? The $164,000,000 spent on revenue sharing could have been added to your investment returns!!
As a result of a class-action lawsuit, the company now fully discloses this information on their website. Their website also notes that “the receipt of revenue sharing payments creates a potential conflict of interest in the form of additional financial incentive and financial benefit to the firm, its financial advisors and equity owners in connection with the sales of products from these product partners.” These revenue sharing payments accounted for approximately 30% of the company’s $555,000,000 in net annual income in 2012. Wow! Who are these advisors working for? You or their company?
Revenue sharing arrangements are not at all unusual in the financial services industry, but because many consumers don’t always ask the correct questions or dig into the fine print, they don’t know about these potential conflicts of interest. A conflict of interest occurs when an individual or organization is involved in multiple interests, one of which could possibly motivate, influence, or incent that individual or organization to do one thing over another based on personal or corporate gain. These conflicted actions, quite obviously, may not always be in the best interest of the client.
Currently, most brokers are only required to steer their clients to “suitable” products based on a customer’s financial situation, goals, and risk tolerance. Many investment professionals are constrained by their firms’ emphasis on profit-making which may limit the investments they can offer their clients. Under the suitability standard, brokers are free to pick the fund that pays them the biggest commission from among a group of suitable funds, even if it is “less suitable.” It can be difficult to put client needs at the center of the process in a sales-driven culture, when the true incentive is to focus on gaining new clients. Why not hire an advisor that can evaluate and choose investments from the entire universe of investments, not just the ones their company chooses as product partners?
You do have a choice! Don’t settle for something that is simply “suitable” when there are much better alternatives. Consider a fiduciary advisor who has a special relationship of trust to put their customers’ best interests first. This is known as fiduciary duty and is the highest standard of care. Fiduciaries work for the client and make prudent decisions in the clients’ best interest.
When choosing or evaluating an advisor, keep these points in mind:
- Interview an independent “fee-only” advisor that is a fiduciary.
- Conflicts of interest should be eliminated whenever possible. Transparency is key!
- Carefully research all your options – shop around.
- Examine ALL fees (management fees, commissions, fund expense ratios, trading fees, etc.).
- Avoid working with a firm that offers proprietary funds, especially those with sales “loads.”
- Ask your advisor how he or she gets paid!
If you have 2 minutes and 20 seconds, you can also take a look at this YouTube video that illustrates the differences, by analogy, between a broker and fiduciary advisor. Is your trusted advisor the butcher or the dietician? Enjoy!