Physicians must undergo intense scrutiny to qualify to practice medicine. Doesn't it make sense for financial advisors to undergo similar scrutiny to figure out where their true interests lie? Here's how to do it.
After examining a patient, a physician hands him a prescription. At the reception desk, the patient pulls out his credit card, but the receptionist tells him this isn’t necessary. He looks quizzically at the physician, who is passing by. “Why no charge?” he asks. The physician responds: “Don’t worry about it. We’re paid by the drug companies.”
This same dynamic is all too common in the financial advisory industry. Like this hypothetical physician, an overwhelming majority of advisors receive payments and other incentives from outside sources that impair the objectivity of the advice they give clients.
As investors nurse investment wounds inflicted by the Wall Street institutions that helped bring on the worst economic decline since the Great Depression, they’re naturally skeptical of financial advisors. The afflicted investing public includes physicians, who will now have to work longer and harder to fulfill their retirement plans.
The Many Levels of "Fiduciary" Responsibility
The best way for investors to realize these plans is to secure financial advice that is free of conflicts of interest by holding advisors to the highest fiduciary standards. “Fiduciary” is a legal/financial term meaning an individual in a special position of trust and confidence who manages the assets of others with undivided loyalty, avoiding conflicts of interest.
Despite the absolute nature of this definition, there are nevertheless various levels of fiduciary standards. Advisors regulated by the U.S. Securities and Exchange Commission, known as registered investment advisors (RIAs), are required by federal regulations to exercise fiduciary responsibility. Yet, rather than receiving compensation solely from clients for advice provided, these advisors also may receive compensation from other parties and vendors because there are no regulations that categorically prohibit it.
Fee-Based vs. Fee-Only Financial Advisors
More than 90 percent of all financial advisors/planners receive commissions, payments in the form of goods or services and other legal kickbacks from brokerages, product vendors and insurance companies. These advisors call themselves fee-based, meaning that they collect both fees from clients and payments from these other sources.
The other 10 percent of advisors are 100 percent fee-only fiduciaries, meaning that their only source of compensation is their clients. Instead of selling products, they sell their knowledge and guidance. As true fiduciaries, they serve only their clients’ interests because they’re untainted by outside influences. Their fees are typically structured as a percentage of the value of assets under management, an hourly consultation charge or set services such as developing a financial plan.
The practice of not accepting payments from sources other than clients keeps fee-only advisors’ loyalties from being divided, while fee-based advisors have powerful incentives to get their clients into investments that may be expensive, inappropriate or deficient. It doesn’t matter what title an advisor goes by -- independent advisor, wealth manager, financial planner, what-have-you. Either they’re 100 percent fee-only or they’re not.
Choosing a Fee-Only Financial Planner
How can investors ensure that prospective advisors are fee-only professionals who meet the highest fiduciary standards? Require them to sign a written disclosure statement and fiduciary oath. In such an oath, advisors pledge to always put the client’s interests first -- much as physicians pledge to steadfastly serve their patients’ medical interests. This oath should pledge that the advisory firm in question doesn’t receive commissions from or any other payments from vendors. Also, it should require advisors to disclose any conflicts of interest that could potentially arise during the term of engagement.
Requiring advisors to sign a fiduciary oath and a disclosure statement is an essential part of the process of vetting advisors. Here are some questions investors should ask during the interview process:
• Can you provide a written explanation of your compensation? (This documents advisors’ disclosures, holding them accountable down the road.)
• Does any member of your firm have an ownership interest in or receive sales commissions from any vendor of products that you may recommend? (If so, the firm’s product offerings may be tilted toward these vendors.)
• Do you receive referral fees from attorneys, accountants, insurance agents or mortgage brokers to whom you refer clients? (Investors should ensure that such referrals are based on the expertise of these professionals and the suitability of their services, rather than on referral fees.)
Physicians must undergo intense scrutiny to qualify to practice medicine. Wouldn’t it make sense for physicians searching for financial advisors to closely examine their practices to discern where their true interests and loyalties lie?
By asking the right questions and insisting on getting the answers in writing, investors can determine whether an advisor is on their side. Unlike the hypothetical patient whose office visit is effectively paid for by pharmaceutical companies, investors who exercise this discretion won’t have doubts about the objectivity of the advice they’re getting.
Tim Decker, a fee-only financial planner and author of The Sleep-Well-At-Night Investor, is president of ISI Financial Group Inc., a 25-year-old firm serving clients throughout the world. The questions for advisors and the fiduciary oath described in this article come from Decker’s Financial Advisor Questionnaire & Answers, available for downloading free.
This content is based upon information believed to be accurate by ISI Financial Group. However, it should not be relied upon for legal or accounting purposes. Past performance is not indicative of future performance. Investments involve risk, including the possible loss of principal. Always seek professional advice before making any financial or legal decisions.