Why is my Financial Advisor giving me bad advice?
Suhas Joshi
Mar 14, 2023
Kurt Russell as Rudy Russo from Used Cars. https://thenewswheel.com/top-5-worst-car-salesmen-from-movies/
I had a few conversations recently where someone asked me to make sense of advice they received from a financial advisor. Digging into the investment, with them, confirmed their suspicions. The recommended investments seemed like bad deals. So what gives? Why would a financial advisor give bad advice?
To start with, it’s important to understand what a financial advisor is, and who might call themselves one. A financial advisor is someone who provides financial advice and guidance. Financial advisors can provide advice on a broad range of financial topics, including retirement, insurance, investing, and various money matters. Broadly speaking, there are three classes of individuals who describe themselves as “financial advisors”:
Investment Advisor Representatives(IARs)
IARs are individuals associated with a Registered Investment Advisor (RIA). IARs and RIAs are required to act as fiduciaries, and put their clients interests before their own. Prospero is an RIA, and I am an IAR.
They are compensated in the form of fees, which can be flat, hourly, or as a percentage of assets under management (AUM). These fees must be disclosed in advance.
IARs make more money (in the form of AUM fees) when their clients’ assets grow. As such, they have an incentive to help their clients choose the lowest cost investments that provide the best returns for the level of risk that is appropriate for their clients’ risk tolerance. It’s a somewhat weak alignment of interests, but an alignment nevertheless.
Broker/Dealer Agents
As the name suggests, Broker/Dealer agents work for Broker/Dealers. There are over 3500 registered Broker/Dealers in the US, including some household names such as Schwab and Vanguard, and a lot of names most people have never heard of. Broker/Dealer agents are only required to recommend investments that are “suitable” for their clients, but are not required to act in their best interests. The suitability standard is a lot weaker than the fiduciary standard. For example, there is no expectation that a client be told about better or lower cost investments.
Broker/Dealer agents are compensated in the form of commissions on trades, and are not typically required to disclose commission amounts ahead of time.
Broker/Dealer agents make more money when their clients perform more trades, and when their clients purchase securities that pay bigger commissions. The securities that pay the biggest commissions are also typically more costly to own. These costs are transferred to clients in a few different ways:
Front-end load: A front-end load is a charge that is made when you buy the security. You instantly lose money when you purchase a security with a front-end load because it’s immediately worth less than you paid for it.
Back-end load: A back-end load is a charge that is made when you sell off the security, typically within a lockup period that can be several years long.
Management fees: High expense ratios represent a permanent drag on the clients portfolio, by ensuring that the investment consistently performs worse over a long period of time.
Most Broker/Dealer agents will only recommend funds managed by the Broker/Dealer they work for. This might seem fine if that Broker/Dealer is one that’s known for its commitment to low costs (e.g. Vanguard), but, in most cases, these funds are much more expensive than similar funds. It’s also not always obvious when a fund is more expensive than similar products. I’ve seen egregious examples such as a “passive S&P 500 index fund” with a 1% expense ratio!
A Broker/Dealer Agent is incentivized (and sometimes required) to convince their clients to buy costly securities, and to trade more often than is in their best interests. A Broker/Dealer Agent’s incentives often run contrary to their clients’ interests.
Insurance Agents
As the name suggests, insurance agents work for insurers. Like Broker/Dealer Agents, they are also only held to a weaker suitability standard.
They are compensated in the form of commissions on sales.
Insurance agents only recommend products sold by the insurance company they represent.
Insurance products are inherently hard to price. Humans did not evolve with an inherent ability to price risk, and there’s a huge asymmetry between insurance companies who have actuarial tables, advanced risk models, and the ability to distribute risk between multiple insured parties, and individuals who have none of these. However, when multiple insurance companies sell identical products, such as term life insurance, they are forced to compete on price, and individuals have a shot at getting a fair deal, simply by comparing them.
Many “investment products” sold by insurance agents blend the idea of insurance and investment to create bespoke products that are difficult to compare across insurers. Further, they often include high initial, ongoing, and termination fees that further eat away at the buyers value. They are almost always terrible (not just bad) “investments”, and one can almost always buy separate ‘pure insurance’ and ‘pure investment’ products that provide much better returns at similar prices. The industry also likes to make up names to get away from the stigma that’s rightfully associated with their other products (such as annuities).
Insurance agents are incentivized to convince their clients to buy products that make the insurance company, and the agent, a lot of money at the expense of their clients.
Multiple Hats
Many individuals who are broker/dealer agents or insurance agents are also IARs. They often describe themselves as fiduciaries, or say that they ‘hold themselves to a fiduciary standard’. They might provide free or low cost financial plans for their clients, but these plans often include costly funds or insurance products, and the agent will switch hats when selling those products to their clients.
The Bottomline
You should only work with financial advisors who are required to act in a fiduciary capacity at all times. You should explicitly ask anyone you’re considering working with how they are compensated (that is not a rude question to ask at all!), and whether they receive any compensation in the form of markups, markdowns, or commissions. Walk away if they answer in the affirmative to the latter question. Your financial advisor should be an IAR and be compensated exclusively in the form of the fees you pay them.
The future is inherently unpredictable, and investment is an inherently complex area. There is no guarantee that a fiduciary advisor will give you great advice, but you can at least be certain that they are acting in your interests, rather than someone else’s.
Kurt Russell as Rudy Russo from Used Cars. https://thenewswheel.com/top-5-worst-car-salesmen-from-movies/
I had a few conversations recently where someone asked me to make sense of advice they received from a financial advisor. Digging into the investment, with them, confirmed their suspicions. The recommended investments seemed like bad deals. So what gives? Why would a financial advisor give bad advice?
To start with, it’s important to understand what a financial advisor is, and who might call themselves one. A financial advisor is someone who provides financial advice and guidance. Financial advisors can provide advice on a broad range of financial topics, including retirement, insurance, investing, and various money matters. Broadly speaking, there are three classes of individuals who describe themselves as “financial advisors”:
Investment Advisor Representatives(IARs)
IARs are individuals associated with a Registered Investment Advisor (RIA). IARs and RIAs are required to act as fiduciaries, and put their clients interests before their own. Prospero is an RIA, and I am an IAR.
They are compensated in the form of fees, which can be flat, hourly, or as a percentage of assets under management (AUM). These fees must be disclosed in advance.
IARs make more money (in the form of AUM fees) when their clients’ assets grow. As such, they have an incentive to help their clients choose the lowest cost investments that provide the best returns for the level of risk that is appropriate for their clients’ risk tolerance. It’s a somewhat weak alignment of interests, but an alignment nevertheless.
Broker/Dealer Agents
As the name suggests, Broker/Dealer agents work for Broker/Dealers. There are over 3500 registered Broker/Dealers in the US, including some household names such as Schwab and Vanguard, and a lot of names most people have never heard of. Broker/Dealer agents are only required to recommend investments that are “suitable” for their clients, but are not required to act in their best interests. The suitability standard is a lot weaker than the fiduciary standard. For example, there is no expectation that a client be told about better or lower cost investments.
Broker/Dealer agents are compensated in the form of commissions on trades, and are not typically required to disclose commission amounts ahead of time.
Broker/Dealer agents make more money when their clients perform more trades, and when their clients purchase securities that pay bigger commissions. The securities that pay the biggest commissions are also typically more costly to own. These costs are transferred to clients in a few different ways:
Front-end load: A front-end load is a charge that is made when you buy the security. You instantly lose money when you purchase a security with a front-end load because it’s immediately worth less than you paid for it.
Back-end load: A back-end load is a charge that is made when you sell off the security, typically within a lockup period that can be several years long.
Management fees: High expense ratios represent a permanent drag on the clients portfolio, by ensuring that the investment consistently performs worse over a long period of time.
Most Broker/Dealer agents will only recommend funds managed by the Broker/Dealer they work for. This might seem fine if that Broker/Dealer is one that’s known for its commitment to low costs (e.g. Vanguard), but, in most cases, these funds are much more expensive than similar funds. It’s also not always obvious when a fund is more expensive than similar products. I’ve seen egregious examples such as a “passive S&P 500 index fund” with a 1% expense ratio!
A Broker/Dealer Agent is incentivized (and sometimes required) to convince their clients to buy costly securities, and to trade more often than is in their best interests. A Broker/Dealer Agent’s incentives often run contrary to their clients’ interests.
Insurance Agents
As the name suggests, insurance agents work for insurers. Like Broker/Dealer Agents, they are also only held to a weaker suitability standard.
They are compensated in the form of commissions on sales.
Insurance agents only recommend products sold by the insurance company they represent.
Insurance products are inherently hard to price. Humans did not evolve with an inherent ability to price risk, and there’s a huge asymmetry between insurance companies who have actuarial tables, advanced risk models, and the ability to distribute risk between multiple insured parties, and individuals who have none of these. However, when multiple insurance companies sell identical products, such as term life insurance, they are forced to compete on price, and individuals have a shot at getting a fair deal, simply by comparing them.
Many “investment products” sold by insurance agents blend the idea of insurance and investment to create bespoke products that are difficult to compare across insurers. Further, they often include high initial, ongoing, and termination fees that further eat away at the buyers value. They are almost always terrible (not just bad) “investments”, and one can almost always buy separate ‘pure insurance’ and ‘pure investment’ products that provide much better returns at similar prices. The industry also likes to make up names to get away from the stigma that’s rightfully associated with their other products (such as annuities).
Insurance agents are incentivized to convince their clients to buy products that make the insurance company, and the agent, a lot of money at the expense of their clients.
Multiple Hats
Many individuals who are broker/dealer agents or insurance agents are also IARs. They often describe themselves as fiduciaries, or say that they ‘hold themselves to a fiduciary standard’. They might provide free or low cost financial plans for their clients, but these plans often include costly funds or insurance products, and the agent will switch hats when selling those products to their clients.
The Bottomline
You should only work with financial advisors who are required to act in a fiduciary capacity at all times. You should explicitly ask anyone you’re considering working with how they are compensated (that is not a rude question to ask at all!), and whether they receive any compensation in the form of markups, markdowns, or commissions. Walk away if they answer in the affirmative to the latter question. Your financial advisor should be an IAR and be compensated exclusively in the form of the fees you pay them.
The future is inherently unpredictable, and investment is an inherently complex area. There is no guarantee that a fiduciary advisor will give you great advice, but you can at least be certain that they are acting in your interests, rather than someone else’s.
Kurt Russell as Rudy Russo from Used Cars. https://thenewswheel.com/top-5-worst-car-salesmen-from-movies/
I had a few conversations recently where someone asked me to make sense of advice they received from a financial advisor. Digging into the investment, with them, confirmed their suspicions. The recommended investments seemed like bad deals. So what gives? Why would a financial advisor give bad advice?
To start with, it’s important to understand what a financial advisor is, and who might call themselves one. A financial advisor is someone who provides financial advice and guidance. Financial advisors can provide advice on a broad range of financial topics, including retirement, insurance, investing, and various money matters. Broadly speaking, there are three classes of individuals who describe themselves as “financial advisors”:
Investment Advisor Representatives(IARs)
IARs are individuals associated with a Registered Investment Advisor (RIA). IARs and RIAs are required to act as fiduciaries, and put their clients interests before their own. Prospero is an RIA, and I am an IAR.
They are compensated in the form of fees, which can be flat, hourly, or as a percentage of assets under management (AUM). These fees must be disclosed in advance.
IARs make more money (in the form of AUM fees) when their clients’ assets grow. As such, they have an incentive to help their clients choose the lowest cost investments that provide the best returns for the level of risk that is appropriate for their clients’ risk tolerance. It’s a somewhat weak alignment of interests, but an alignment nevertheless.
Broker/Dealer Agents
As the name suggests, Broker/Dealer agents work for Broker/Dealers. There are over 3500 registered Broker/Dealers in the US, including some household names such as Schwab and Vanguard, and a lot of names most people have never heard of. Broker/Dealer agents are only required to recommend investments that are “suitable” for their clients, but are not required to act in their best interests. The suitability standard is a lot weaker than the fiduciary standard. For example, there is no expectation that a client be told about better or lower cost investments.
Broker/Dealer agents are compensated in the form of commissions on trades, and are not typically required to disclose commission amounts ahead of time.
Broker/Dealer agents make more money when their clients perform more trades, and when their clients purchase securities that pay bigger commissions. The securities that pay the biggest commissions are also typically more costly to own. These costs are transferred to clients in a few different ways:
Front-end load: A front-end load is a charge that is made when you buy the security. You instantly lose money when you purchase a security with a front-end load because it’s immediately worth less than you paid for it.
Back-end load: A back-end load is a charge that is made when you sell off the security, typically within a lockup period that can be several years long.
Management fees: High expense ratios represent a permanent drag on the clients portfolio, by ensuring that the investment consistently performs worse over a long period of time.
Most Broker/Dealer agents will only recommend funds managed by the Broker/Dealer they work for. This might seem fine if that Broker/Dealer is one that’s known for its commitment to low costs (e.g. Vanguard), but, in most cases, these funds are much more expensive than similar funds. It’s also not always obvious when a fund is more expensive than similar products. I’ve seen egregious examples such as a “passive S&P 500 index fund” with a 1% expense ratio!
A Broker/Dealer Agent is incentivized (and sometimes required) to convince their clients to buy costly securities, and to trade more often than is in their best interests. A Broker/Dealer Agent’s incentives often run contrary to their clients’ interests.
Insurance Agents
As the name suggests, insurance agents work for insurers. Like Broker/Dealer Agents, they are also only held to a weaker suitability standard.
They are compensated in the form of commissions on sales.
Insurance agents only recommend products sold by the insurance company they represent.
Insurance products are inherently hard to price. Humans did not evolve with an inherent ability to price risk, and there’s a huge asymmetry between insurance companies who have actuarial tables, advanced risk models, and the ability to distribute risk between multiple insured parties, and individuals who have none of these. However, when multiple insurance companies sell identical products, such as term life insurance, they are forced to compete on price, and individuals have a shot at getting a fair deal, simply by comparing them.
Many “investment products” sold by insurance agents blend the idea of insurance and investment to create bespoke products that are difficult to compare across insurers. Further, they often include high initial, ongoing, and termination fees that further eat away at the buyers value. They are almost always terrible (not just bad) “investments”, and one can almost always buy separate ‘pure insurance’ and ‘pure investment’ products that provide much better returns at similar prices. The industry also likes to make up names to get away from the stigma that’s rightfully associated with their other products (such as annuities).
Insurance agents are incentivized to convince their clients to buy products that make the insurance company, and the agent, a lot of money at the expense of their clients.
Multiple Hats
Many individuals who are broker/dealer agents or insurance agents are also IARs. They often describe themselves as fiduciaries, or say that they ‘hold themselves to a fiduciary standard’. They might provide free or low cost financial plans for their clients, but these plans often include costly funds or insurance products, and the agent will switch hats when selling those products to their clients.
The Bottomline
You should only work with financial advisors who are required to act in a fiduciary capacity at all times. You should explicitly ask anyone you’re considering working with how they are compensated (that is not a rude question to ask at all!), and whether they receive any compensation in the form of markups, markdowns, or commissions. Walk away if they answer in the affirmative to the latter question. Your financial advisor should be an IAR and be compensated exclusively in the form of the fees you pay them.
The future is inherently unpredictable, and investment is an inherently complex area. There is no guarantee that a fiduciary advisor will give you great advice, but you can at least be certain that they are acting in your interests, rather than someone else’s.
7724 35th Ave NE #15170
Seattle, WA 98115-9955
(971) 716-1991
hello@prosperowealth.com
Prospero Wealth, LLC (“PW”) is a registered investment advisor offering advisory services in the States of Washington, Oregon, and California and in other jurisdictions where exempted. We are conditionally registered in Texas.
© Prospero Wealth 2024. All rights reserved.
7724 35th Ave NE #15170
Seattle, WA 98115-9955
(971) 716-1991
hello@prosperowealth.com
Prospero Wealth, LLC (“PW”) is a registered investment advisor offering advisory services in the States of Washington, Oregon, and California and in other jurisdictions where exempted. We are conditionally registered in Texas.
© Prospero Wealth 2024. All rights reserved.
7724 35th Ave NE #15170
Seattle, WA 98115-9955
(971) 716-1991
hello@prosperowealth.com
Prospero Wealth, LLC (“PW”) is a registered investment advisor offering advisory services in the states of Washington, Oregon, California, and in other jurisdictions where exempted.
© Prospero Wealth 2024. All rights reserved.