Financial advisors come in all shapes, sizes, and forms of compensation. When their mode of compensation influences their recommendations, you often get advice that is not free from bias.
The most influential conflict is found when a financial advisor is actually a salesperson in disguise. If an advisor gets paid a commission for selling financial products, no matter how much they say differently, the recommendations they make are influenced by this method of compensation. They get paid better if they steer you to certain products so that is exactly what they do.
I know a physician who was compensated on a straight salary. When he got a consult for a colonoscopy, and he couldn’t easily squeeze it into his schedule, he would ask me to do the scope because he would not get paid extra for working it into his schedule. Later, when his compensation method changed to production based, he never called me again to do a colonoscopy for him. He found time to do the scope and he enjoyed the extra income it produced. Same doctor, same morals, but with a different compensation model, his behavior and recommendations changed. Financial advisors are likewise influenced by their method of compensation.
Here are some of the ways this conflict of interest could affect you.
Paying Off Debt
If you want to pay off your house and get out of debt, an advisor who is paid by assets under management will tend to recommend that you keep your home mortgage. By taking money out of the assets she manages and using that money to pay off your house, you will decrease her income.
Giving
If there is a particular charity you want to support while you are still alive, enabling you to see the good work your money is doing, an advisor who gets paid for assets under management or commissions on selling you financial products does not want you do give those funds to charity. They may play on your fear of running out of money during retirement to encourage you to keep your money invested with them and not give that money to charity. Giving money away for any reason will result in lost income for the financial advisor. They will advise you to give the money in your will so it will not hurt their bottom line.
Investment Options
When I first started investing, I got an advisor who I didn’t realize was a commissioned salesman. He recommended a mutual fund for my IRA and I went with his advice. I found out later that the fund he recommended was paying him the highest front load commission allowed by law. He only recommended things to me that also maximized his profit. I cut ties with him after I learned of his high commission.
If your financial advisor works for an insurance company, you will likely be steered into life insurance products, such as whole life or annuities, that will pay a huge commission to the advisor. It is interesting that whole life insurance is almost never recommended by an advisor who is not a whole life salesperson getting a commission. The same with annuities. These products are designed to produce great commissions for them but are not great investments for you. Be very leery of advice to purchase an investment from someone who gets a commission on the sale of that investment.
Spending Decisions
After we retire, we have more time to enjoy life. The older we get, the fewer years we have left for our money to last. Older retirees have more leeway to spend their money on fun things. If your advisor gets paid based on the amount of money you have invested with them, they will not be encouraging you to enjoy your hard-earned savings. At this point in your life you don’t need to maximize your earning potential, you deserve a chance to enjoy the money you have saved for retirement.
If you want to travel on a four month world cruise for you and your spouse in a vista suite, it will cost about $90,000 for the pair of tickets. If you pull $150,000 out of a taxable retirement account in order to live this dream, it will cost your advisor who gets paid based on assets under management about $1,500 a year for the rest of your life. Or, if you decided to cash out a whole life policy for the trip, your insurance advisor will stop receiving annual commissions. If you cash in a CD, your banker will no longer have the money to lend out for higher interest loans to others. You can see why many advisors might have an incentive to push you towards not spending your money on things you would enjoy.
The bottom line here is to always be sure you know how your advisors are getting paid. If you use the phrase from the movie "All the President’s Men" and “follow the money,” you will have a handle on the potential conflicts of interest you are up against.
The best way to hire a financial advisor is to pay them for their time. A good example is one who charges a flat fee. The worst way to hire a financial advisor is under an agreement where they get paid by commissions on the products they sell you. Pay close attention to who you turn to for your financial advice.
Dr. Cory S. Fawcett can be found blogging at FinancialSuccessMD.com and his award winning Doctors Guide book series is available on Amazon. He is a 2019–2020 Doximity Fellow.
