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Monday, August 9, 2010

When an Advisor May Not Be Acting in Your Best Interest

Fee-only registered investment advisors like to puff themselves up and proclaim how they are different from brokers. They emphasize that they are fiduciaries: they are "on the same side of the table as their clients". Really?

Many also manage assets. In fact, managing assets is typically their primary profit center. Watch them closely when they ask you how much in total assets you have to be managed. You'll notice their eyes narrow a bit and their lips purse out somewhat as their brains mentally calculate what they'll make off of you.

Let's break it down in simple terms. If an advisor charges 1% of assets (this is at the lower end), then he gets $10,000/year to manage $1.0 million. If you buy an annuity for $500,000, say, then obviously his compensation (his annuity, you might say)is cut in half to $5,000/year.

For many clients, handing over all of their money to be managed in the risky asset markets is not in their best interest. It is, however, clearly in the interest of the advisor.

In fact, we know from surveys that the number one fear of retirees is that they will run out of money. In most instances, it is why people do a financial plan in the first place. To alleviate this fear, the planner should, as a fiduciary, show people how to intelligently buy an annuity.

The bottom line is that people may want to separate the financial planning function and asset management function. At least then they'll know incentives aren't misaligned.

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  1. I've never used a financial advisor. I've always had the idea stuck in my head that if I educated myself enough I could construct an investment plan with no fees attached that would perform just as well as the advisor. I've had a number of them give me their sales pitch, even had one lower his fee from 2% down to .75%, but ultimate I said no and have never regretted it.

  2. Is this 1% on top of the fees that are charged by the investment vehicles themselves? That is quite a hefty price to pay...

  3. Re Grouch: I do realize that a blog like this is preaching to the choir to a certain degree. Polls show,however, that 40% of the American workers have never tried to figure out where their income is going to come from. Many people sit down with an advisor and blindly accept what they say without realizing that there are some perverse incentives taking place. A good advisor would have put retired people in single premium immediate pay annuities in 2007 when the S&P 500 was hitting a peak!
    re: Kevin Yes the 1% is on top of the other costs. The other costs are costs the client doesn't explicitly see.

  4. You are preaching to the choir.... but the sales of paying 1% in fund expenses and then an additional .75% to 2% for someone else to move my money around as they see fit made absolutely no sense to me.

  5. Re: Grouch you are exactly right but people don't know and some that do know think, well "it's only 1%" and they have no clue on compounding and what it really costs!

  6. This is why discount brokerage firms and a DIY investing strategy makes so much sense.

  7. Shawn: Exactly right. I would add financial literacy programs as well. It would be good I think if educators directed students to some of the personal finance blogs. There is so much good stuff being written at all levels including a number of blogs presenting their personal financial journeys with specifics of spending and savings. Add in the comments from those who have made moves and mistakes and you have the means of educating young people to be financially literate.