Financial planner Allan Roth has a pretty good piece in the latest issue of AARP the Magazine on “The Two Faces of Your Financial Planner” (renamed “How to Choose Your Financial Planner,” a much snoozier headline, in the online version). Although it’s geared for older readers, it should be read by anyone who gets professional advice. The piece discusses the inherit conflicts of interest with every method of compensation, from commissions to assets under management to hourly, and points out that the people you trust with your money may not be worthy of that trust:
My point is this: Bad advice is epidemic in my industry, and it doesn’t come only from villainous fraudsters such as [Bernie] Madoff. It also comes from pleasant, empathetic folks who are merely responding predictably to my industry’s perverse incentives and self-serving ethical standards.
We financial planners are masters at persuading ourselves that what’s in our best interest also happens to be the moral thing to do. By and large, we’re good people, which is why we can be so convincing — and so potentially dangerous to your money.
The conflicts inherent in a commission-based model are pretty apparent. If a planner gets a big payday when you buy a specific investment, but less of a payday or none at all if you buy another, that’s a pretty good incentive to rationalize putting you in the investment that will do the most good for him or her.
There are also conflicts that come with the hourly model (the potential to run up the bill) and the assets-under-management model, although I don’t quite agree with the example Roth uses: “That’s why few of us will ever tell you to pay off your mortgage: Using $100,000 to discharge a loan rather than investing it could cost us $1,000 a year in fees.” Actually, the reason fee-0nly planners typically don’t recommend mortgage prepayment is that most people have much better things to do with their money than pay off a low-rate, tax deductible loan–things like catching up on their retirement savings, paying down every other debt and making sure they’re adequately insured, among others.
The article offers some excellent advice for how to get the best money advice, including checking credentials, refusing to commit to a plan or investment on the first meeting, asking what the penalties are if you want your money back from an investment and requesting the planner to put in writing why he or she thinks an investment is suitable and the total cost you’ll be paying.
It’s true that many people have more important things to do with their money than pay off their mortgage. But, it’s also true that any commission or asset-fee based planner will never suggest that, even when it is appropriate. They are also unlikely to suggest insurance (unless they’re an insurance agent themselves, or have one in the office they can get a kickback from) nor an emergency fund, nor perhaps even maxing out your 401(k) at work.
The “bulked up hours” argument for fee only planners seems like far less of an issue. At least then the cost is obvious (rather than hidden) and people are probably going to notice and object.
A fee-only planner providing a comprehensive financial plan will most certainly review insurance coverage and recommend changes, as well as maximizing tax-deferred options for retirement. A good chunk of CFP training emphasizes the importance of reviewing every major aspect of the client’s life, from cash flow to taxes to estate planning.
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Loved this article. So true about a financial planner not being a “villain” type. I just finished a great book about similar information. The book is called The Vigilant Investor and it gives you information on how to recognize certain things before investing to help protect yourself.