The Wall Street Journal recently published a column provocatively titled “Your Financial Advisor Doesn’t Want You to Know About These Conflicts,” by Anne Tergesen.
As an owner of Berkshire Money Management, a financial advisory firm, I appreciate all consumer education regarding the industry. Advisors should consider education for themselves to be good stewards of clients’ money. Often, in life, we humans react subconsciously to conflicts or nudges. Being aware of potential sins can help advisors (myself included) develop a checklist to be sure advice is being properly administered.
I will boil Ms. Tergesen’s column down in bullet-point fashion and offer my two cents. My intent, and possibly Ms. Tergesen’s, is for you to be better prepared to ask your financial advisor questions regarding their advice.
First, some context. As the author notes, many financial advisors have changed their business models over the years. Once upon a time (and still sometimes today), financial products were sold to customers. Sometimes, these financial transactions benefited the customer because they had an incidental positive outcome for the buyer. But the seller (sometimes called an “advisor”) did not have to match the product with the client’s best interest. The goal was the transaction, using financial advice as the sales script.
Financial advisors are more frequently aligning their compensation structure with the client’s outcome. This client payment structure is called “fee-based.” For example, a client might have a $1 million portfolio, and the advisor would charge the client a fee equal to one percent of the portfolio, so when the client makes more money, the advisor will make more money. The cost of other money management services, such as Social Security or Medicare advice, estate and tax planning, insurance recommendations, and family meetings, are often rolled up into that fee. The larger the portfolio, oftentimes, the greater the complexity of a client’s situation, and the more sophisticated the process, justifying the fee-based structure.
While that fee structure may eliminate the previous conflicts of selling a financial product that pays a high commission or locks an investor into an investment through a high back-end load, fee-based structures create their own conflicts. For instance, if a fee-based financial advisor gets paid more if the client’s portfolio is larger, the advisor may find reasons not to withdraw money from the portfolio. Tergesen highlights three potential conflicts of interest: Social Security, paying off a mortgage, and buying an annuity.
Social Security
Americans can begin receiving Social Security benefits as early as age 62. Some people elect to take those payments when they are older, and when the monthly benefit amounts are larger.
Tergesen rightfully points out that if a fee-based client is advised to take Social Security payments sooner, they do not need to withdraw money from their portfolio to supplement their cash flow. In that case, the portfolio would remain larger, and the advisor would get paid more. (Of course, instructing the client to take a larger Social Security payment when they are older would benefit the advisor later—there are conflicts on both sides.)
Tergesen’s article suggests that putting off Social Security benefits as long as possible is usually the best plan. Generally, I agree. There are some notable exceptions, however, whereby it may make sense for someone to claim benefits sooner. For example, if the person has health issues that may limit their life expectancy, claiming benefits early could help them receive a larger portion of their payout over their lifetime. And some people claim benefits early and invest the money to try and generate higher returns.
Paying off a mortgage
Telling a client to hold a mortgage may be the best plan for a client, but both the advisor and the client should be aware of the conflict of that advice. If a homeowning client is instructed to hold the mortgage in lieu of liquidating their portfolio to pay off their debt, the client’s portfolio would be larger, their financial complexity (theoretically) would remain elevated, and the advisor would get paid more.
Tergesen calculated that such advice has mostly helped homeowners historically. She points out that the S&P 500 has experienced a half-decade stretch of annualized 14.7 percent returns, “far exceeding” the cost of the mortgages, especially when applying tax deductions for interest. I am sure that many investors were glad they held onto their mortgages and stayed invested in the stock market during that period. But now mortgage rates are higher, and stock returns could be lower.
When clients ask me if they should sell their investments to pay off their mortgage, I remind them that it is not just about the numbers. The math typically dictates that homeowners should hold their mortgage and invest the money, they would have spent into the stock market—even at today’s high mortgage rates. But there is a feeling that has nothing to do with math: It feels safe and comfortable to be debt-free. At least to me, it does (said the guy who has a million-dollar mortgage). There is an emotional value to paying off your mortgage that may be worth more than just dollars and cents.
No matter what the decision, clients and advisors need to keep in mind that a bias could affect the advice.
Buying an annuity
I am a fan of Ms. Tergesen, but I think she missed the mark here a bit. She notes that some advisors do not sell annuities because doing so would mean taking money out of the client’s investment account to make the purchase, thus reducing the portfolio size and the advisor’s fee. However, not only could the advisor charge an annual fee on the annuity assets, but the advisor could get paid handsomely on the transaction.
For example, let’s say I allocated just one-tenth of Berkshire Money Management’s clients’ money into annuities. That would be roughly $100 million of client assets. Suppose I could negotiate a 10 percent commission from the annuity provider, yielding me a $10 million windfall. In that case, if I moved all my clients’ money to an annuity, I would be looking at a payday closer to $100 million—and still get paid an annual fee in either case.
The Wall Street Journal article points out a quote from financial advisor Ken Fisher of Fisher Investments. The company’s website says, “Our founder, Ken Fisher, is fond of saying ‘I hate annuities’ because he believes anything you can do with an annuity can be done better with other investment vehicles.”
I am fonder of Fisher’s other quote regarding annuity products. Fisher says, “I would die and go to Hell before I sold an annuity.” Seeing how I am not taking a $100 million payday, you might suspect that I agree with Mr. Fisher.
More conflicts to look out for
Ms. Tergesen’s column was exceptional, and I am glad to see any attempt to help consumers make informed decisions. There are some additional conflicts to be aware of.
- Commission-based compensation. Commissions (or premiums, or loads, or whatever language is used) can incentivize an advisor to recommend products that generate the highest advisor payout, even if it is not the best fit for the client’s needs.
- Revenue sharing. Some investment companies offer additional compensation to financial advisors for recommending their products, even if the products are not the best. An investment firm with a local office was fined nearly $2 million for a similar undisclosed conflict, so you know that is a problem.
- Soft dollar arrangements. Some advisors receive research, technology, or other benefits from investment companies in exchange for directing client assets to those companies.
- Referral fees. Advisors may receive compensation for directing clients to certain professionals, such as attorneys or accountants. There may also be a quid pro quo in referral exchange.
- Outside business activities. Advisors may have other business interests, such as insurance sales, bookkeeping, and bill paying, which could be recommended as a preferred vendor.
For investors, generally, none of these are unethical so long as they are disclosed. I am of the mind that when it comes to their money, people can make good decisions if they have all the information. It is up to the advisor to disclose anything that might be a conflict so that it can be discussed and contemplated. It is not up to the client to ask, but it is their right to do so.
For financial advisors, generally, you are all amazing people with a passion for helping people. I celebrate you. However, we are just humans. Myself included. Advisors should be aware of possible conflicts and then create a decision-making process to avoid those conflicts. That way, not only can we help the client trust us more, but we can also be sure that we are not subconsciously being nudged to do something other than what is best for the client. That is a best practice because it constantly makes advisors track, explore, and assess the latest and greatest client advice finding its way into the industry.
Allen Harris is an owner of Berkshire Money Management in Dalton, Mass., managing more than $700 million of investments. Unless specifically identified as original research or data gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. Advisor makes no representations that any of the securities discussed have been or will be profitable. Full disclosures here. Direct inquiries to Allen at AHarris@BerkshireMM.com. A recommendation to roll over 401(k) account assets creates a conflict of interest if BMM will earn an advisory fee on the rolled-over assets. No client is under any obligation to roll over retirement plan assets to an account managed by BMM.
