Financial Planning

Financial Advice May Not Be Your Adviser's Specialty

Here's how to tell. Before investors make any moves, they should look beneath the surface by thinking about what could be motivating the person they are working with and asking these questions.

“You look amazing!

“You did an amazing job!”

Not blown away by the compliment? Join the club. “Amazing” made Lake Superior State University’s List of Words Banished from the Queen’s English for Mis-use, Over-use and General Uselessness. Its illustrious peer group includes the “nothingburger.”

As with “amazing,” loose application of the term “Financial Adviser” has chipped away at its meaning, too. In fact, the Financial Industry Regulatory Authority (FINRA) encourages prospective clients to:

“…be aware that Financial Analyst, Financial Adviser (Advisor), Financial Consultant, Financial Planner, [etc.] are generic terms or job titles, and may be used by investment professionals who may not hold any specific credential.”

Most providers of financial advice do so with the best of intentions, but despite sharing a common title, they can bring a wide array of skillsets, may provide vastly divergent services and even answer to different standards. Broadly speaking, some financial professionals enter formal financial planning arrangements with their clients. Their purview extends beyond the transactional and encompasses many aspects of the financial picture. These advisers act as fiduciaries, meaning that they must put clients’ needs above their own.

Others approach client relationships from mainly a transactional perspective and focus on deploying products, from investment securities to insurance contracts. Their standard for recommending specific products is suitability, which means that if a product is a reasonable fit with the client’s objectives and risk tolerance, it passes muster.

Do what? For whom?

Competent, trustworthy advisers can be found in many different niches of the financial services industry, but investors should be aware of the incentives that may drive the dispensation of financial advice.

A captive agent at an insurance company sells insurance and annuities. He or she provides incidental financial advice during the sales process but does so as an employee of the insurance company, not as a representative of the client. He or she has access to non-proprietary products, but this is a far cry from actually recommending them. After all, the agent’s quotas and compensation are closely tied to the volume of business directed into proprietary products. While a proprietary annuity contract may pass the suitability test for a client — meaning that it is not inappropriate — other options may offer better pricing or address the client’s needs more completely. This agent faces a conflict between his or her own paycheck and the best interests of the client.

Meanwhile, at a large brokerage firm affiliated with a retail bank, the same person managing a client’s investments, savings and debt also offers products that solve for these needs. This adviser’s compensation can be tied to the number of deposit and loan accounts he manages and some can even be tied to the amount of interest clients pay. The resulting conflicts are best illustrated through examples, such as the following.

Uncovering Conflicts of Interest: 2 Client Stories

One of the bank representative’s clients is planning to sell a home in the next five years, so an adjustable rate mortgage (ARM) could provide an appealing short-term reduction in monthly expenses. The rep stands to make more money if the client refinances the current fixed-rate mortgage into an ARM, so he presents the benefits of refinancing without reviewing the very real risk of exposure to rising interest rates if the client is unable or disinclined to sell the home by the time the ARM’s introductory rate expires.

The same bank representative is paid a percentage of the interest generated on margin accounts. Another of his clients holds appreciated stock and wishes to free up cash to meet a liability. Rather than liquidate the stock and pay capital gains taxes, this client could borrow against the stock using margin. The tax deferral would improve short-term cash flow, but the longer-term wisdom of this strategy hinges on the difference between the margin interest rate and the portfolio’s expected return. If the client is invested conservatively, i.e. with a relatively low expected return, introducing margin could convert a portfolio yielding a modest return to one whose return is negative. Good for the representative’s compensation; potentially unfortunate for the client.

3 Questions to Ask

When evaluating an adviser, consider these questions:

  • Is the individual compensated as a brokerage representative or as an investment adviser representative (IAR) when giving me advice?
  • Whom does the individual represent – me or a third party?
  • Does the individual’s firm or employer manufacture the products they sell or otherwise benefit disproportionately when I choose to buy one product over another? (Use the business card test here: Is the firm name on the adviser’s business card also the name of the firm that manufactures the product(s) I am buying?)

Beyond ‘Amazing’

When considering whether to engage someone for financial advice where a financial professional’s profit and compensation vary widely based on product selection or strategy implementation, clients should remember that advisers are only human. Many people are unlikely to sacrifice their own needs to deliver what they may perceive as an only slightly less-than-optimal solution for a client.

Good, trustworthy advisers can be found in any of a number of employment arrangements, and a conflicted environment does not necessarily make for bad advice. But when better structures exist for working together in service of your financial well-being, it pays to look beyond titles and make sure that sound advice is the top priority.

Advisory Services offered through MACRO Consulting Group, a registered investment advisor with the Securities and Exchange Commission. MACRO only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements.

About the Author

Mark Cortazzo, CFP®, CIMA®

Senior Partner, MACRO Consulting Group

Mark Cortazzo, CFP®, CIMA® is the founder and senior partner of MACRO Consulting Group, an independent wealth management firm located in New Jersey. He offers expert financial advice as an Investment Adviser Representative and retirement planning specialist. With over 25 years of experience in financial services, Cortazzo has been profiled in many publications and has earned numerous industry awards and accolades.

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