How do you know if your financial adviser is acting in your best interest? It’s ashamed that the question even has to be asked—but it does. Are you truly working with a financial adviser, or are you dealing with a financial salesman?
In its simplest form, a financial adviser is someone who places your best interest ahead of their own—they are a fiduciary for the money you hire them to manage. They operate according to the fiduciary standard outlined in the Investment Advisers Act of 1940 and regulated by the Securities and Exchange Commission (SEC).
A financial salesman, also referred to as a broker, is an employee of the firm that employs them. Those firms are often the big, recognizable names you know. The broker’s first responsibility is to make money for the company. Do you see some potential conflict of interest here?
The financial salesman works under the suitability rule governed by the Financial Industry Regulatory Authority (FINRA). The suitability rule says broker-dealers must reasonably believe that any recommendations made are suitable for the client’s financial needs, objectives, and unique circumstances. But just because a recommendation is suitable doesn’t mean it’s appropriate.
A financial adviser, working under the fiduciary standard, charges a fee-for-service. You hire them just like you hire anyone to work for you. And because you’re charged a fee you never have to wonder if activity in your portfolio is best for you.
A financial salesman, working under the suitability rule, is paid a commission. And anytime a commission is involved in the financial world there is always the potential for conflict of interest. Did the broker sell you that investment because it’s in your best interest as part of a well thought out plan, or was it part of what I call a Pizza Portfolio? The more commissions generated the more money the broker makes.
Fee-for-service has become very popular and the big brokerage firms saw business go out the door. So, they created wrap accounts and charged their customers fees, just like fiduciaries. But in this case, even though the wrap account walks like a duck and quacks like a duck, it’s not exactly what it appears on the outside. The brokerage firms don’t tell you about their internal self-dealing profits made by trading client portfolios along with firm accounts. FINRA-regulated companies are allowed to do such trading. Fiduciaries, on the other hand, are prohibited from buying securities for their own accounts before they buy for the client.
Another distinction that will help you decide if a financial adviser is acting in your best interest is whether that person uses strategy and tactics to manage your funds, or if you’re being sold the stock or bond deal du jour. Strategy is a long-term plan of action to achieve your overall goal. Tactics are how you alter a strategy to achieve a long-term goal.
For example, if you think the market is about to go down you might make a tactical (short-term) shift in your long-term portfolio that allows you to avoid some of the downturn. Strategy and tactics must be used together. It’s not one or the other.
Here’s another example. A long-term strategic plan might be to have 20% of your portfolio in large cap stocks. The tactic would be the kind of large cap stocks used—U.S. or international, will it be a particular sector or a broad index. That would be the tactic used to implement that piece of the strategy.
Ask a financial person to describe the strategy they use. If they can’t explain it to you in a short, succinct paragraph, most likely the’re using tactics and don’t have a strategy.
I’m not saying there are no moral, ethical people who work in the world of broker-dealers, but to make sure you’re getting unbiased information and recommendations ask
- If they are regulated by the SEC or FINRA
- If they work according to the fiduciary standard or the suitability rule
- If they use strategy and tactics to make investment decisions
Is your financial adviser acting in your best interest? They either are or they’re not. There’s no middle ground.