Before you answer, consider the following:

• 95% of financial advisors are required by federal law to serve the best interest of their employers, not their clients
• 99% of financial advisors have a conflict of interest with their clients because their income depends on steering clients to certain financial products

One prominent industry organization has stated “many of the problems that beset Americans today in their financial affairs – including the mismanagement of debt, failure to protect retirement assets, and poor allocation of savings and investments – relate directly to the conflicts of interest that pervade the marketplace”.

What you should know

About 95% of financial advisors are considered “Broker-Dealers” by the United States Securities and Exchange Commission (SEC). They are required by federal law to act in the best interest of their employer, not in the best interest of their clients.

Since broker-dealers are not required to act in their clients’ best interest, they are required by the SEC to add the following disclosure to client agreements. Read this disclosure and decide if this is the type of relationship you want to dictate your financial security:

“Your account is a brokerage account and not an advisory account. Our interests may not always be the same as yours. Please ask us questions to make sure you understand your rights and our obligations to you, including the extent of our obligations to disclose conflicts of interest and to act in your best interest. We are paid both by you and, sometimes, by people who compensate us based on what you buy. Therefore, our profits, and our salespersons’ compensation may vary by product and over time.”

It is unfortunate that the vast majority of financial advisors in the United States are sellers of financial products. Some or all of their income is dependent on their ability to steer clients to a limited number of the thousands of financial products available today. Putting aside conflict-of-interest, this limiting of choices, is enough to impact the quality of the investment advice.

The 1% Solution

It is simple common sense to see how financial advice should be provided if clients’ interests are paramount. A financial advisor should:

• have a legal obligation to place their clients’ interests first
• be required to disclose how they are compensated
• earn their compensation solely by providing independent, unbiased advice

The sole advisory model with these characteristics is the Fee-Only Registered Investment Advisor. Unfortunately for consumers, these advisors represent a mere 1% of the financial advice industry.

Registered Investment Advisors are registered with and regulated by the SEC or their state securities regulator. Federal and state securities laws hold Registered Investment Advisors to a Fiduciary Standard. This means that a Registered Investment Advisor must act solely in the best interest of the client, even if that interest is in conflict with the advisor’s financial interest. Additionally, they are required by law to fully disclose their business practices and how they are compensated before being engaged by the client.

“Fee-Only” means the financial advisor charges clients directly for his or her advice and/or ongoing management. No other financial reward is provided, directly or indirectly, by any other institution. “Fee-Only” financial advisors are selling one thing: their knowledge. “Fee-Only” should not be confused with “Fee-Based” where advisors charge fees AND earn commissions by selling financial products.

Fee-Only Registered Investment Advisors typically charge a fee based on a percentage of total assets managed. This has two key advantages for consumers. One: the fee structure is simple, transparent, and easy to understand. Two: the fee structure does not give an advisor an incentive to recommend one product over another. Therefore, the client can feel confident that the advisor is making recommendations based on what is best for the client’s situation and your portfolio.

So, now that you have the facts, whose interests does YOUR advisor serve – yours, or the advisor’s and the advisor’s employer?

The answer apparently is zero, because, as the chart below clearly demonstrates, economists never predict recessions. This is just one example of why we advise clients to ignore virtually all of the economic and stock market discussions going on in the mass media. Because if economists with PhD’s can’t predict events intelligently imagine how good the talking heads on CNBC must be.

This chart was created by James Montier (at Societe Generale in London) whose book on Behavioral Finance was subtitled “Insight Into Irrational Minds and Markets.” We like the subtitle because it describes so much of what we read and hear daily in the media. Nothing could be more irrational than highly trained “experts” who constantly talk about and publish research on the economy but who NEVER forecast the thing we care most about – when things are going to go bad.
This is why we say that our primary job is to provide “rational advice” to our clients. It turns out that rational advice is much harder to come by than people imagine. The good news for us is that high IQ is not necessarily required. As Warren Buffett said about himself: “Plenty of people have higher IQ’s…but I am rational about things.”
The ongoing purpose of this blog will be to provide clients a source for “rational” economic and investment understanding. We hope to do so in a simple, summarized and entertaining (relatively speaking) form. For important issues which clients may want to know more about we will provide links to more in-depth discussions and explanations.
So, stay tuned for more and remember – ignore as many economists as possible.