That friendly, accommodating fellow who wants to help you choose investments for your retirement portfolio may be your worst enemy. If he's not a fiduciary, you should be scared to death.
If you?re asking why, pick up today's edition of The Wall Street Journal, Barron's, Investment News or any other national media covering the markets. Chances are there will be at least one story about a stockbroker or a brokerage firm being sued or investigated for investor abuse or fraud. It's become so commonplace it hardly raises eyebrows anymore - but it should. The firms being sued are not SEC-registered fiduciary advisors; they are non-fiduciary advisors "governed" by the NASD. These stories should thrust a great big red flag in front of every investor to stop whatever they are doing, pick up the phone, call their investment advisor and ask this question: "Are you a fiduciary?"
There is a pitched battle going on behind the scenes in the financial services industry. The combatants are stockbrokers and Registered Investment Advisors, and the war is all about investor money - your money.
As an investor, you have two primary sources of financial advice. One source is any advisor registered and governed by the National Association of Securities Dealers (NASD). In providing investment advice, these advisors adhere to a standard of care known as "suitability", which is comparable to the standard of care you receive from the used car salesman at the local Ford dealer.
Does that mean your stockbroker is out to cheat you. No. There are a lot of honest, conscientious brokers. There are also a lot of honest, conscientious car salesmen. But how can you tell when neither are under any obligation to sell you the product that is in your best interest?
Remember the movie "Miracle on 34th Street" where Santa becomes a Macy's employee and directs customers to other stores when Macy's didn't have the Christmas toys they want? Of course, that's only in the movies. No one expects a store clerk or an auto salesman at Ford to recommend a Toyota because it better suits a customer's needs. In fact, the Ford salesman may not even recommend the appropriate Ford if there is a bigger commission on one model than another. That's simply human nature.
Unfortunately, human nature can be awfully costly when it comes to choosing investments for your portfolio. Do you expect a broker at Merrill Lynch to recommend a Smith Barney product if it is a better fit for your needs? Hardly. Caveat emptor my friend. They have no duty to tell you which products are in your best interest; they are responsible only to tell you about products that are suitable. The brokerage industry has the same vertical integration as the car business, and like the Ford salesman, the friendly Merrill Lynch broker may not even recommend the best Merrill Lynch product if the product with the highest profit margin can legally be deemed "suitable" for your needs. So you stand a good chance of being loaded up with municipal bonds, hedge funds and other high-profit items that make the brokerage - rather than you - lots of money.
Now this is not to say that Merrill Lynch or Smith Barney do not offer some good products. They have some solid mutual funds and float some decent bond issues. But the issue is whether, based on your specific needs and objectives, these products are best for you or are merely suitable. There's a world of difference and it's a big part of what the big battle raging in the financial services business is all about.
The second source of investment advice is a Registered Investment Advisor (RIA) such as Capital Financial Advisors, LLC. We are fiduciaries and regulated by the Securities & Exchange Commission (SEC), not the NASD. That means we are legally obligated to provide investors with a higher standard of care - fiduciary care - which is comparable to the standard of care you receive from your CPA, attorney or physician, not your local car dealer. That means you are more likely to have a better outcome with your planning and investment strategies because as an RIA, we have disclose any conflicts of interest. And even if we do have conflicts, we are still legally obligated to put your best interests ahead of our own.
As an RIA, our fiduciary relationships are based on fee-only accounts. This is completely different from the "fee-based" accounts now offered by some advisors and brokers. Fee-only means we do not accept commissions or compensation from outside sources for the investment products or advice we recommend. Our fee is based on percentage of the assets we manage for our clients. Our fiduciary responsibility is to our clients, not to investment or insurance product sponsors or brokerage companies.
On the other hand, "fee-based" advisors and brokers can collect fees, commissions and other forms of compensation from product sponsors or their own brokerage firm. They can charge you a fee based on the size of your account and simultaneously collect commissions for selling you the products they recommend. They can even earn fees from the investment inside your "fee-based" account. In point of fact, these are brokerage accounts with a deceptive name designed to sound like a "fee-only" account. Read the fine print in a Merrill Lynch, Smith Barney or other "fee-based" brokerage account: You?ll see words to the effect that ..."Our interests may or may not be the same as your interests."
The best advice anyone can give you is don't expect to get advice that's best for you from someone whose first duty is to their shareholders.
Another clever obfuscation the brokerage community employs is the word "independent". Lots of advisors claim they are independent. Independent of what? Advisors who work for Wells Fargo may be independent from Merrill Lynch, but they are definitely not independent of the influence of their own brokerage, Wells Fargo. Like all advisors who are not fiduciaries, they are always subject to the influence of hidden fees and commissions, as well as other behind-the-scene financial incentives. Just as deceitful, they have no duty to disclose these conflicts to investors.
There are advisors who sponsor investment advice shows on local radio, and I hear them claim to be independent. Well, they?re not independent of the brokerage firm that employs them. And being "independent" doesn't prevent them from recommending investment products that compensate them at higher rates. So what does "independent" really mean to investors? Other than the personal financial independence these product pushers enjoy from the commissions they earn, "independent" means virtually nothing.
An unbelievable amount of money is spent annually by brokerage firms, banks and insurance companies claiming to be resourceful, independent, dedicated investment advisors whose only mission is to help their client achieve financial success and a secure retirement. But every one of the people working at those brokerage, bank and insurance companies owes their first allegiance to their shareholders, not to their investor "clients" - customers would be a more apt description. Insurance companies probably have the worst products when it comes to meeting clients? best interests because it's often virtually impossible to discern who's getting paid how much in an insurance product sale. Investors asking a licensed insurance broker for financial advice might as well paint a bulls-eye on their forehead and hand out guns. Typically, investors pay a fee for an "independent, comprehensive" financial plan, and part of the plan is a recommendation for whole life insurance for which the planner receives a fat commission, unbeknownst to the client, of course. So do you suppose there is a tendency of the part of these advisors to over-recommend whole life insurance?
Investors who receive financial advice from a fiduciary face no such distortions. The fee is up front and clear. Fiduciaries are not allowed to change their compensation or receive any commissions based on what they recommend. If they have any conflicts of interest, they must be clearly disclosed.
Another subterfuge involves brokerage fee-based accounts that resemble and are competitively priced with fee-only accounts. At first glance, it may appear the broker is not making all that much money, but realize that brokers receive only about one-third of the account fees, the balance going to the brokerage firm. Hidden in this facade is the brokerage firm's incentive to churn the account to run up transaction costs. Their investment recommendations generally contain elements like separate accounts, which individually buy stocks and bonds in small lots, which is expensive for investors and runs up transaction costs which equals profits for the brokerage. Another profit maker for the brokerage is portfolio turnover.
I was recently asked to review the brokerage account of a retired investor on a fixed income. I was appalled when I discovered that the previous year, the account had a turnover rate of 300%! You can imagine the transaction costs and fees that generated for the brokerage...all perfectly legal but, in my opinion, morally reprehensible. The turnover rate in our client portfolios and other fee-only registered investment accounts might be 5-6%. We are not allowed to receive compensation for transactions, so there is no incentive for us to churn accounts. When I calculate the actual fees on a brokerage account - the bid/ask spreads, insurance commissions, hedge fund fees, and the rest - I see trusting investors paying 3-5% or more of their asset value annually in fees, and not realize it. The majority of financial advisors charge these hidden and excessive fees. RIA's do not.
Here's another little slice of the scam pie that goes largely unnoticed. Non-fiduciary advisors know that if they are caught circumventing NASD suitability regulations or generally abusing their clients, they are not subject to the legal system. When you read about the investigation of a brokerage firm that subsequently pays a settlement without admitting guilt, there's no justification for their executives not being throw in jail for destroying the financial lives of thousands of investors. They should be incarcerated but they aren't. That's because when they commit abuse, their investors can't take them to court and sue. In fact, investors have only one recourse; NASD arbitration, a sham overseen by the NASD itself, purportedly to police its members. It's a slow, expensive and binding process and no matter what the outcome, investor portfolios are not going to be made whole again. And guilty brokers are not going to get hurt much or pay any meaningful fines. Every brokerage agreement has a clause mandating NASD binding arbitration that serves to protect non-fiduciary advisors from the legal system and hoodwink gullible investors into believing they will have some avenue for justice if they are cheated. It's the old story of the fox guarding the hen house.
RIA's are fiduciaries and have no such escape clause. So not only do our investors receive a higher legal standard, we can be sued in court, unlike non-fiduciaries, who can hide behind toothless NASD arbitration. A fiduciary who abuses investors risks losing all his assets in court.
Here's the latest chapter in the brokerage industry's history of snubbing their nose at the investing public. Non-fiduciary advisors have secured an unprecedented legal exemption to the requirement that they register with SEC when they give investment advice versus conduct brokerage. It's called the "Merrill Lynch Rule". They are now being sued by the Financial Planning Association for passing this ridiculous exemption. The brokerage industry has made a mockery of financial advice by blurring the public's perception of the differences between a broker and an advisor. So while they are legally prohibited from calling their people financial planners, they are allowed to call them financial advisors, investement counselors, and the like. How many people do you know that can explain the difference? That's the idea.
In realty, a brokerage firm is only supposed to charge for conducting trades. They are supposed to be conducting brokerage - taking orders and doing transactions. They are not supposed to be asking investors, "What are your retirement goals" or "What is your risk tolerance?" The laws governing brokerage are written around that concept and so do not protect investors. But of course the brokerage industry is now heavily into the financial advice business. If you doubt it, consider how many of those expensive TV commercial tout the brokerage firm's talent for taking and processing orders. On the contrary, they are all about offering "sound financial and retirement advice".
Make no mistake, they are in the advice business alright, but it's the biased advice business and now they have an exemption to the requirement that as advisors, they act in the best interests of their clients. It's an enormous scam perpetrated by a huge, entrenched industry that is not going to come clean anytime soon. It's a scheme of unfathomable proportions that, were it occurring in any other industry, would be headline news every day.
Imagine if your doctor received commissions for recommending certain drugs. What if you trusted he was looking out for your health but in reality, he had no duty to you but was being paid by a drug manufacturer? Imagine the effect that would have on the healthcare industry. Imagine the public uproar and the congressional investigations (not to mention the political grandstanding) such a scandal would prompt. Yet that's exactly what is happening in the financial services industry, to the tune of untold billions of dollars and millions of diminished or destroyed retirements.
As an investor, avoiding all this is uncomplicated. All you have to do is a little homework, made even easier by our ready access to information via the internet. Learn what the various terms mean, look a little closer, read a few articles and learn which questions to ask. As I mentioned previously, you can start by asking your advisor the $64 question: "Are you a fiduciary?" Anyone working at a brokerage firm is not. That's pretty simple.
You can log on to www.feeonly.org. to get a list of 26 questions to ask any financial advisor, among them, "Will you act as a fiduciary under the Investment Advisors Act of 1948?" Also, you can check www.iard.com to see if an advisor has ever been disciplined by the SEC, the legal governing body for all fiduciaries.
Don't be fooled by impressive-sounding designations, like Certified Financial Planner CFP? , ChFC, or CFS. That does not mean he is a financial planner, and certainly not a fiduciary. In reality, he could be a product pusher. The same goes for the various insurance designations like CLU. Same concept; same model; same distortion.
Finally, never work with anyone who is not a fiduciary advisor. The public would be much better of if all advisors were forced to be fiduciaries, but sadly, they are not. Until they are, caveat emptor.