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Distinguishing Between a Salesperson and an Independent Advisor

These days, a dark secret of many financial institutions is that the advisers they hire do not consider your best interests. What I mean by this is that without a regulatory body providing them a set of standards, they are free to suggest investment options that may not be the best idea for you and your family. Unless an adviser is a CFP, CFA, CPA, or any similar designation, they have not passed any tests to certify their knowledge, nor are they bound to important principles of conduct. I use these three main professions sometimes interchangeably, but in general, CFPs are good for holistic estate planning, CFAs are good for portfolio management, and CPAs are good for tax planning.

Surprising? Not really, because taking a quick look at the mutual fund industry, we see that there are still plenty of fools buying into underperforming funds that overcharge fees. The reason that people still buy mutual funds? Not everyone understands the impact of fees on a portfolio, and people believe their returns are good enough as long as it’s paying out.

People may also know about these concepts, but when your time is limited, the last thing you want to think about after coming home is your finances. Instead, the easiest thing to do is to throw the money into a reputable firm that’s also managing your friend’s retirement.

As of 2019, 46% of American households own mutual funds, and there is an estimated $21 trillion invested in US mutual funds alone. Mutual funds charge higher fees and track the same indexes that ETFs do.

Another way to think about the importance of someone who truly cares for you is by remembering the Wells Fargo scandal. In summary, millions of fraudulent accounts were created without the consent of clients to meet management quotas. Salespeople were incentivized and pressured to cross-sell, focusing on the importance of increasing revenues, rather than caring about their clients. Through these accounts, unexpected charges built up for victims and Wells Fargo were eventually fined millions.

Think back to the last time you went to a bank appointment, and you might remember that the person may have asked about your mortgage, or suggested an investment option for you and your family. Do you want to change your mortgage to a fixed rate? The rates are only going to increase! Take a look at our new brochure for our mutual fund products. Assuming a hypothetical $1,000 investment 5 years ago, you would have $1,500 excluding fees today!

Now, why did I mention the Wells Fargo scandal? Because many banks employ the same cross-selling practices today, just on a subtle scale. Instead of fraudulently creating accounts for you that you don’t know about, they can profit off management fees on your same-bank mutual fund. Banks have one of the best business models in the world, they borrow money for cheap through your deposits, and lend it out again to others charging much higher interest. Right under your nose, they are cross-selling you all the time through the retail banking division, but today is when that changes.

By speaking about a Financial Adviser, I don’t mean the person you set up a meeting at your bank regarding a new account or mortgage. In this article here’s what I define a financial adviser to be:

An independent licensed professional, who has a fiduciary duty to you and your family’s best interests

By the end of this article, you’ll have a red flag pop up every time somebody at a bank suggests you a mutual fund or new investment opportunity from the bank. Advisors at banks may have to be trained under the bank’s policies and learn the basics of investments, but they are not professionals. The kindest way to refer to them would be to refer to them as salespeople.

Ethics is a huge part of finance and investing, but with many scandals plaguing the industry such as Ponzi-schemes, fraudulent accounting, and endless conflicts of interest, I’m here to preach the importance of finding a licensed professional who is bound by a strict code of ethics. This will ensure that you receive the best objective advice, and provide you with a chance to recoup losses if any arise.

There are many different designations out there, and each body has a different set of standards for its members. I’ve boiled the bulk of them down into several common themes, to reduce repetition and redundancy.

Proven Competency

To start, let’s talk about their duty to be competent when advising you on certain life-changing decisions. Professional CFAs undergo a rigorous, three-tier examination before being eligible to become a charter holder. Pass rates are roughly 40% through each exam and require roughly 300 hours of studying for each exam. Not only do these professionals study and preach ethics, but they must also have a solid understanding of almost all concepts pertinent to the investment field.

Accounting, economics, corporate finance, financial assets, are all concepts familiar to a CFA. Similarly, the CFP and CPA designations are also difficult, meaning that they also know their stuff. Not only do these guys do exams, but they also need a significant amount of relative work experience (documented by other professionals) to receive their designation.

Due to the significant challenges prospective professionals face in this industry, you can bet that they will do their due diligence when deciding what’s best for you and your family. It would be negligent of them to forget something about your estate, which breaches their code of ethics. Expect them to come at you with a ton of questions around your situation, as well as requests for financial information. Don’t be alarmed though, would you want a doctor who prescribes you cancer medication without knowing your entire medical history?

These are not your engineering neighbors who made a killing off purchasing Apple back in the 90s and have bragged about it for the past decade. They’re also not your relatives who are day-trading cryptocurrencies to turn a quick buck. They are professionals who have proven their ability and competence in the field that they are advising. You should expect nothing less from a person you’re entrusting your hard-earned money with.

Maintaining Integrity

Before you scoff at this concept for the irony, professionals must maintain their integrity with their clients. I mention the irony because scandals even amongst licensed professionals are frequent. This is a huge concept group and ranges from objectivity to confidentiality. If a CFA owns interests in a particular investment, you can bet your money that you won’t see them suggest that investment to you. Profiting off conflicts of interest is a huge breach, and unless the professional is willing to risk their careers, it won’t happen.

For an unlicensed salesperson pitching a particular financial asset, you probably won’t see any repercussions. How many news articles do you see mentioning a 6-figure binary-option trader scammer getting caught? How about the recent college grad who convinced you to purchase a bank mutual fund, which subsequently only earned you 10% over 10 years? On the other hand, the CFA lays out a global list of all members/candidates who are sanctioned.

With these things in mind, you can expect objective advice and an obligation to all parties involved. Here’s an example:

You are recently divorced, and your CFP advisor is the advisor of your spouse who currently receives money from your business post-divorce. You visit the CFP advisor and inform them that your business is now bankrupt. Your advisor has an obligation not to tell your spouse this information.

Despite what it might seem like on the surface, you told the advisor this in confidence, and they must keep it that way. Of course, the situation is messy because you can argue that after a divorce the two parties should have different advisors, but keep in mind that as two different legal people, the CFP would keep this information confidential.

Choosing an Advisor

Okay, so now that we know that we should hire an advisor, how do we know who’s the right one for us? This question may seem simple but can be hard to answer in practice. Deciding between two CFAs, what if one of them barely scraped by, but the other one was in the top percentiles? What’s the difference between a professor from Harvard and a professor somewhere else? Both may teach the same subject, but one would have deeper insights compared to the other. Here are my most important tells, for whenever I have to decide between different professionals.

Advisor Compensation

I’ve stressed the importance of using an independent financial advisor instead of one tied to a bank because incentives and compensation drive human psychology. Why is an independent advisor so important? Because many bank advisors receive a commission fee after they refer a client to a certain mutual fund. These funds are generally from the same bank that employs the advisor. Now independent advisors aren’t perfect, and can still collect a commission from certain funds, but that’s when you need to be on the lookout.

Annual flat fees generally tell you that an advisor may provide more objective advice. They have less of an ulterior motive and are only compensated if you are satisfied with their advice and come back.

Teaching vs. Telling

A good advisor will always explain the thought behind what they are suggesting. No matter how incompetent you may be regarding a certain topic, it is their duty and obligation to ensure that you understand what you’re getting into. No good advisor would tell you to invest 20% in X, 30% in Y, and 50% in Z without mentioning the risks and rewards of each.

You’ve come all this way and committed to finding the right advisor, you should go all the way and understand what they’re recommending.

You should never feel like the advisor is covering your eyes with a blindfold, while you make a decision. If you agree with their recommendation while you fully understand the situation, it may be the optimal solution. In contrast, if you’re confused and unsure about the topic, but the advisor is pushy despite your confusion, you should consider bringing your business elsewhere.

Knowing Your Client

Before a licensed advisor provides you with a recommendation, they will almost always require information about yourself to generate their recommendation. Your financial position, net worth, current investments, investment goals, family status, and any other pertinent information should factor into a recommendation.

Are you open to taking on more risk for more reward, or are you less risk-taking? A strong financial advisor would be able to summarize what you told them, and also provide insights on things you might not have even known. Perhaps your habit of gambling at casinos shows that your risk tolerance is higher than the average individual, which means you can handle a riskier investment portfolio.

Tough Conversations and Empty Promises

A professional should never promise returns without making sure that you understand the risks involved. You should be cautious if an advisor tells you that they can easily achieve certain results based on past performance. Know that even the best portfolio managers often fail to beat index funds.

Advisors also need to give you the tough talk about achieving your dreams. If they don’t make you aware of certain risks and hold off on the tough conversations, think of how things would go if your advisor made a mistake. If your goal is to own a million-dollar house, but it’s extremely difficult for your financial situation, your advisor should let you know. Empty promises should be red flags, and they should always be ensuring that you’re caught up with any tough ideas.

Takeaway

Compensation structure can easily let you distinguish between a salesperson and an independent advisor. Choose objectivity and competence over convenience. Be skeptical about your choices, and make sure that you find one who can help you through the good times and the bad. Instead of spending time doing your finances, a strong advisor can save you time, money, and give you peace of mind.