Wise Money Decisions

In my line of work I get a constant stream of phone calls from three types of people: headhunters, brokers, and financial planners.

The headhunters always ask the same thing.  They want to know if I’m happy with my job.  They’re a very sweet bunch to be so concerned about me.

The brokers and planners don’t ask about my happiness.  They want to talk money.  They want to know how much I have in investable assets.

To keep things simple, you can divide financial planners into two categories: fee-only investment advisers and salesmen.  Brokers are NOT investment advisers.  Brokers are a separate category.  More on that in a minute.

Investment Advisers

Investment advisers have passed the Series 65 exam (to be precise, the adviser’s “representatives” have passed the exam), are registered with the SEC or a state regulatory agency, and are legally required to act in the best interests of their clients. 

Financial planners other than “fee-only investment advisers” are more like salesmen.  They advise you to buy various products, typically insurance and investment products such as mutual funds or annuities.  Many are conduits that don’t invest your money directly, but instead farm it out to other advisers or mutual fund companies.  That results in another layer of fees. 

Other advisers are compensated for each trade they make on your behalf.  If you use this kind of adviser, it’s highly likely your account will be churned.  “Churning” is when your adviser makes unnecessary trades in your account to generate fees.

Brokers

Brokers are not investment advisers.  There is an important regulatory distinction between the two.  Brokers are not required under the law to act in the best interests of their client.  That’s why a broker who knows nothing about me or my financial situation can cold-call me and promise me a 60% annual return by putting a large portion of my portfolio into covered call options on a single oil refiner (which happened last week). 

A good investment adviser would not make that recommendation to me until he understood my financial situation.  A good investment adviser would learn about my financial situation and determine an investment strategy that makes sense for me.  He is obligated under the law to know my situation and make recommendations that are in my best interests. 

A broker is neither required to understand my financial situation nor act in my best interests.

Complicating Things

Now here’s where it gets complicated. 

Some investment advisers think they’re salesmen.  Rather than act in their clients’ best interests, they try to sell expensive, fee-laden mutual funds to their clients. 

Why would they do that?  Because the mutual fund compensates them with a kickback.  The higher the fee paid by the client, the higher the kickback.

This is not in the best interests of clients because you can stack the research a mile-high showing that fee-laden mutual funds tend to underperform the market.  But it’s standard fare for many brokers and investment advisers.

So how can you protect yourself? 

Don’t listen to brokers.  Their interests are not aligned with yours.

Use a “fee-only investment adviser.”  A fee-only investment adviser does not receive kickbacks from mutual funds or insurance companies.  His advice should be independent and not tainted by his own interests.

I love reading The Mole’s column on CNN Money.  Everybody’s got a gimmick, as they say, and his is an undercover financial planner giving his readers a behind-the-scenes look at the financial planning industry. 

His latest column describes a recent meeting of financial planners trying to figure out how to handle the recent market volatility.  The Mole writes:

I heard much discussion among planners about the “unusual behavior” of today’s market and what to do during “uncertain times.” In reality, what’s going on now is pretty common; the recent five-year run of steady gains was the unusual time.

Despite Standard & Poor’s recent report about a 70-year high in market volatility, my understanding is that the last five years of steady gains are more out of the norm than the recent market volatility. 

He continues:

From this meeting it was clear to me that some financial advisers chase performance just as much as individual investors do. They load you up on stocks or funds that are doing well and tell you to sell when the tables start to turn. Often these planners are simply following your emotionally driven pleas.

But a financial planner should rein in your emotions, not react to them, and help you stay the course in both up and down markets.

Well said.

Walter Updegrave Defends an Adviser

Walter Updegrave writes “Ask the Expert” at CNN Money.  A reader asked whether he should stick with an adviser that didn’t pull his money out in October 2007 before the market started dropping.  Updegrave responds:

First, let me say that it’s not at all clear to me that your adviser has done anything wrong. Frankly, I’m more suspicious when advisers are eager to dump existing investments and buy into new ones. After all, making more buy and sell recommendations is usually in the adviser’s financial interest, since more moves can generate more commissions, or at least make it appear that the adviser is on top of the situation.

So the fact that your adviser didn’t play yes-man to your urge to move into more conservative investments doesn’t automatically suggest to me that he’s incompetent or lazy. Quite the opposite. As long as you were going into 2008 with a reasonably diversified portfolio that made sense given your particular situation, then it seems reasonable to me that he would want to caution you against making any big moves.

Well said.  And he took some heat in his comments for saying it.

Don’t Use an Adviser that Churns Your Account

The following is a topic for another day but it’s worth a brief mention.   Updegrave mentions that some advisers make trades in their clients’ accounts to generate more commissions and earn more money.  It’s called “churning” and it’s a dishonest tactic that some advisers and brokers use to enrich themselves at the expense of their clients. 

If your adviser churns in your account, even once, it’s time to find a new adviser.  Preferably a fee-only adviser that doesn’t have any incentive to churn your account.