Incentives really matter.
On the Liberty Wealth website I use the term ‘fee-only fiduciary financial advisor’. A few people have asked me what it means. It’s a defining feature of Liberty Wealth and it’s worth explaining in the wider context of how advisors get paid, which itself is critical to understand.
A ‘fee-only’ advisor is one that does not generate any commissions from selling anything to you, or from trading on your behalf. The only compensation they receive is directly from you as the client for the services that they provide. A ‘fiduciary’ advisor is one that is always acting in your best interests, and therefore puts your interests ahead of their own. Fee-only advisors almost always act as fiduciaries because they have removed the huge conflict of interest that exists when commission payments come into the picture.
I want to explain the importance of that paragraph by taking a 20,000 ft view.
I have written before about how disillusioned I find myself by my industry. Read this article to see very recent instances of both JP Morgan and Wells Fargo ripping their customers off. They are not alone. It’s amazing that in 2018 this kind of thing can still be going on anywhere, but particularly at massive companies.
It’s still happening today because of the way in which advisors are incentivised.
If you meet with a financial advisor, a financial planner, wealth manager, investment manager (or anyone with the word ‘financial’, ‘wealth’ or ‘investment’ in their title) you might assume that this person has your best interests at heart, and that they are required to have your best interests at heart. It seems a reasonable assumption after all.
It is probably the wrong assumption.
In most parts of the world, an advisor follows one of two rules. The first is the suitability rule, and the second is the fiduciary rule. If you are looking for financial advice then the difference is critical to understand.
When an advisor acts under the suitability rule whatever they recommend, or sell to you has to be suitable for you. However, it does not have to be in your best interests. It can just as easily be in the advisor’s best interests (i.e. an advisor is allowed to pick from a range of options the option that pays them the most even though something else might be better for you). I know I know…
If an advisor is acting under the fiduciary rule whatever they recommend to you has to be in your best interests. Full stop/period.
Think about that for a moment.
We are starting to see a shift from the suitability rule to the fiduciary rule in some countries. But it’s slow.
Another way to think about this is to be clear on the distinction between sales and advice. An advisor that generates commissions is selling something (and may also be giving advice). A fee-only fiduciary is only giving advice.
Sales are not bad per se, so long as you, the client, understands that it is sales and you are not expecting unbiased advice. The problem lies in the fact that the advisor is incentivised to sell in the first place, and in the fact that they are not required to ensure that what they sell you is in your best interests.
If you want to read more about incentives and how wrong they can go, read this fantastic article by Josh Brown. The title ‘show me the incentives and I will show you the outcome’ is a Charlie Munger (Warren Buffett’s long-term partner) quote.
The key thing for you, as a consumer, is to be aware of how your advisor is incentivised and to understand the rule under which they are operating. Only then can you, the client, make a decision that you feel confident is in your best interests. According to J.D. Power and Associates, 85% of investors don’t understand the difference between the suitability standard and the fiduciary standard, and therefore don’t understand the basis of the advice they are being given.
Jason Zweig (columnist at the WSJ) has a great list of questions for any financial advisor that gets to the heart of this. I have a link to this article on the Liberty Wealth website (under FAQS) and I am happy to answer every single one of those questions.
And finally, if I haven’t confused you enough, the fact that Edward Jones (a company with 14,000 advisors) has a FORTY-EIGHT page document titled ‘Understanding How We are Compensated for Financial Services’ says it all.