Inside the mind of an adviser
When you sit down Before you take your financial pro's advice, consider what's behind it. From Money Magazine's George Mannes
NEW YORK (Money Magazine) -- When you seek out the guidance of a financial professional, it's for something big, something you feel you can't handle yourself.
You're leaving your job and want to know what to do with your 401(k) plan. You've saved a tidy sum and now fear that your investments are poised to go down the tubes. Or you've just had your first child and already you're worried that you won't have enough money to send her to Yale.
Your options, as you seek help, are plentiful. More than 380,000 professionals in the U.S. make a living by giving people financial advice, according to Tiburon Strategic Advisors, a financial services consulting firm.
That mass of people - who go by a variety of not-always-illuminating titles like financial consultant, wealth manager or investment adviser representative - includes professionals with a wide range of employers, expertise and ways of earning a living.
You could hire an adviser who solely picks investments or one who guides you through every aspect of your financial life. You could find one at a brokerage, bank or two-room office. You could pay a fee on every penny you entrust to a pro or a commission on everything you buy. These are variables you can spot.
What's tougher to figure out is something that's not printed on a business card or fee schedule: the motives behind your planner's advice. An adviser, after all, isn't a robot. Just like you, he has a mortgage to pay and children to send to college. His workplace, like yours, is filled with rewards and punishments. And nearly every financial decision he or she makes on your behalf can affect his or her finances too.
While your planner may vehemently deny it, the financial and psychological incentives built into the advice business sway the nature of the advice that's dispensed. Some of those influences - a hope that you'll be satisfied enough to refer friends, for instance - can work in your favor. But most incentives don't, even if your planner is a genuinely nice guy.
"I think the majority of advisers have clients' best interests at heart," says Bing Waldert, associate director of the financial services research firm Cerulli Associates. Maybe so, but that's a paradox you face as a financial client.
Your biggest challenge isn't to avoid crooks and incompetents (though both exist). It's to make sure you're getting the most from an adviser with good intentions - but with interests that may run counter to yours. The more you know about these motivations, the better you'll be able to ask tough questions and choose the best action for yourself, not for the planner.
Where Greed Is Good
When you're sitting across the desk from a financial professional, you should realize that there's a fundamental misalignment of interests. You're looking for sage advice. Chances are your adviser is looking to hit sales targets. However much your adviser's office strives to impress clients as a place of refinement and learning, behind the wood paneling it's a sales culture.
Every influence, from crass coercion to gung-ho competition, is designed to increase revenue. The organization can enforce its goals in brutal fashion. Consider the allegations in a class-action complaint filed in January against the insurance giant MetLife (Charts, Fortune 500) on behalf of clients.
According to the suit, the amount MetLife would pay in health insurance premiums for agents who worked for the company was tied to sales quotas for certain company-owned mutual funds - an arrangement that gave advisers a compelling reason to favor MetLife funds over those from other companies. (MetLife says it can't comment on pending litigation.)
Similarly, ex-employees say that Lincoln Financial Advisors and AXA Financial doled out health insurance and 401(k) matches to advisers via formulas that favored the sale of company products, the trade magazine InvestmentNews reported.
Lincoln Financial declined to comment; in a statement, the AXA Equitable insurance arm acknowledges that it requires "a measure of proprietary production" from advisers but adds that AXA doesn't forbid the sale of outside products and is committed to recommending only appropriate investments.
The sales culture isn't all threats. It's about the rewards too. In most workplaces, it's considered impolite to talk about what you make. In a brokerage firm or insurance agency, it's front and center.
Enter a room of brokers, says former broker Patrick Collins, and the conversation revolves around how much business they produce. With good reason: The more they sell, the more they get to keep of the revenue they generate. (At firms such as Morgan Stanley (Charts, Fortune 500), Smith Barney and UBS (Charts), top producers earn shares that are at least 50 percent bigger than what the lowest sellers make.)
Regular memos from his manager, says Collins, spotlighted the latest big marketing push - and rankings of top sellers. "You would see people really jump on trying to sell more," says Collins, now a certified financial planner in Towson, Md. "People want to see their name at No. 1."
At his own weekly sales meetings, says former broker James Kibler, someone would present a new investment for sale. "Almost every time," says Kibler, a certified financial planner in New York City, "the first question was, 'So how do we get paid?' Then everyone would laugh."
Advisers are driven by more than money, says Keith Singer, an insurance agent who now works as a wealth manager in Boca Raton, Fla. At meetings, he recalls, agents wore ribbons on their name tags honoring sales achievements.
When Singer was called onstage to be honored as a top first-year salesperson, "I felt amazing," he says. "Like a celebrity. Your identity is based on how successful you are selling company products."
After five years of working in operations and trading on Wall Street, Tim Maurer wanted to take his market knowledge and become a financial adviser. One interviewer rejected him, he says, because his financial expertise was no substitute for retail sales experience.
"He said I'd have been better off if I were selling copiers for the past five years," says Maurer, now a financial planner in Lutherville, Md.
Sins of Commission
As you know if you've ever bought a flat-screen TV or a time-share, commissions are the rule in sales professions. The advice business is no exception. But a commission adds up more when it's levied on an appreciating financial asset than when it concerns, say, a 46-inch TV.
Imagine putting $50,000 in a fund that grows 7 percent a year on average; a $2,500 commission will nick nearly $10,000 from the value in 20 years. Even though many planners and wealth managers charge fees instead of commissions today, if you have less than $100,000 to invest you may have few options but to work with an adviser who collects a cut on every fund or annuity he sells you.
At banks or insurance companies - two of the few outlets that welcome people with relatively small portfolios - commissions are still the norm. At banks, two-thirds of advisers make their money primarily by commission or through commissions and fees, according to Cerulli Associates; at insurance companies, it's more like 90 percent.
The only way a commissioned adviser can help you is by selling you something. When you walk into an adviser's office, she could be thinking less about your needs than about what products she has that can be shoehorned into meeting your needs.
Kent Grealish, an ex-broker who now works as an investment adviser in San Bruno, Calif., faced this problem when he was urging clients not to buy tech stocks during the dotcom bubble.
It was, he says, a "perverse" compensation system: "Sometimes by giving the right advice - don't buy- you didn't get paid," he says, "while you could be rewarded handsomely for giving bad advice."
Once you've bought an investment, your commission-generating potential has by no means been exhausted. Manhattan Beach, Calif. certified financial planner Eileen Freiburger recalls that on one of her first days as a bank branch manager a decade ago, an employee proudly showed her a thick file of customers whose annuities, he said, were "coming due."
Problem is, annuities don't "come due"; these were annuities that soon could be surrendered without penalty, making it easier to switch these customers unnecessarily into new annuities and earn a new round of fat commissions.
"I recall he ended with a 'cha-ching' and a wink," says Freiburger. When an adviser wants to swap out an old investment for a new one, press hard for a good reason why.
The Sum of All Fees
As long as you're wealthy enough, it's easy to avoid paying commissions altogether. Driven partly by customer suspicions that advice is all about generating sales - and partly by Wall Street's desire to have more predictable fee income - the industry is moving away from commissions to fee-based advice.
Under this system, you might pay your adviser an annual fee that's calculated as a percentage of the value of your assets he oversees - ranging generally from 0.5 percent, if you've got millions, to 2 percent. (That same broker might also collect some of what you pay in mutual fund expenses, so ask.)
Alternatively, you could pay an hourly rate for your adviser's time ($150 to $250) or a flat amount for a plan (say $2,000).
Does this ensure you'll get advice that's free of bias?
No, you'll just encounter a different bias. Certainly a fee-based adviser has less incentive to urge you to buy and sell, though he may suggest portfolio shifts merely to show he's doing something for his annual 2 percent fee.
More important, an assets-under-management fee gives an adviser cause to discourage you from withdrawing any of your money, even if you'd be better off doing so.
When you cash out $500,000 in stocks to buy a house, your adviser feels the loss. And management fees give him all the more reason to suggest ways for you to bring him more money - from swapping perfectly good bank CDs for bond funds to pulling equity from your home to invest.
The Best Fund (I Can Sell)
When you walk into a Ford (Charts, Fortune 500) dealership looking for a minivan, the salesman isn't going to recommend a Toyota (Charts). The same is true for the many brokers and advisers who sell only from a limited menu.
The difference? At an auto dealer you have no illusion that the guy will steer you to anything off the showroom floor. But when you're working with an adviser, you may harbor the fantasy - one that he and his company's advertising may encourage - that what he's offering are the best choices from a wide variety of companies.
At its most basic, that means that brokers paid on commission won't suggest no-load funds. Don't be surprised if, when you're investing for your child's college education, a commission-earning adviser recommends not the no-load funds offered by your state but a broker sold plan that pays her $5.75 for each hundred dollars you deposit.
A sales push from advisers is why, for example, Maine's broker-sold 529 college savings option has more than $4 billion in assets, 10 times the amount in Maine's direct-to-customer one, which is also managed by Merrill Lynch (Charts, Fortune 500) but has annual expenses that are 50 percent lower.
Suggesting that you open a 529 is good advice; just don't be led into overpaying for one. Even if your adviser can offer you thousands of funds - many onetime no-load firms now have adviser-sold options - another consideration may be swirling through his mind: Some investments are far more lucrative to sell.
The most glaring disparity occurs when an adviser offers annuities as well as funds. With mutual funds, he earns just a portion of the load you pay, which usually tops out at 5.75 percent. First-year commissions on variable annuities run as high as 9 percent, says Mary Rae Fouts, a life insurance analyst in Walnut Creek, Calif.; those for equity index annuities can be 18 percent.
If your adviser is paid more to sell a house brand over an outside fund, you'll be hard-pressed to spot that, because the commission you pay may be the same. What's different is what portion of that fee the broker collects. Uneven compensation is perfectly legal, and in this case your adviser doesn't have to mention it. (The Securities and Exchange Commission says that rules mandating disclosure of the practice are pending.)
Don't just ask what you're paying. Ask what your adviser is making off you. While an adviser or agent may give you the impression that he's not wedded to his company's products, his training may be telling him otherwise.
Keith Singer remembers that when he was a rookie insurance agent, he asked a sales trainer during one meeting how to go about selling outside products. "He looked at me like I were a ghost," says Singer. "He wouldn't answer it. He was nervous even broaching the subject."
When he studied to be an insurance agent, Lutherville, Md. planner Tim Maurer learned sales techniques useful for steering a client into a profitable whole life policy while showing it alongside a less expensive term policy that might have been more suitable.
"You're trained to present situations to customers as though they're the ones making the decision," he says. "But the whole point was to nudge them to do exactly what you wanted them to do."
Your adviser, steeped in the home-team culture of his company, may believe that these limited choices are fine, just as your Ford dealer may be sure that he has the best cars.
"It's very easy to get caught up in the thinking that this is as good as I can do," says former broker Kibler. "Because a lot of smart people are doing this, it must be in the best interests of my client."