What if your doctor didn’t get paid for their advice or treatment they gave their patients? What if seeing your doctor was “free”? Sounds good, right? We all love free! The problem is nothing is free— someone pays the bill. Facebook, for instance, is not free. Your personal information is paying the bill, despite what Mark Zuckerberg says. You just don’t see the bill. When the methods of payment are not transparent and the public isn’t served with their best interests in mind, people can get hurt.
Suppose the doctor mentioned above was paid by the drug companies? If no drugs were prescribed, they did not get paid for an office visit. What would the outcome be? You guessed it! Most, if not all patients, would be prescribed a drug. And what if the doctor got paid more for some drugs than others? What would the outcome be? You guessed it again! The drugs that paid the highest commission would be prescribed more often. You can call the payment what you will—a commission, revenue sharing, incentive, or a bonus. The bottom line is, it is a conflict of interest that harms the patient.
Even the best person can be tempted by bad incentives. Many times, the good professional has no choice. If the hospital makes money from prescribing drugs, they will make the doctor prescribe the drugs. The doctor will have no choice but to “make their numbers”. Much like those that cheated in the college admission scandal, doctors feel they have to be ethically and morally flexible because of the environment around them.
How your financial planner is compensated dictates what they recommend to you. Some advisors work under a standard that requires only that their recommendations be suitable to your particular situation, which really means almost anything goes. Other planners work under a fiduciary standard that requires advisors to consider what is in their client’s best interest. Some businesses have structured compensation or ownership models allowing them to be legal fiduciaries, but not real fiduciaries in practice. Some discount brokerage firms and larger RIAs are a good example of this.
There are three basic ways in which financial advisors are compensated:
· Through a commission-based model
· Through a commission & fee model (dual-registered)
· Through a Fee-Only & Fee-Based model
The goal of being a Fee-Only, and to a lesser degree a Fee-Based advisor, is to eliminate any conflicts of interest. It also fosters an environment in which the educated and experienced professional is unshackled by bad incentives.
Other than commissions, there are other possible conflicts of interest in the financial planning and investment management world:
- Revenue sharing (most often from mutual fund families)
- Incentives or bonuses tied to product sales and/or priority products or services
- Any proprietary product or service (most often discount brokerage houses)
- Product or service from a company that owns the company giving the “advice” – a referral. A holding company that owns an RIA and an insurance brokerage is a great example. They may be legal fiduciaries, but they are not “real” fiduciaries.
The bottom line is, unless the client is paying the advisor solely for advice, the recommendations given may not be in the interest of the client.
Fee-Only means to pay for advice, and that is it. You pay the advisor on an hourly basis, or through a retainer or project. The advisor has no other competing interests. No one telling them to sell this mutual fund, or that insurance product. They will give advice on assets regardless of where the assets are held. Their only incentive is to help you, the client.
This is a close second! Fee-based is most of a fee based on the percentage of assets under management, or AUM. The fee can range from 0.25% for a robo-advisor to 2% for some of your more expensive RIAs (Registered Investment Advisors). The advisor in this case has an incentive to advise the client to move assets to the advisor’s custodian. They may also be tempted to advise against a client paying down debt, since they do not get paid when the advisor does not hold the assets. There is an advantage the fee-based advisor has over the fee-only advisor: if the client does well, the advisor does well. When the client’s account goes up in value, or goes down less, the advisor will benefit. It is said that the advisor and client are “on the same side of the table”. For most financial firms, they are not. The insurance company does well regardless of how the client does. They already got their commission.
Before you get advice from any professional, make sure you know all the factors influencing that advice. Your physical and financial health of you and your family is essential!