My Own “Jiminy Cricket”

Brett Horowitz

Brett Horowitz, CFP®, AIF® Principal, Wealth Manager

Whether you are working with a doctor, lawyer, or financial professional, you need to be aware of who is watching over you. It’s not enough to simply assume that they are on your side. When someone gives us recommendations, we want them to be like the Jiminy Cricket character in Pinocchio—a trustworthy person who is looking out for us and helping us make good decisions. Let’s look at an example to help frame this discussion.

You go to the doctor’s office complaining of muscle pain, and the doctor offers you a choice of medications. He hands you Medicine A and you walk out the door, feeling comfortable that he gave you the right medication that will make you feel better in no time. Why are you so at ease with the doctor’s recommendations? The short answer is that you trust the doctor. You believe that they will follow the Hippocratic Oath, which says in summary “above all, do no harm.” You have come to expect that they are providing you with advice that is in your, the patient’s, best interest. What if I told you that the financial profession doesn’t work that way? Surprised? Confused? If you’re like most Americans, you’re not alone.

According to a recent study by the RAND Corporation, commissioned by the SEC, most Americans have trouble distinguishing between advisors and brokers. As the study’s authors note, “Our analysis confirmed findings from previous studies and from our interviews with stakeholders: Investors had difficulty distinguishing among industry professionals and perceiving the web of relationships among service providers.” When a financial professional can have dozens of different titles, ranging from investment advisor to wealth manager to financial planner, it’s not hard to see why consumers are confused. One of the major differences comes down to a popular buzzword in the industry that every investor should understand: the term FIDUCIARY.

What is a fiduciary?

Quite frankly, one of the first questions you should ask your investment professional is this: Are you a fiduciary and do you acknowledge this in writing? (If you’re already working with someone and are unsure of their status, it’s a good idea to call them up and ask them.) A financial advisor held to a fiduciary standard occupies a position of special trust and confidence when working with a client. As a fiduciary, the financial advisor is required to act with undivided loyalty to the client. This includes disclosure of how the financial advisor is to be compensated, elimination of any significant conflicts of interest to the extent possible, and full disclosure of any remaining significant conflicts of interest. In other words, the financial advisor must place their client’s interests first.

Our website specifically states, “As a fee-only financial advisor, our revenues derive solely from fees paid directly to us by our clients. We have no potential conflicts associated with commissions or proprietary products.”

Our firm charges fees based on the amount of money that we are managing for our clients (i.e., assets under management). If you are a client of our firm and are interested in paying off a mortgage to free yourself of the debt, we acknowledge the potential conflict of interest that exists in you withdrawing money from the portfolio and the resulting drop in our fees, but we will help you make the right decision. In fact, over the last few years, we have helped many clients pay off their mortgage. It’s with this peace of mind that they can sleep comfortably knowing that we are on their side.

Let’s say that you just found yourself the recipient of an inheritance or a large bonus check and are thinking about possibly investing it in your portfolio. Without this fiduciary relationship, the answer would be simple: invest everything, because the more you invest, the more fees the firm will reap. But that’s not how we answer the question. We would want to know whether you expect to make any significant withdrawals from the portfolio during the next five years. We do not believe any investor should invest money in the market if they expect to need it back within the next five years. If you’re likely to need funds annually to supplement other outside income, we would make sure that you have enough cash set aside in case the markets go down so that you don’t have to sell anything in the next year and you know exactly where your grocery money will come from. Once again, the decision is not how to maximize our short-term profits; instead we are looking to make smart decisions that will benefit our clients.

On the other hand, brokers and other commission-based advisors are held to a “suitability” standard, which states that they must recommend a product that is suitable for the client, but that may not necessarily be the best recommendation for that person. For example, you’ve probably seen situations where a representative from XYZ Company recommends buying the XYZ Bond Fund, the XYZ Large Cap Growth Fund, and the XYZ International Fund. Is it really likely that XYZ Company could have the best mutual fund in every category?

Fees, fees everywhere

Some firms charge an annual rate, some charge based on assets under management, and some build the fees into the stock and bond transactions. None of these are inherently unfair as long as you know exactly how the advisor is getting paid, whether the fees are reasonable, and what their duty is to you (i.e., business standard or fiduciary). There may also be additional fees—such as mutual fund expenses, transaction fees, account opening or closing fees, and such—so it’s important to know how much those fees are and who receives those fees. At our firm, we use no-load mutual funds and exchange-traded funds. As there are no commissions involved, these investments have relatively low expense ratios, and fees are paid directly to the fund companies. There are small transaction fees as well, and these fees are paid directly to the custodian. We are paid only by our clients, who receive a bill each quarter with the calculation and amount of those fees. Performance is calculated net of fees where possible so that it’s in our best interest and the client’s best interest to limit all fees as much as possible.

You should always be aware of conflicts of interest as they pertain to fees. Will buying the mutual fund, annuity, or life insurance contract primarily benefit you or the person selling the product? The type of legalese you might look for is something to the effect of “Your account is a brokerage account and not an advisory account. Our interest may not be the same as yours … We are paid both by you and, sometimes, by people who compensate us based on what you buy. Therefore, our profits, and our salespersons’ compensation, may vary by product and over time.” (Italics are my emphasis.)

For example, a representative at the XYZ firm may recommend a high-yielding bond to their client. What the client doesn’t know is that the firm is trying desperately to sell the bond to everyone it can so that it doesn’t have to keep the bond on its books due to expected losses (I have taken this example from the book Liar’s Poker by Michael Lewis, a nonfiction book describing his experience as a bond salesman in the 1980s). Who is the best prospect to sell the bond to? Their client, of course. They can do this because as long as the client asked for income in their portfolio, this investment would be suitable.

None of this by itself implies that there is anything wrong with compensation by way of commission. The bottom line is that you, as the client, need to understand how the advisor is getting paid, whether they are being held to a fiduciary or suitability standard, and whether these details are in writing. If in doubt, simply ask your advisor if they will sign a statement similar to the following:

  • In our relationship I will always place your interest first.
  • I will act with prudence; that is, with the skill, care, diligence, and good judgment of a professional.
  • I will not mislead and will provide you with conspicuous, full, and fair disclosures of all important facts.
  • I will avoid conflicts of interest.
  • I will fully disclose and fairly manage, in your favor, any unavoidable conflicts.

It’s time that we break down the confusion surrounding investment professionals so that the public understands who their Jiminy Cricket is.

Feel free to contact Brett Horowitz with any questions by phone 305.448.8882 ext. 216 or email: BHorowitz@Evensky.com

For more information on financial planning visit our website at www.Evensky.com