Entrusting someone with your financial well-being is a difficult task. Like many service providers, financial advisors come in all shapes and sizes. This article discusses the potential conflicts that can arise with an investment / financial advisor and how to avoid them.
The following is a guest post by Stephan Shipe at Bullincaptivity.com. Dr. Shipe holds a Ph.D. in Finance and focuses his academic research on compensation contracts and agency relationships. Aside from publishing academic articles, he uses his blog to break down common financial problems and game plans for those seeking financial independence.
Entrusting someone with your financial well-being is a difficult task. If you have decided that you would like to outsource some or all of your financial decisions, then you will likely be searching for a financial advisor.
Like many service providers, financial advisors come in all shapes and sizes. There are a plethora of fee structures and so many certifications and acronyms that will make your head spin. Unfortunately, navigating this decision is difficult.
This article isn't going to debate whether financial advisors are necessary or what is the best financial credential. Instead, I want to discuss the potential conflicts that can arise with an investment advisor and how to avoid them.
Who writes the checks?
First, how you pay your advisor is very important. Your goal is to align your interests with your advisor. To do this, the compensation arrangement should make it easy for the advisor to make decisions with only your well-being in mind. If an advisor is paid on commission, then you will likely not ever have to write him a check. Sounds great right?
The reality here is that someone else is writing the check to your advisor in return for selling their product. In a commission arrangement, it is possible that your advisor may choose to invest your money in a product or fund that has a high payout for him, even though it is not the best choice for your financial future. While this is not always the case, it is better to avoid the possibility of this conflict by avoiding commission-based advisors.
Fee-only advisors are the best choice for financial advice. These advisors will either take a fee based on the size of your investments or charge a flat fee regardless of investment size. The latter offers less potential for conflict because there is no incentive for the advisor to do anything but give you personalized financial advice.
Education matters
Before entering into an advisory relationship, check that your advisor is qualified to manage your finances. You wouldn't go to someone for medical advice that didn't have an education in medicine, so why would you ask for financial advice from a philosophy major? This statement is a tad facetious but holds a lot of truth. I see "investment advisors" all the time that have no background in finance. They come out of school, take one test, get a job at a financial firm selling insurance, and now they are giving advice on decisions that will affect the client for the rest of their lives. Scary.
A financial advisor doesn't have to have a degree in finance, but there should be some education to replace this degree. Maybe they have worked in finance or have studied on their own to earn a financial reputation through writing, credentials, or research. There are many possibilities, but making sure the advisor has the experience or education necessary to handle your finances is key to a successful relationship.
Ask Questions
There should never be a time when you are confused by the words or actions of your financial advisor. If you have concerns, you should voice them and ask for an explanation. A good advisor will be able to explain to you what is going on with your portfolio and why he recommends one option over another.
Many conflicts arise when an advisor does not clearly disclose important information. Here is a list of some of the information you should have and understand when working with an advisor:
- The compensation agreement and which account the payment comes from
- Can your advisor access or make trades in your account?
- The timing of statements to track performance
- Frequency of meetings
- The ability and details to contact your advisor directly
- The goals your advisor has for your portfolio
Signing the agreement
A financial advisor can provide many benefits to their clients. From making financial decisions to calming nerves during market swings, an advisor should be there for their client for every bump on the road to retirement. Avoiding potential conflicts of interest in an advisory relationship will help ensure that you as a client can trust the decisions that your advisor makes.
Conclusions
Don't be fooled by fast talking representatives, one size fits all investment policies or a fancy office. Do your research and understand the relationship you are about to enter with an advisor. With all information clear for both parties, you will be well on your way to reaping the benefits of a financial advisor and not wishing you had done so as someone whittles away at your nest egg.
https://www.flickr.com/photos/davedugdale/5099605109/in/
