As an investor, it is unlikely that you understand how the investment profession operates and why your financial adviser really cannot advise you.
This lack of understanding stems from the fact that it is in the interest of the people with power to keep you somewhat in the dark because then they can extract higher fees from you. Your government does not help you because the Securities and Exchange Commission, charged with the responsibility for transparency, does a poor job and is inclined to go along with the powers of the investment industry. In fact, did you know that a large segment of the investment industry, the brokerage firms, are permitted to regulate themselves?
So be clear that no one is looking out for your interest as you do.
First, understand that any financial adviser is selling you something. In the case of registered representatives (commonly known as commissioned stock brokers), they are selling you stocks or bonds or mutual funds or some other product for commission. In the case of a registered investment adviser (RIA), they are selling you their service which is typically the management service of stocks bonds and mutual funds. In neither situation will the advisor ever recommend that you put your money into products or services that they do not offer. So, you are not really dealing with a true advisor but some form of salesman.
As an example, you won't find a broker at Merrill Lynch or your registered investment advisor at ABC Capital ever recommend that you invest in private mortgages. Because these individuals don't deal in private mortgages, they cannot profit from such advice. Unless you are wealthy, say have a net worth of $10 million or more, can you afford to hire somebody for say $100,000 annually, who will give you completely independent advice. Such a professional sells no products, sells no services and solely acts to direct your investment funds where they will receive the highest risk-adjusted return. Since few consumers can afford such assistance, few consumers will ever get it. This is a warning to any investor who is not in the lofty levels of net worth–you must always take financial advice in the context of the advisor having something to sell you.
Some examples where you will get biased advice:
- The Merrill Lynch broker who recommends a Merrill Lynch mutual fund instead of a competing fund with better performance where he earns a lower commission.
- The registered investment adviser who knows that his risk-adjusted performance is not as good as another RIA, will of course not recommend the other RIA's services.
- The Allstate agent who will never recommend a State Farm policy even if the coverage is as good and the price is less.
- The life insurance agent who places most of his business with two companies because they send him on great annual vacations who never recommends other companies that are as financially sound and charge lower premiums
Government regulation meant to protect you may also hurt you. For example, it is not permitted for a registered investment adviser (RIA) to manage your money for percentage of profits unless you are an accredited investor. The government feels that this incentive would cause the RIA to be too aggressive with your money and therefore only allows wealthier individuals to have such performance-based accounts. Unless you are an accredited investor, no money manager is permitted to ask you for percentage of profits as their fee.
There are also structural constraints in the investment industry that prohibits straight-up advice. Most advisers will never tell their clients to get out of the market. They realize that should they do so, it will be difficult to get you back in. Since investment professionals only collect fees or commissions when your money is invested, there is a structural disincentive for them ever to tell you to get out. That is why when the market is falling, most every adviser will tell you "be patient." Income tax issues only add to the same problem as to sell a winning position creates a tax liability and therefore creates some incentive to hold longer than may be otherwise prudent.
In summary, this is not to say that people in the financial services industry are intentionally ripping you off, it is only to remind you as the investor, that it's likely no one is acting in your interest, unless you are wealthy and you pay them a sufficient amount to do so. Believed to have been coined in the year 1523, the warning of caveat emptor still applies.
Thanks for this article! Concise and well worded.