Yes, it can matter significantly how a financial advisor is paid.
The heart of the compensation issue is an advisor’s potential “conflict of interest” with respect to payments from third parties. Does third party compensation change the quality of the recommendations that the advisers make? If an advisor works on sales commissions or accepts other third party payments, will he still provide the best recommendations based solely on the client’s best interests?
The Skilled Investor believes that the great majority of advisors are ethical. They work to manage properly the conflicts of interest associated with third party compensation that most advisors receive. Many objective, competent, and ethical practitioners are doing excellent jobs for their clients – no matter what their source of compensation.
Fee-only advisors, receive compensation directly and solely from their clients. Other advisors receive compensation from third parties. Some may receive both. When choosing an advisor, individuals should first decide the type of advisor compensation that makes them most comfortable. (For information on the different types of advisor compensation, see: Financial planner and investment advisor compensation paid by clients and Financial planner and investment advisor compensation paid by third parties)
However, the problem for individual investors is not the ethical majority of practitioners. The problem is the ethically challenged minority.
The heart of the conflict of interest issue is whether a client can tell the difference between an ethical practitioner who “just happens to be paid by third parties” versus an unethical advisor to whom the client’s interests are secondary.
As you might expect, substantial controversy exists within the advisory industry about which forms of advisor payment are better for the client. Fee-only advisors argue that they have absolutely no conflict of interest in their obligation toward their clients. Assuming that a fee-only advisor is competent and diligent, a client can reasonably expect that the advisor’s recommendations will be objective and in the client’s best interests. Fee-only advisors say that commissioned advisors are just disguised salespersons.
Advisors who accept various forms of third party compensation insist that they can be objective. They also contend that they still can and do offer the best products to their clients.
Some commissioned advisors suggest that they are more motivated to meet clients’ needs. They say that their advice costs nothing, unless the client acts on a recommendation. Commissioned advisors may say that fee-only advisors are too disinterested, because they are paid whether or not a client acts upon their advice. They also argue that a client will still have to pay a transaction charge, if he were to go elsewhere to make the recommended purchase. Note that the size of the transaction charge is the crux of the issue, as well as the ongoing charges. See: Excessive investment costs are a huge problem for individual investors
Note also that conflict of interest relates only to suboptimal advisor recommendations and to associated actions that confuse fiduciary priorities. Clients will still receive legitimate financial products for their money. These products just might not be the best or the most cost effective product available.
More severe ethical shortcomings involve outright fraud. Such actions are not the subject of this article. For more information on protecting oneself from advisor fraud, see:
Also, see these related articles on advisor compensation:
Tags: investment advisor
Personal Financial Planning
- Fund Authority Scores for Stock ETFs and Mutual Funds – Fund maturity and operating efficiency (
Fund Authority Scores rate mutual funds and ETFs on the most important economic factors affecting long term diversified stock or equity investment fund performance. This article explains the investment fund maturity and operating efficiency factors.
<<-- Go to Part 2
Parts 1 and 2 of this article discussed the first three, most heavily weighted factors used in [...])
- Stay Invested in Securities Markets to Earn Risk Premiums (You must stay invested in the securities markets to earn market return risk premiums
Securities markets pay risk premiums to risk takers
You have to have your money invested and at risk to be paid a risk premium. Attempting to avoid risk or losses by jumping in and out to "time the markets" does not work. Scientific [...])
- Commodity Futures in Your Investment Portfolio (Commodity futures in your investment portfolio - Is there really any future for individual investors?
The Skilled Investor's previous article, "Be wary of the new investment asset classes," voiced skepticism about many supposedly new asset classes. This article delves into the financial science behind this skepticism, as it relates to one of these supposedly new asset [...])
- Using Google Scholar to Find Financial Articles (
Using Google Scholar to Find Finance Articles
If you want to do some research about financial planning and investing by yourself, try using Google Scholar.
Be prepared for a lot of the material you find to be esoteric. Nevertheless, Google Scholar is littered with diamonds that can improve your understanding of personal finance and save you money.
- Vanguard Total Stock Market Index Fund (VTSMX) achieves a +9 Fund Authority Score (
The diversified investment fund strategy of the Vanguard Total Stock Market Index Fund
According to the Vanguard website, the investment strategy of the Vanguard Total Stock Market Index mutual fund is to use a "passive management—or indexing—investment approach designed to track the performance of the MSCI® US Broad Market Index, which represents 99.5% or more of [...])
- Factors Favoring Roth IRA and Roth 401k Plan Contributions (Factors that tend to favor Roth IRA and Roth 401k tax-advantaged plan contributions
In a recent article, "Traditional versus Roth tax-advantaged plan contributions," The Skilled Investor discussed why the average taxpayer would tend to benefit more by contributing to traditional rather than to tax-advantaged Roth IRA and Roth 401(k) retirement plans. This follow-up article in two-parts [...])
- Roth IRA Contributions Versus Traditional IRA Contributions for Renters (Introduction: Roth IRA Contributions versus Traditional IRA Contributions for Renters
In a series of articles, The Skilled Investor compares different lifetime financial planning projections for Fran and Fred Frugal to illustrate the relative value of adopting different financial planning strategies. Fran and Fred, both ages 30, are a married working couple with $100,000 in combined annual [...])
- Assess your personal investment return and risk preferences – Step 3 of 10 Financial Planning Steps in the Right Direction (CLICK HERE TO READ THE SKILLED INVESTOR's OTHER ARTICLES ABOUT THESE "10 FINANCIAL PLANNING STEPS IN THE RIGHT DIRECTION."
Investors with different levels of risk tolerance are more satisfied with investment strategies that are better aligned with their risk preferences.
Differences in investors' personal risk tolerances mean that more risk-averse investors are personally more satisfied with a [...])
- Lifetime Investment Assets of Renters with Reduced Investment Costs (Lifetime investment assets of renters through investment cost improvements
Improving on Fran and Fred's lifetime financial plan through lower investment costs
Fran and Fred Frugal, both age 30, are a married working couple with $100,000 in combined annual earned income. They want to understand how valuable different personal finance strategies could be to their lifetime finances and [...])
- Part 3 of the Never-Do List – What Not to Do with a Financial Advisor (
Part 3 of the The Never-Do List - 22 Good Ways to Avoid Financial Advisor and Investment Counselor Frauds and Scams
This article discusses things that you should "never do" with a financial planner or investment advisor, and it covers unsolicited advice, sales pressure, and account decision-making discretion.
You should never do certain things with a financial [...])
- Financial Industry Product Development and Your Best Interests (
Financial research drives industry product development, but not necessarily toward the best interests of individuals
Personal financial decisions seem to have become very complicated. To add to the confusion, the financial services industry develops an unending array of supposedly innovative new products. However, a large part of the complexity that individuals face results from the proliferation [...])
- Avoid Mutual Fund and ETF Sales Commissions and Fees (Avoid mutual funds and ETFs with sales commissions and marketing fees
Summary: There is no convincing evidence that sales loads and other sales fees charged to investors result in higher mutual fund and ETF performance.
In fact, the opposite has repeatedly been proven true with mutual funds, which have a long performance history to evaluate. Paying a [...])
- The Heavy Burden of Recurring Investment Expenses and Fees – Part 2 (
The heavy burden of recurring investment fees (Part 2 of 2)
< < -- Go to Part 1
By charging fees as a percent of your assets, the investment industry can make their recurring fees seem small – like they are “just a few” percent.
Furthermore, by charging fees against your assets the industry can still bill you [...])
- The most effective strategy to increase your mutual fund and ETF investment returns (
What is the most effective strategy you have to increase your long-term mutual fund and ETF investment returns?
Just reduce your investment fees to rock bottom and buy directly to eliminate all sales loads. This strategy is both simple and entirely within your control. You do not have to be smarter than all those other smart [...])
- How to Lie with Statistics – Investment Performance Charts (How to lie with statistics: Investment performance charts - A Tip from The Skilled Investor
Darrell Huff wrote a short and very informative book, "How to Lie with Statistics," which was first published in 1954 and was amusingly illustrated by Irving Geis. This book is still in print and remains very popular (Amazon book rank #2,040 [...])