If you choose to work with an adviser to help you invest your money then the most important terms that you need to learn about are "fiduciary" and "fee-only". Do you even know if you are working with a fee-only fiduciary adviser? We constantly see commercials for large brokerage firms who imply that they are on your side. But are they really? Perhaps the single biggest mistake made by investors (who don't do it themselves) is to just assume that the financial professional that they get advice from is working in their own best client interests. Shockingly about 85% of investment professionals in the US are not fiduciaries, and most investors don't even know what a fiduciary is.
A fiduciary adviser has a legal duty to select investments for you that are in your best interests, whereas a non-fiduciary is legally allowed to select inferior and more expensive investments for you based on how much commission money he stands to earn from the transaction. In other words, with non-fiduciary advisers, conflict of interest is perfectly legal! In fact if they want to stay in business they must sell you those expensive, inferior commission-based products! They call themselves "advisers" but in reality they are nothing more than SALESMEN in search of excuses and ways to convince you to make another transaction so that they can get paid again. Legally these "advisers" work for the best interests of themselves or their company whether the investments they push on you are good choices for you or not. By default you can expect to be sold expensive actively managed mutual funds with either high expense ratios (fund management fees) or front end loads, or other inferior, illiquid, "alternative", riskier and vastly more expensive investments. This conflict of interest is perfectly evident when you compare "passively managed" mutual funds with "actively managed" mutual funds or when you compare annuities to better alternatives. You think that you're getting a bargain because your adviser doesn't directly charge you any fees, or perhaps because he sold you a "no-load" investment product that outwardly appears to be free of fees, when in reality you are indirectly being taken to the cleaners. Most investors are completely unaware that they are being fleeced. You may even become a victim of churning.
FACT: Three out of four U.S. investors mistakenly think that financial advisers at brokerage firms are required to put clients’ interests first. Source
Understand the difference between commissions and fees
Commissions = Money paid to a broker / adviser (agent or other salesman) by the company that offers securities or financial products (such as annuities and mutual funds) when the adviser manages to convince the client to invest in the security.
Fees = Compensation paid from client to adviser as consideration for services provided.
How much do broker / agents earn in commission money?
Index Annuities, Equity Index Annuities, etc: As much as 5% - 20% up front, plus a possible trailer commission of typically around 1/4% per year for as long as you hold the annuity or have the agent's name listed on your statements. The commission is likened to the surrender period.
Variable Annuities: About 7% - 10% up front, plus a possible trailer commission of typically around 1/4% per year for as long as you hold the annuity or have the agent's name listed on your statements. The commission is likened to the surrender period.
Life Settlement Investments: About 4% - 8%, but as much as 15%.
Non-Traded REITS: Usually over 10%
Limited Partnerships: Anywhere from 1% – 10%, followed by a 1 – 2% annual trailer commission.
Actively managed mutual funds: 2% - 4%.
Passively managed mutual funds AKA Exchange Traded Funds (ETF's): NO commission! Now you know why non-fiduciary (commission-based) advisers never recommend ETF's, even though ETF's are the lowest cost and superior choice, and even though ETF's should represent the vast majority if not all of your portfolio!
How much do fee-only fiduciary advisers earn in commissions?
Nothing! Legally a fee-only fiduciary adviser may only be compensated directly from you, and this cuts out conflict of interest.
Fee-only is the best choice
The best line of defense in weeding out conflict of interest is to seek out a "fee-ONLY" fiduciary adviser (rather than a "fee-BASED" fiduciary adviser) because "fee-only" means that legally they cannot earn compensation from any source other than you. Fee-only advisers legally may not earn compensation from transactions, which means at least legally these is no opportunity for conflict of interest resulting in you being sold inferior products like annuities, actively managed mutual funds and other oddball investment products.
A warning about fee-based fiduciary advisers
Call these guys "the loophole advisers" -- as in legal loophole. Fee-based means that they are paid by you and have a legal duty to work in your best interests, but they may also be allowed to earn commissions when they sell you investment products. This is a conflict of interest! You can never be certain if they are 100% on your side. Would you pay a fee to a car salesman? That's kind of what a fee-based adviser is.
It is shocking how often I encounter fee-based fiduciary advisers who cannot resist the urge to aggressively push annuities. The scary part is that it's probably not even illegal. These advisers simply go the extra mile to protect themselves by asking you "leading questions" (that will elicit a desired answer) such as "Is preservation of capital important to you?" They aren't searching for the best investments for you. They are merely looking to legally protect themselves when they sell you an annuity and one that has all of the bells and whistles such as riders and death benefits (that increase agent commissions).
The way to legally eliminate this conflict of interest is by working with a fee-only adviser, preferably on a one-time or one task basis!
Fiduciary laws are only a legal line of defence
Never lose sight of the fact that the fiduciary standard is only legal. Some bold advisers may flat out break the law, risking suspension, being barred from the industry, and even jail time. This firm boasted of having fiduciary registered investment advisers but as it turns out was running a Ponzi scheme. This underscores the importance of not just having a written contractual agreement, compensation disclosure documentation, etc but learning which investment products to avoid, what basic rules to follow and other lines of defense, most of which are discussed on this educational web site.
Nothing good is free
If you can't do-it-yourself then the bottom line is that the superior choice is a fee-only fiduciary adviser working on a one-time or one-task basis. Many people hesitate because these advisers may charge as much as $300 an hour or more. Trust me that you do NOT want to work with the free guys (commission-based advisers who sell you expensive products)! This is the most expensive free advice you will ever get! These free guys will cost you much much more in the end.
Click here to find a fee-only adviser in your area. Again be sure to first read on this site about how to avoid being taken advantage of.
Some question where is the potential conflict of interest with an on-going fee-only fiduciary "asset manager" who charges you perhaps monthly, quarterly or annually. If the adviser charges you based on the dollar value of your account then if you ask for advice on what to do with money that you are considering investing in things like real estate or metals then a NO recommendation might be due to conflict of interest. Asset managers are also always going to try to convince you that you need them to constantly manage your money (and bill you).
Brokers are legally allowed to choose just about any title for themselves such as "adviser", "financial planner", "financial adviser", "vice president", "investment consultant", "investment strategist", "wealth manager", "investment advisory services adviser" or any other title of their own choosing that gives the impression that they are trustworthy in selecting investments that are in your best interests. Never make the mistake of using a non-fiduciary to help you buy, sell or hold securities. Non-fiduciaries are nothing more than salesmen who are driven to make transactions!
A CFP (Certified Financial Planner) credential does not tell you whether an adviser has fiduciary duty when recommending financial products. In fact the CFP board will not say that all CFP's are fiduciaries. I encounter many CFP's who aggressively push products like annuities. That should tell you everything about that adviser's priorities because annuities (other than Vanguard) are commission-based products. CFP's sometimes get disciplined. When it comes to selecting investments, by default NO certification should ever be relied upon as a seal of trust unless they are representing you in the capacity of a fee-only fiduciary, and preferably on a one-time or one-task basis.
Also never seek personalized investment advice from other non-fiduciary "advisers" such as insurance agents or bank employees. If you choose to seek help with investing or financial planning then the first line of defense is always to be certain that you are at all times working under written contract with a fee-ONLY fiduciary on a ONE-time consultation or ONE-task basis. This legally eliminates the potential for the most common conflicts of interest.
The non-fiduciary "Suitability Standard" that supposedly protects you by law is nothing short of a joke!
Never lose sight of the fact that non-fiduciaries are nothing more than salesmen. Brokers and other non-fiduciaries love to falsely put you at ease by telling you that the law requires them to only sell investments that are "suitable" for the client. Sounds like you're safe and secure right? Wrong!!! Unfortunately this "suitability standard" is a joke and will not protect you from being sold more expensive and more inferior financial products! The suitability standard is the problem! Licensed brokers are legally allowed to select investments for their clients based on how much commission money they stand to earn or earn for their company. Accordingly expect your broker to sell you the very investments that you should be AVOIDING -- namely long term, illiquid investments with high fees, front end loads or back end loads, higher taxes, higher risk, etc. For example an actively managed mutual fund with no front-end load may seem like a sound investment until you compare the high fees with equivalent ETF's. If you insist on seeking financial advice from someone, then never let them broker the deal, process the paperwork, etc. That means only work with a fiduciary. After you pay for their advice, then you should process your investment transactions on your own via a deep discount brokerage firm. Discuss this with them up front.
Registered Investment Advisers VS Certified Financial Planners
Remember that certifications are not the most critical determinate in selecting an adviser (if you need help). The most important question is whether your adviser is a fee-ONLY fiduciary or not. They must accept fiduciary duty to you in writing (via a signed contract), and provide you with copies of both parts of a "Form ADV", and a written disclosure of exactly how he will / may be compensated for his services and list any potential conflicts of interest. Also avoid "asset managers". It doesn't do you any good if they are charging you on a percentage basis year after year. You want to hire them on a one-time or one-task basis.
The securities and exchange commission has this to say about the two certifications:
Q: What is the difference between an investment adviser and a financial planner?
A: Most financial planners are investment advisers, but not all investment advisers are financial planners. Some financial planners assess every aspect of your financial life—including saving, investments, insurance, taxes, retirement, and estate planning—and help you develop a detailed strategy or financial plan for meeting all your financial goals. Others call themselves financial planners, but they may only be able to recommend that you invest in a narrow range of products, and sometimes products that aren't securities.
STORY: There is a reason why in England it is now illegal for advisers to earn commissions off of the investment products they sell. Commissions = conflict of interest. Hopefully one day the United States will wake up and protect the fleecing of American investors that happens every day. Don't expect this to happen without a fight from insurance company lobbyists, full service brokerage firms and other special interests because they know full well that their entire business model (of fleecing investors) will suffer greatly if their advisers are not allowed to recommend inferior investment products that pay large commissions.
Pop quiz question:
From January 1, 2000 until January 1, 2013 the S&P 500 price return index only gained 1.73%. That's not 1.73% per year but 1.73% for that entire 13 year period! So how much did $100,000 (with 25% invested in an S&P 500 index fund and 75% in 10-year Treasury bonds) grow to by the end of 2012 if dividends and interest were reinvested, and a simple annual rebalancing strategy was implemented once per year to maintain the 75/25 ratio?
A) $110,316 --- B) $148,084 --- C) $176,459 --- D) $218,904
CLICK HERE for the answer
Many "advisers" prey on investors who are ignorant of how bonds protect against stock crashes
Have you given up on the stock market because you lost a lot of money during the so-called lost decade? It wasn't the stock market's fault that some investors lost their shirts from 2000 to 2009. It was their own fault for failing to diversify into bonds, and this wreaked havoc on their savings. CLICK HERE to read about how diversification into bonds has been protecting investors through times of depression and even the 1929 stock market crash. Unfortunately there are commission-based advisers out there who will gladly jump at the opportunity to sell you inferior, expensive and illiquid financial products like annuities and other alternative investments, most of which are "advertised" as being less risky than the open markets but in reality are not.
Some "advisers" prey on investors who are ignorant of what an adviser does
Are you looking for an adviser with a good "track record" who will help you beat the market averages or who will hopefully time the market by anticipating the next market decline and then pull your money to safety? This is not what an adviser should do! Avoid any adviser who boasts of having a track record of picking the best stocks or mutual funds, or has been helping his clients outperform market averages. They are selling snake oil. The efficient market hypothesis says that nobody should be able to “beat the market”. Anyone who really has been beating the market is simply taking on more risk, which could backfire at any time.
If you are really hell bent on going against the grain by attempting to beat the indexes that represent the asset allocation strategy that fits your appetite for risk then at least keep in mind that anyone can take on more risk by simply investing in more volatile indexes (example - a small cap growth index). Therefore paying someone to hopefully "beat the market" is a pointless waste of your money. Nobody can predict the next market crash and studies have shown that a strategy that attempts to time the market is a losing effort that over time doesn't work. Instead an adviser should have you remain constantly diversified while rebalancing from time to time, which anyone can do on their own (without an adviser). Rebalancing is not "timing the market".
Note that "timing the market" is not the same as implementing a long-term allocation strategy. For example most fiduciary advisers are recommending a shift out of long-term bonds and into short and medium term bonds due to the simple fact that interest rates are at historical lows, and long-term bonds are most at risk of interest rate increases.
Beware of oddball investment products
When non-fiduciary "advisers" try to get their clients to buy annuities, limited partnerships, life settlement investments, pooled funds, house funds, non-traded REITs, or other oddball investment "products" that have "guarantees", "front end loads", "entry fees", "early withdrawal penalties", "early exit fees", "redemption fees" or "surrender fees", they are foaming at the mouth over the giant commission that they will earn. Instead of pitching a mix of stock and bond based ETF's, they push investments that benefit THEMSELVES or their firm!
It's usually when investors say "I have given up on the stock market" that they get themselves into trouble through riskier, expensive, under performing alternative investments sold by commission hungry brokers, insurance agents, bank employees and other self-serving salesmen, none of whom legally work for you. You should know that over long time periods of 10 to 15 years it is stocks that have historically been the best performing asset class. The best, most successful and most promising companies and investments are liquid and publicly traded (as stocks or as stock or bond ETF's) all sold for less than $10 per trade through any deep discount brokerage. In this day and age there is NO NEED to invest your money in illiquid oddball investments that you can't touch for a number of years. With over 6,500 listings traded on the stock exchanges there is absolutely no reason why an investor would need to look elsewhere.
Regardless of whether you do it yourself or work with an adviser, the only investment checks you write should always be paid to the order of your deep discount brokerage firm (such as E Trade, Scot trade, TD Ameritrade)!
Critical line of defense: If an investment is not sold through your deep discount brokerage firm then don't touch it! Never ever ever hand your investment money over to anyone else! This way no adviser can access, control or steal your money. It follows that you should never hand investment money to any investment planning firm or individual, financial consultant, money manager, retirement planner, estate planner, investment strategist, registered representative, adviser, proprietary offering, trust, insurance company, etc.
If you can't invest in it by placing an order through your deep discount brokerage then by default you ought to consider it inferior, riskier than disclosed, a scam or a high commission based investment product that a broker, insurance agent or bank employee is trying to sell you. Buying securities online is incredibly simple and easy, and by default you can only buy publicly traded investments. Deep discount brokerage firms only provide trading services while you do all of your decision making and investing yourself. I happen to use E Trade, but others include AmeriTrade and Scot trade. Deep discount brokerages do allow you to purchase mutual funds of all flavors, but after doing your own due diligence, you will want to avoid "actively managed" mutual fund products in favor of "passively managed" funds which merely track indexes (also known as ETF's or index funds). "Passively managed" funds consistently outperform "actively managed" funds and have MUCH lower fees. Also beware that deep discount brokerages also allow you to purchase penny stocks, but after doing your own due diligence and reading this article on Pump & Dump hopefully you will know to avoid those as well. Instead stick with broad market index funds (ETF's).
Placing an order to buy an index fund is very easy through deep discount brokerages like E Trade, AmeriTrade, or Scott Trade. And whether you buy a thousand dollars worth of shares or a hundred thousand, it's still just a $10 trade! Compare that with whatever Mr. Broker is trying to sell you! (WARNING: Be sure not to confuse "deep discount brokerage firms" with "full service brokerage firms" which have non-fiduciary "advisers" who by default should be regarded as nothing more than salesmen).
Don't trust ANYONE not just with, but involved with large amounts of your money!
PONZI SCHEMES and other FRAUDULENT SCEMES
All too often investors let their guard down for various reasons, such as when they do business with a company or person who is a friend or referred by a friend or family, someone with high profile clientele, someone nice, charming, charismatic, professional, religious, a philanthropist, well credentialed, well certified, long established, well dressed, young or old, famous, articulate, an eloquent speaker, high profile with fancy brochures and a nice website, someone well connected, or even low key and meek. These attributes mean nothing! Con artists usually fit some or most of these profiles. They're the people you would least expect to rip you off, give bad advice or dis serve you in any way. Ponzi schemes are not rare. Only the highest profile ones get news coverage. In realty Ponzi schemes are constantly being uncovered, and the typical victim of fraud is often affluent and college educated. Also it is not uncommon for advisers to unwittingly solicit Ponzi schemes to their clients. Even the very best intentioned investment advisors and firms sometimes know nothing about the investments they pitch beyond what they’re told by promoters! What good does that do you? Money does not grow on trees and it shouldn't be treated so loosely, yet we constantly hear new stories about everyday people losing big chunks or all of their life savings to some sort of investment fraud, con-artist, Ponzi scheme, bad investment, etc because they broke the most simple, basic rules of investing, that all began when they started working with a non-fiduciary (violating rule #1). Had these people simply followed either rule #2 (the 5% rule) or rule #4 (avoid investments that are not publicly traded) then these investors wouldn't be in such financial ruin!
CONFLICT OF INTEREST
EXPENSIVE, RISKIER, UNDERPERFORMING INVESTMENT PRODUCTS THAT PAY MR. BROKER BIG COMMISSIONS: There's more than just Ponzi schemes that you need to look out for. Investors are usually completely unaware that they have been victimized by conflict of interest. Investors are dis served every day and usually it isn't even illegal. Understand that non-fiduciary advisers earn large back door commissions even when they don't directly charge you any fees at all. Simply having their name listed on certain investment statements as your "agent", "rep" or "broker" can entitle them to commissions and "trailer fee" commissions without you ever knowing it. How can you trust ANY adviser to give advice in YOUR best interest when they earn a hefty 5 to 14% commission when they convince you to buy that annuity, limited partnership, or other inferior, expensive investment that has an early withdrawal penalty, but earn nothing extra when touting ETF's? "Actively managed" (professionally managed) mutual funds typically pay Mr Broker a 2 - 3% commission, even though unman aged index fund ETF's consistently outperform the average professionally managed fund. Whenever you hear the words "front end load, "entry fee", "surrender fee", "exit fee", "redemption fee" or "early withdrawal penalty" attached to an investment, that's code for "your broker will earn a big sales commission if he can convince you to invest in it". Yet no investment adviser will ever explain to their client the many negative reasons why the securities they are pushing, such as actively managed mutual funds, annuities, are inferior investments because the commissions that they stand to earn are too irresistible. Typically these investment advisers push long term, non liquid investments on clients even though you should avoid putting your money in "prison". In fact SEC (Securities and Exchange Commission) laws actually allow brokers to select investments for their clients based on how much commission they get to earn for themselves as long as the investment is "suitable" for the investor. The problem is that the requirements for what is "suitable" is very low and hardly protects the public enough.
FROM BAD TO WORSE: CHURNING
Non-fiduciary advisers are always looking for justifications to call you to get you to buy new securities as often as possible because their income is dependent on making transactions. But at some point too much trading becomes illegal, even under the low "suitability standard". Churning occurs when a broker engages in excessive buying and selling of securities in a customer’s account chiefly to generate commissions that benefit the broker. Churning is against the law. What constitutes churning is a complex subject that an attorney should tackle, but one thing that can be said is that long-term investments like annuities and mutual funds are almost always not meant to be surrendered short-term.
Doing it yourself: Buy, hold and rebalance bond and stock ETF's
BUY EXCHANGE TRADED FUNDS (ETF's): Overshadowing all of the many pitfalls of investing is a little known fact that no non-fiduciary will ever tell you, and that is that the statistical evidence is clear that unman aged index funds (example: the Total Stock Market index) outperform actively managed mutual funds. As of 2014, Warren Buffet recommends that for long-term results the average investor put 90% of their money in the S & P 500 index and the other 10% in short-term government bonds. If you can't figure out how to do it yourself (it's very easy) or what is the right bond/stock allocation then hire a fee-only fiduciary adviser for a one-time or one-task consultation. Don't pay 1% to 2% per year to an "asset manager" to hold your hand and simply rebalance. Any 1st grader can rebalance a portfolio that becomes imbalanced.
There are super low cost ETF's for whatever your investment strategy may be, from aggressive or conservative. Investing in index ETF's is as easy as opening an account with a deep discount brokerage firm and then placing a "buy" order for less than $10 per trade. And you can can sell an ETF at any time for less than $10, and without the early withdrawal penalties that are typically associated with annuities, limited partnerships, "actively managed" mutual funds, non-traded REIT's, etc. And ETF are generally taxed at the lower, more reasonable "capital gains" rate -- unlike some other investments such as annuities which are taxed as "ordinary income". With ETF's you'll have the peace of mind in knowing that nobody can take advantage of you. Even Jim Cramer (MSNBC's Mad Money), who devotes about 99% of his show to discussions about individual stocks, has recommended ETF's to those who don't have the time to study stocks. Because he has a TV show devoted to stock picking, he might be biased. In reality most investors who do study stocks and market trends would probably fare better by investing in ETF's than if they were to try to beat the indexes by trading stocks and racking up trading costs. According to Jack Bogle (of the Vanguard fund group) it is a mathematical certainty that over a lifetime you cannot beat the indexes with active management (example- actively managed mutual funds). Source: PBS Jack Bogles has also said that over the long-term probably only about 1% of managers do better than the market indexes. Source (Skip to 13:14)
In this 5-year study (ending in June 2012) randomly selected 3-fund portfolios consisting of actively managed funds were compared versus a comparable index fund portfolio. The three funds were Intermediate-term municipal bond funds, large cap blend US stocks and large cap blend foreign stocks. A whopping 82% of the actively managed 3-fund portfolios were beaten by the comparable benchmark index fund portfolio. The average "actively managed" portfolio did 1.1% worse than the comparable index fund portfolio. 1.1% might not seem like a lot but when compounded year after year, at that rate an investment of $100,000 into actively managed funds would be worth $234,573 versus $259,374 in plain old index funds. That's $24,800 less than the index fund portfolio after just 10 years! I repeat, that's a difference of not 1.1% but about ten percent of your wealth! In other words small fees matter greatly! Avoid actively managed! See chart below.
"All the time and effort that people devote to picking the right fund, the hot hand, the great manager, have in most cases led to NO advantage.” -- Peter Lynch, legendary manager of the highly successful Fidelity Magellan mutual fund
"By periodically investing in an index fund the know-nothing investor can actually outperform most investment professionals." -- Warren Buffett
"The statistical evidence proving that stock index funds outperform between 80% and 90% of actively managed equity funds is so overwhelming that it takes enormously expensive advertising campaigns to obscure the truth from investors.” -- Peter Lynch
Another must read article: Avoid individual stocks. Buy ETF's.
Another article: Over a 5-year period from June 2009 through June 2014, only 26% of actively managed funds beat their respective index benchmarks. Only 13% of large-cap stock-fund managers beat the S&P 500 index.
Not sure how much risk to take or where to invest? Check out Vanguard's portfolio creation tool as well as Ric Edelman's portfolio creation tool then check out EasyAllocator.org which not only selects a portfolio for you but gives you projected portfolio growth. And check out Vanguard's nest egg calculator. Of course hiring a fee-only fiduciary adviser for a one-time consultation is a smart thing to do too.
Still not convinced that "fee-based" is the superior and only choice? Clark Howard agrees (Pay for investment advice or get it "free"?
NEXT ARTICLE: Simple basic rules of investing
DISCLAIMER: Nothing on this public service website shall constitute personalized tax, legal or investing advice, including but not limited to strategies or advice to buy, hold or sell securities. Always hire and consult with a fee-only fiduciary before making any such decisions. The accuracy and completeness of information presented on this site cannot be guaranteed.