Watch Out For The Three “I”s When Engaging Financial Advisors

Seek a fiduciary-only advisor who understands your vision

Ah, the three trip wires that can deep six any financial scenario – ignorance, incompetence and incentives. This became quite evident to me recently in speaking with a couple and the decision they were going to have to make regarding taking a pension or a combination of a lump sum and pension. They had interviewed several financial advisors before sitting down with me. As we talked they expressed concern over the health of the employer (a local government) and I could tell it was weighing heavy on their mind. And rightly so, they had worked for over 30 years and this was going to be a major component of their retirement resources.

We initially discussed some of the potential protections that could be available to them and that their concern, while completely valid, was one that needed to be put into proper context and that a goal-based approach would assist in determining what course of action to pursue. Having a goal-based approach would allow us to look at the decision from both a quantitative approach (the hard numbers) and a qualitative one (the emotional side). After explaining the process, they informed me that my response was much different than the ones they had received from other financial advisors. They told me that once they communicated they had a lump sum option available the conversation turned and the focus became how they could assist in managing those dollars. Just like Pavlov’s dog salivating to the conditioned sound of a ringing bell, these advisors were now laser-focused on getting that lump sum into their assets under management!

So we began to put this scenario through the proper scrutiny. We looked at the probability of the economic benefit to them of a lump vs a pension over their lives and found that there was a 73% chance that the joint life with 100% survivor pension option (the option we were considering) would provide a higher benefit to them over the economic benefit provided by the lump sum. Looked at another way we found that the return they would have to make on an investment portfolio to generate the same level of monthly income would have to be 6.6% over a 30 year period. We also considered the current insurance marketplace to see what an annuity would pay and found that they would receive less than half of what was being offered to them. Another factor was that the pension provided a unique contingency in that if the spouse died the payment would increase by $1,000 per month to the single life option! All of these things pointed to the richness of the pension benefit they had available to them. After analyzing the question this way, we were able to discuss the more qualitative elements of the situation with questions like, “How much do you value having some of the funds available to you?”. Utilizing a goal-based approach and crunching the numbers allowed us to put the choices in front of them in an even-keeled way eliminating any bias that might exist.

As I reflected on this situation and the approach the other financial advisors took it caused me to wonder what got in the way of them having an intellectually honest conversation with these individuals. I came up with three possibilities – ignorance, incompetence or incentives. It is possible that they just didn’t know how to analyze the situation. It is also possible that they did not have the right resources or if they did how to apply those resources the right way. It is also possible that the incentive structure they had trumped everything and motivated them to recommend the lump sum. Regardless of which of the “I”s applied it was detrimental to these individuals in their pursuit of understanding what the best option was for them. Working with the right advisor not only can give you the answers to some of the big financial decisions you have, but also provide additional benefits in the totality of an ongoing relationship. Research from Vanguard attempts to quantify the additional value one can receive when working the right advisor. The benefits they highlight are as follows:

Think about what an extra 3.75% could do for your wealth over time. If you take $100,000 and earn 3.75% you get a future value of $208,815. That’s an extra $108,815 for every $100,000 invested! Having the right advisor matters. Sadly, a lot people are not in a situation where they can actualize this additional savings because they are dealing with various levels and combinations of ignorance, incompetence or incentives.

So how can you increase the odds that you will achieve some of the benefits mentioned above? Take these steps:

1. Ensure you are working with a fiduciary. Work with someone that is a fiduciary who is legally required to put your best interest first. If they are a broker or dually registered as a broker and fiduciary, thank them for the free coffee and move on.
2. Ask the right questions. Inquire about their level of knowledge, experience and incentives.
3. Consider their approach. Watch for solution language before understanding the context. What is the approach taken to identify the needs of an individual?
4. Incorporate a litmus test. All products and most solutions have pros and cons to them. If all you hear are the advantages of something that should at least kick in some healthy skepticism. Inquire about the pros and cons of doing something other than what is being recommended. If they can’t provide what the other side looks like it could be due to ignorance, incompetence or incentives.

You wouldn’t go to a doctor and expect him to provide a solution with the mention of a few symptoms would you? You would expect him to go through the paces to fully understand what is happening internally to then prescribe the right course of action. Diagnosis without proper diagnostic can lead to deficiency, danger, or death when it comes to medical issues. Don’t subject yourself to this same approach when it relates to your finances. Seek out someone that isn’t subject to the three “I”s!