Think your broker or financial advisor is on your side? Think again

Peter Mallouk
JD, MBA, CFP®
Chief Investment Officer
cpi@creativeplanning.com
Creative Planning’s Director of Financial Education, Jonathan Clements, shares with CEO Peter Mallouk some of the red flags that could indicate that your financial advisor is not looking out for their clients’ best interests.

Peter Mallouk, CEO: Hi, I’m Peter Mallouk, the president and chief investment officer of Creative Planning. With me today is Jonathan Clements, our newest advisory board member and director of financial education. Jonathan, you have over thirty years’ experience serving as a financial advocate to consumers, more than 20 years writing for The Wall Street Journal. Welcome.Jonathan Clements, Director of Financial Planning Education: It’s great to be with you, Peter.

PM: Tell me a little bit about, I know you’ve got over 30 years’ experience in the financial services field, writing about financial industry and helping consumers protect themselves. Tell me a little bit about your history with that and what attracted you to Creative.

JC: As you’ve mentioned, I’ve spent thirty-one years writing and thinking about money, and twenty-five of those years has been as a financial journalist, including twenty at The Wall Street Journal where I was the paper’s personal finance columnist. And what’s driven me throughout my career and continues to drive me today are all of the letters and emails that I’ve received from investors over the years. It’s really shocking how poorly treated many investors are in this country. They send me their portfolios and I look through them and I see mutual funds with terrible performance, I see mutual funds with high annual expenses. I see portfolios that were created five years ago, and the financial advisor hasn’t been back in touch with the client to make sure that things are still on track. There is really a terrible, terrible problem in this country when it comes to financial advice. A lot of people go to one of the big brokerage firms, they think they are going to be helped by the best and brightest in the industry, and in fact they often end up in the worst possible place.

PM: You go to a brokerage firm and there’s a big difference between brokers and independent advisors, as you know, in the independent side you’re getting a fiduciary, and I know you have a lot of thoughts around that.

JC: You’re absolutely right. As you know, Peter, there are two different types of advisor out there. There are advisors who follow the fiduciary side, which means they are legally obligated to act in the best interest of the investor. And then there’s this thing called a suitability standard, which is really only on Wall Street. A suitability standard is we are going to sell you something that, you know, isn’t so bad for you. And the problem is if you have a traditional brokerage relationship, what you have there is a suitability standard. Which means the financial advisor, who’s really just a broker, isn’t obligated to act in your best interest, and that’s why you end up with these portfolios which are full of mutual funds, with five and three quarter percent up-front commissions, full of B shares which are sold as no load funds, but end up having a back-end commission when you sell. And the investors often know no better until somewhere down the road their eyes are open and they realize they had maybe ripped off this too-strong…that they had been treated badly.

PM: Yeah, the suitability standard is fascinating because in America we make our lawyers act as fiduciaries, we make our CPA’s act as fiduciaries, we make our physicians act as fiduciaries. It’s really unique to financial services, and across the world, you look at Australia, The United Kingdom, they require their financial advisors to be fiduciaries too. It’s really unique to United States financial advisors. It’s the one place where you can give something to a client that you know is not in their best interest.

JC: And even when you find somebody who says they are a fiduciary, you need to be tactful and ask a few additional questions. For instance, in some instances, a broker can be acting as a fiduciary if say they have a managed account where they’re charging, say, 1.5% percent a year to manage that money. But then you turn around and they’re dealing with a different account and maybe they’re not acting as a fiduciary anymore, now they are following a suitability standard. The other issue that comes up is people may be acting as a fiduciary, but they have their own in-house investment products that they are selling you. And this doesn’t just happen at the big brokerage firms. So, what does that mean? Okay, so, you have this relationship with an advisor and they are charging a reasonable one percent a year to manage your money and you’re thinking “Okay, that’s good,” and they are putting you in a series of mutual funds that you assume are the best possible funds for you. And then it turns out that they also have a stake in the funds they are selling you, so they are essentially double dipping.

PM: Right. I look at the space and this has always been a hot topic for us at Creative, and you basically see there’s brokers and there’s fiduciaries, but most people don’t know the difference between those. They finally figure out, they go “I want a fiduciary. Someone who has to act in my best interest.” And then they go to their advisor and say, “Are you a fiduciary?” And most of them will say yes because like you said, brokers in some cases may be a fiduciary and independent advisors are sometimes also a broker. So, you really have to ask your advisor, “When it comes to my investments are you a fiduciary 100 percent of the time, or are you dually registered, are you really a broker part of the time, an independent advisor part of the time, are you a broker that is sometimes a fiduciary? It’s an incredibly confusing space and until congress cleans that up it’s going to be that way, unfortunately.

JC: So, you raise the issue earlier in the conversation, “Why did I agree to sign on with Creative?” And at the time that you called me, I could have gone anywhere, I wasn’t associated with any financial advisory firm, and the thing that drew me to Creative is not only are you a fiduciary, but, you don’t have this in-house suite of products that you are trying to sell people. So, you truly are a fiduciary, you truly are acting in the best interest of investors.

PM: And I think that really impacts portfolio design. So, if you look at portfolio design, the first thing you want is you want to make sure that the advisor doesn’t have their own product to put into that portfolio or receive revenue sharing from somebody from putting that product in that portfolio. Because if you’ve got that, you’ve got somebody fishing from a pond instead of an ocean. I don’t want to go to a doctor that gets paid more if I use three different types of medication and ignores all the other ones out there that might be better for me. When it comes to portfolio design, what other issues do you think are really relevant to the investor?

JC: One of the things that you have to be aware of when you’re dealing with any Wall Street firm is that they are getting compensated for managing your money. For the actual portfolio. And so, what you end up with is this laser-like focus on the portfolio. The problem is, when you manage somebody’s money, when you design a portfolio for them you need to think about much more than just what their time horizon is, what their goals are, how risk tolerant they are. You have to look at their broader financial life. For instance, you might look at how much they have in debt. If they have a lot of money, a lot of debt, you might build a more conservative portfolio in case they need to liquidate part of that portfolio to service their debt. If you look at somebody and they, say, are a venture capitalist or they work on commission, and so their paycheck really fluctuates from one year to the next, you again might want to have a more conservative portfolio because there could be a year where they have very low income, perhaps no income. So as a consequence, when you design somebody’s portfolio you need to look at their broader financial life and yet a lot of financial advisors don’t do that.

PM: Yeah, if you’ve got somebody in the real estate business you don’t want to be putting real estate in their portfolio, if somebody is in the energy business you want to account for that in the portfolio as well. And there are so many other factors as you talk about from social security to pensions to rental income, and other things as well.

JC: One of the reasons these issues are so important these days, Peter, is that investors have this incredible opportunity. The financial world has never been kinder to investors. You think about what’s happened over the last couple of decades. First of all, we’ve seen the tax code become incredibly friendly to investors. And then the capital gains rate is as low as I can recall. There is a special low rate on dividends. Meanwhile, we have all of these tax statement/favorite accounts. Not just IRA’s and 401K plans, but have Roth IRA’s, 529 college savings plans. And then on top of that, what we’ve seen is a dramatic reduction in investment costs. We’ve seen the perforation of exchange-traded index funds with rock bottom annual expenses, we’ve seen brokerage commissions sliced to almost nothing, we’ve seen tightening of the bid ask spread on stocks. So what that means, is a really smart advisor can slash the amount you’re paying to invest and they can drastically reduce the amount you pay in taxes. And if you’ve got a traditional advisor who isn’t aware of these issues, you’re paying way too much. And frankly, the stakes are just too important to allow that to happen. Remember, you know, we get one chance to make the financial journey from here through to retirement and you don’t want to do anything that imperils that journey.

PM: Yeah, that’s a great point and that’s for all investors and for the affluent investors there’s so many advance strategies that they can take advantage of that weren’t available decades ago, that can really enable them when the portfolio is designed correctly within them to make their wealth generational too, and really protect it.

Thank you for being with us, Jonathan.

JC: It’s been my pleasure, Peter.