Common Problems With Financial Advisors
These are the common problems you are likely to encounter:
1. Some advisors get a commission (basically a kickback) for referring investors to specific funds. That was probably why the advisor I described above was recommending me inappropriate margin loans. For example, if your advisor recommends that you put $100,000 into the high-fee, hypothetical Adamantine Investment Fund, he might score a 1% commission if you go ahead with it. That’s $1,000. Worse, this might be a trailing commission. That means he gets 1% for every year that you’re in the fund. Five years later you may have increased your AIF investment to $200,000 and that advisor from ages ago who you’ve totally forgotten about is still helping himself to $2,000 every year!
That is unfair, it is overly expensive and worst of all, it provides an incentive for your advisor to recommend AIF when another option might be better for your individual circumstances. In other words, he might consciously or unconsciously put his own financial interests ahead of your own. That’s what such incentives do. Why else would they exist?
In some cases you can cease the commission after a certain time, but many people are too financially illiterate to even realize that they are still paying.
At the time of writing, such commissions are legal in some countries and illegal in others. Even if they have been prohibited, you might run into the following problem:
2. Some advisors also get commissions for referring you to specific types of insurance. Perhaps this is why my first advisor was recommending insurance that I already had. The problem is the same as above – a commission provides the advisor with an incentive to recommend insurance that you don’t need or which is inferior to what you’ve already got. Advisors sometimes also get commissions if you change policies, so they encourage you to ‘churn’ through different policies when you’d be better off sticking with the same one.
3. Advisors, especially free ones who work for large institutions like banks or mutual funds, are often expected to recommend products offered by their own institution, even if these are not in your best interests.[i] For example, XYZ Bank might expect their advisors to offer customers the most appropriate product offered by . . . XYZ Bank (or its subsidiaries that go by other names). In many cases this advice is okay, but may not be the very best advice you could receive. It is likely to only be the most appropriate out of the institution’s own products. Another, outside product might be better for your circumstances, especially if it offers lower fees. Independent advisors (i.e. ones not working for a big bank or other organization) who are free to recommend the services of any institution can often find you a better deal.
4. This industry also contains some downright charlatans. Of these, there are two main categories. The first are unlicensed con artists who are trying to pinch your money. The second are licensed but unscrupulous providers, some of whom work for big institutions. For example, there was a scandal at a major Australian bank some time back with advisors recommending inappropriately high-risk products to customers, and even falsifying documents to make it happen in some cases. This and other rumblings eventually led to a Royal Commission which uncovered all sorts of wrongdoing by the big banks.[ii]
Edit: tune in next Friday for a step-by-step guide to avoiding these problems and finding a good advisor.
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