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Seeking Financial Advice 1. Getting A Financial Plan From A Free Adviser.

OK so you are thinking ahead, investing or planning to invest and you are interested in getting a retirement plan or even a comprehensive financial plan.  Common sense suggests that given the wide range of considerations and huge range of investment products available to you, you should probably seek some advice from a Financial Advisor.  I agree.  But you need to proceed with knowledge and care.

In this first installment on Seeking Investment Advice I want to talk about incentives and “Free” or “Fee-based” (a misleading term for a class of advisor very similar to free) advisors.  Nobody works for free.  Even good people are swayed by their incentives and as Upton Sinclair, famous consumer advocate and author once quipped “It is difficult to get a man to understand something when his salary depends upon his not understanding it.

budgets, retirement planner and personal finance blog
Free or very inexpensive
advisers are usually sales people.

First the good news.  All Financial Advisors want your business, and they want it for years and decades if possible.  This alone provides a degree of alignment independent of their incentive structure and it generally means that with the right approach you can potentially get value from any flavor of financial advisor.

Nonetheless, if you take advice from a financial advisor, financial planner or investment advisor who is not explicitly “Fee-only” and charging you for their time (or use personal financial planning or financial forecasting software provided “free”), you are almost certainly dealing with a sales person. Their job security and income is tied to their ability to get you to buy the investment products like stock and bond mutual funds, annuities, insurance policies and other instruments that they are recommending.  This is a very popular model and is how quite a large number of name brand companies make money.

The realities you must consider when this kind of incentive structure is in place include the following:

  • Free and “Fee-based” advisors, or the companies they work for, get paid commissions by investment product companies when you buy into a fund or other investment product they recommend.
  • Sometimes a financial analysis will show that you should be doing things with your money other than investing.  This can commonly include paying down debt or keeping a cash emergency fund on hand.  Commissions create an incentive to recommend money be invested.
  • There are lots of bad investment products, usually because they include unnecessary expenses.  Examples in my opinion include actively managed stock mutual funds with expenses over 1% (index funds do just as well on average without the cost), annuities with hidden costs and penalties for early withdrawal and many others.
  • Not surprisingly, investments with higher expenses tend to pay higher commissions.  This creates an incentive for a “free” advisor (or free financial planning or forecasting software) to recommend the worst investment products.
  • The right investment mix for you is dependent upon your risk tolerance, when you think you will need access to the funds and always includes a mix of asset types (e.g. stock, bonds and real estate).  Incentives created by commissions may bias an advisor toward a mix that is not right for you.
  • Advisors usually have access to several different but similar funds in the same general category (e.g. Large Cap Growth Stocks).  This means that there is almost always at least one that has done well vs. the market in the last year, 3 years and 5 years they can select.  If an advisor suggests a mutual fund that has “beaten the market” for some period of time, while factually accurate, this is a marketing ploy that means absolutely nothing.  Also be wary of the possibility that this data is presented without accounting for expenses.

The bottom line is that if you go talk to a financial advisor that is taking commissions for recommending investment products, treat them like the sales person that they are.  You should expect them to be honest, to answer your questions about the features and costs of different investment products that they are selling and provide you with a wide selection of products to choose from.  At the same time assume that they will not go out of their way to volunteer information that might make you choose not to invest in their products and that their opinion is going to be that you should buy their more expensive premium products.  Do not blindly allow them to choose your investments for you.  To work with this kind of advisor, you’ll need to be an informed consumer and already know what you want or wait until you do to make a decision, and this means you’ll need to gain some financial savvy of your own.

Continued in Seeking Investment Advice: 2. Finding a Good Advisor.

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