CHAPTER 15

The Gift of Discretion

CHOOSING A FINANCIAL ADVISOR

“Everyone is biased.” Those were the words of a mentor of mine shortly after I entered the business of financial advising. I had already been working in the financial industry for several years, but this was the second time my idealistic view of the objective, trusted financial advisor received a healthy dose of reality. The first time was about three years earlier. I had just finished celebrating my rite of passage into the stockbrokerage world—successful completion of the “Series 7” examination allowing one to sell stocks, bonds, mutual funds, options, and various other securities to the public—when I left my entry-level back-office job at a reputable brokerage firm to join a successful team of stockbrokers at another firm as a junior broker.

The celebration continued as I settled into my new office (with walls) and my 100 percent raise. Now I was ready to conquer the financial world. I intended to set up shop as a financial doctor and wait to see wealthy patients line up at my door eagerly awaiting my professional diagnosis and walking away with a prescription of financial wisdom.

I showed up the first day, bright and early, in my token blue pinstriped suit, starched white shirt, and bold power tie. I sauntered into the team leader’s office to await my very first “morning call.” I listened intently and began feverishly taking notes as a man’s voice rang through a small box detailing the economic events and nonevents that were expected to influence the stock and bond markets that day, as well as the state of the current “inventory” held by the company.

As the call wrapped up with a dose of encouragement—akin to a team chant before a football game—I took a deep breath, a final swig of coffee, and moved forward onto the edge of my chair, eagerly awaiting the golden wisdom from my suspender-bound leader as I set out to save the populace from their deviant financial ways. He stood up, glanced out over the magnificent view of the Baltimore harbor visible from his corner office, and invited me to walk across the hall to get comfortable in my new confines.

He grabbed a three-ring binder, six inches thick, and opened it to the first page. Then he told me to write down the only note he had taken during the morning call: “BGE 6.5% Preferred.” My mission was to call the first number attached to the first name (of many) on the first page (of many) and begin a conversation to help bring whomever answered the phone to the conclusion that they could simply not go another day without putting some of their hard-earned money to work for them in this bargain-basement deal with an unbeatable yield on this new issue of the bedrock Baltimore utility company’s preferred stock.

I was told to start by putting a smile on my face, because my joy would better translate through the other end of the phone. I should talk and talk and talk until the voice either transitioned into a static dial tone or submitted to my plea to “talk to the resident expert” in house (my team leader), at which point I should put the voice on hold and alert the big shark that we had a fish on the line (I’m not stretching the metaphors here; that’s really how they talked).

This was my professional dream? Several weeks later, driving home from a client lunch with the shark, I got up the nerve to ask him a question, the answer to which I was dying to know: “What drives you? A genuine interest to guide a client to the path of financial success or a pure love of the sale?”

I appreciated his honesty as he let out a “hrmph” and retorted, “The sale—of course! If this business dried up, I’d sell snow cones to Eskimos!”

He was the resident trainer for the company’s new breed of financial advisors who would guide (or pester) the residents of the Baltimore metropolitan area. I talked to him a few days later and told him I felt we had a “philosophical disconnect” in the way we viewed the business. He agreed, saying, “Yeah, some people just aren’t cut out for the phone,” and we parted on good terms.

The celebrated entrance into the business I had dreamt about since the eighth grade ended in disappointment after only two months. I regrouped and accepted a job as an equity trader on the trading floor of a regional brokerage firm.

Fast-forward three years. I was back in the game with more experience and only slightly less naiveté. I had joined a company that convinced me they were dedicated to the financial planning process, a large insurance company said to be transitioning from a single line of business to a comprehensive planning process to include investment and other financial analysis.

I was teamed up once again, this time with a 30-year veteran of the insurance business. He was (and still is) a good man, well-intentioned, and a leader in the community. Having one of many heart-to-heart conversations on the road home from an appointment, I shared with him my view of the importance of pure objectivity in the planning process—that we must be advocating on the clients’ behalf, in search only of the products that would best serve their needs.

He saw through my veiled attempt to suggest our process should be less insurance heavy and spoke those words that have rung in my head ever since, “Everyone is biased. There is no true objectivity.” His bias just happened to lean toward the value of permanent insurance products. One year later, I had to move on once again. Not able to change the world in which I existed professionally, I had to find another one.

Several years and two more companies later, with the Certified Financial Planner (CFP) designation and seven industry licenses behind me, I have arrived at some important conclusions:

• First, the behemoth financial industry—including the major brokerage firms, insurance companies, and banks—is inherently set in a way that puts the company first, the broker of products and services second, and the client’s interest no higher than third.
• Second, the industry implicitly promotes itself as the fiduciary of the public, placing their clients’ interest above all. This is a dangerous impression because, as employees of these companies, the advisors’ primary duty is to represent their company while clients are encouraged to believe (through an endless marketing campaign) their interest is coming first. Put to the test, the vast majority of brokers and salespeople—or advisors and consultants, as they are often termed these days—would not be able to sign (per their own compliance departments) a pledge that they will place the interest of their clients above all, even though many of them want to.
• Finally, everyone does carry a certain bias, but the interest of the client will best be preserved in environments that do not encourage behavior to the contrary. Different professionals in any line of highly regulated business, such as doctors, lawyers, architects, or engineers, may have differing and even opposing opinions and may legally support their opinions and encourage clients to act accordingly. The problem in the institutional financial industry is that it calls itself advisory, but it is actually a sales operation—a veiled misrepresentation.

This is not a “whistle-blowing” or “tell-all” of a repentant, once-wayward soul. It is also not meant to decry every advisor, stock broker, or insurance representative at the establishment companies worthy of criticism. Some of the best financial minds and well-intentioned individuals I know work for these companies and work hard for their clients despite the institutional pressures to do otherwise.

This is a bringing of truth to light; a guide for what you should know and probably don’t about the financial advisory business; an explanation of exactly what a fiduciary is, why it’s important, and how it is different from the premise under which most business in the financial industry is conducted; and suggestions for how you can find an advisor who has the best of intentions and—just as important—the freedom, encouragement, and mandate, all the way up the corporate ladder, to act on them.

“The Big Three”

So, how do you find a good advisor if you don’t have one? And how do you determine if the one you have is good or not? We’ll begin to answer that by telling you a bit more about the Big Three—banks, brokerage firms, and insurance companies—and the instrumental role they’ve played in shaping the financial advisory business. As they are often quick to remind us, the Big Three have been around forever. One of the newest firms, the result of a merger of two of the firms which made headlines for struggling through the financial crisis, has a new slogan: “A new wealth management firm with over 130 years of experience.” They advertise that they, alone, have 18,000 financial advisors. It is thought there are up to half a million individuals calling themselves some creative variant of a financial services professional, and most of them work for the Big Three.

A little history first. The Glass-Steagall Act of 1933 was passed after the collapse of much of the banking system during the Great Depression. When enacted, it effectively put each of the Big Three in a silo, and allowed them only to conduct their primary line of business. So banks could be banks and only do banking—not offering brokerage services or insurance products, and so on. This act remained in place until it was repealed in 1999. After the repeal of Glass-Steagall, it was once again a free-for-all. It’s hard to tell which company is what anymore, because when you go into the bank, they offer to sell you life insurance and open an IRA. Much in the same way, insurance salespeople are also selling investment products, and brokerage firms also offer to be a one-stop shop. Here we are, only a decade removed from the repeal of the Glass-Steagall Act, and we’re again talking about new regulation for the financial industry after a collapse of the banking system.

And I’m not sure the industry has actually received the message just yet. In the Wall Street Journal, July 31, 2009, the front-page headline read, “Bank Bonus Tab: $33 Billion.” Here is how the article starts:

Nine banks that received government aid money paid out bonuses of nearly $33 billion last year—including more than $1 million apiece to nearly 5,000 employees—despite huge losses that plunged the U.S. into economic turmoil.

Wait—weren’t these the companies that needed a bailout from U.S. taxpayers just to stay afloat in 2008 and 2009? The article goes on to say, “Six of the nine banks paid out more in bonuses than they received in profit.” All I can say is, hmmmmmmmm.

Despite their attempts to convince us otherwise, the Big Three are each still loyal to their primary line of business. While bankers, brokers, and insurance agents are now called financial advisors, financial consultants, wealth managers, or financial planners, a bank financial planner is still pushed to bring deposits to the bank and sell mortgages, a broker/financial advisor is still expected to pitch the proprietary investment product or service, and the insurance financial planner is required to sell insurance.

The deviation into other product lines is called cross-sell, and the motivation to do it is enormous. Advisors in each model are given statistics that suggest that if a customer has purchased one product—a mutual fund, let’s say—they have a 50 percent chance of remaining a customer. If, in addition to that mutual fund, they also purchase an insurance policy, there’s a 70 percent chance of keeping the customer. But if they also have their bank account or mortgage with us, there is a 90 percent chance that they’ll stay.

So what the heck is financial planning then? Financial planning, as a profession, is actually very young. It’s said to have emerged, “with a meeting of 13 individuals at Chicago’s O’Hare Airport in 1969,” according to Investment Advisor magazine.1 The first class of the College of Financial Planning graduated in 1973. With less than 50 years of history, it’s understandable how the profession has faced difficulty in differentiating itself from the Wall Street institutions dating all the way back to 1790.2 This has been especially difficult as the Big Three have worked very hard to promote themselves as financial planners.

I have worked for each of the Big Three as a financial advisor, and my experience was that financial planning was not the end, but a means to the end of product sales. Have you had a broker, banker, or insurance agent provide you with a financial plan? It may have even been surprisingly inexpensive or free. And I would be willing to bet, if you received a financial plan from a brokerage firm, the actionable recommendations were spearheaded by having them manage your investments. A financial plan done by someone who is employed with or contracted by an insurance company doubtless resulted primarily in recommendations for life, disability, or long-term care insurance.

To understand why independence from any parent company that sells financial products is so important, we need not look any further than the medical profession. Would you be uncomfortable if your family doctor worked for the pharmaceutical company Pfizer? You should expect nothing less of your financial advisor than you do of your physician.

Financial Planner Compensation

How then are the various types of financial planners compensated? Although they can be broken down into subsets, the following are the three broad methods of compensation for financial advisors: Commission-only, Fee-based, and Fee-only. Commission financial personnel only receive their compensation from the commissions resulting from the sale of financial products. The Series 7 investment license, as well as licenses for life and health insurance, do not authorize one to advise clients. They only license someone to transact a product sale; therefore, commission advisors do not have the ability to charge fees for advice. They are compensated only when they sell something.

Fee-based advisors are thought by most to be synonymous with fee-only advisors, but there is actually a world of difference between the two. Fee-based advisors derive a meaningful portion of their compensation from fees they charge for financial planning recommendations and/or from the management of investments. But a fee-based advisor may also receive commissions from transactions. These transactions often come from the sale of mutual funds, but most often from annuities and insurance, products known for especially high commission rates. When an advisor manages investments for a fee, he or she is required to have a Series 65 or Series 66 license, making him or her an investment advisor representative (IAR) of a registered investment advisory (RIA) firm.

When you have this license, and if you are being compensated by fees, the services for which you are taking the fee must be provided on the fiduciary level. While legal definitions of this word vary, the basic gist is that an advisor is required to act in the client’s best interest. While it may surprise you that this is not a standard to which all in the financial industry are held, commission transactions do not require the salesperson to act as a fiduciary. This becomes a very gray area for those in the fee-based world and those who are clients of fee-based advisors, because an advisor who takes a fee for one service is required to act as a fiduciary in the provision of that service, but can then take the fiduciary hat off to sell a product for a commission through another service with a lesser level of responsibility.

I’ve talked to colleagues in the fee-based realm, in which I functioned for several years, and I have encouraged them to move from fee-based to fee-only for the freedom of conscience that I’ve experienced. But the refrain I hear from most is, “Well, the vast majority of my compensation is from fees, but I’m simply not willing to give up those big life insurance and annuity commissions. Somebody’s going to get that commission, so why not me?” I don’t judge, because I have thought and said the same thing, but having moved from commission-only to fee-based to fee-only, I can declare without hesitation that there is a difference in the way I approach client recommendations now that I take no commissions at all, and the only people who don’t seem to believe it’s an issue are the ones still accepting commissions.

A fee-only advisor can only receive compensation from fees. No commissions or referral fees are allowed if you call yourself fee-only, and that term has been institutionalized by the National Association of Personal Financial Advisors. NAPFA-registered advisors are put through a rigorous path to membership. One must have the appropriate credentials and experience, and must also have a personally drafted financial plan pass a peer review. NAPFA advisors are also held to the highest standard in the industry for continuing education, and are required to sign a fiduciary pledge that they will act only as a fiduciary 100 percent of the time (ruling out the fee-based method of planning).

Within the fee-only realm, there are various methods of compensation. Some advisors do hourly-only work, and there is a network of hourly advisors across the country called the Garrett Planning Network. This is an excellent organization founded by Sheryl Garrett to provide access to fee-only planners for individuals and families who aren’t looking for a perpetual relationship or investment management services, but instead want to talk to a professional planner who will render advice on an hourly basis. Some fee-only advisors charge flat fees for comprehensive or modular financial plans, but there are also fee-only advisors who, in addition to providing comprehensive personal financial advice, also manage investments for clients. The most common way these planners are compensated is on an assets under management (AUM) basis, but some do charge an annual retainer. With AUM, you’ll pay a fee of 0.5 percent to two percent (you really shouldn’t be paying much more than one percent) to have your investment assets managed. A flat retainer may also be charged that is revisited and adjusted on an annual basis for comprehensive services and/or investment management.

As mentioned earlier, there are estimates that suggest that over 500,000 people in the United States alone call themselves financial something-or-others. As of June 2009, there were 59,662 Certified Financial Planner™ certificants in the United States, 27,500 members of the Financial Planning Association, 2,093 National Association of Personal Financial Advisors members, and only 1,269 that are NAPFA-registered financial advisors. That tells me there are tons of people out there who would like you to think they are your financial advisor, but only a relative handful are qualified to do so as true professionals.

Finding a Professional Planner

But what does the word professional really mean? Does it have any importance at all, or has it been overused into vernacular oblivion? I’ve had the privilege of getting to know Dick Wagner over the last several years. He has been recognized by the CFP® Board, the FPA, and NAPFA nationally as one of the thought leaders in the industry. He’s seen by many as the conscience of the financial planning profession. It has now been over 20 years since Dick’s seminal paper, “To Think . . . Like a CFP,” was published in the Journal of Financial Planning. CFP stands for Certified Financial Planner™ practitioner—one who has been licensed by the CFP® Board to hold the credentials. The CFP® credential is now appropriately recognized as the minimum standard for a financial planner, but when Dick originally wrote his article, it was not yet a recognizable standard. Dick was calling financial planners to task.

Dick was and is a CFP® practitioner, but he started his career in law. The name of his article, “To Think . . . Like a CFP,” was a play on words from the movie, The Paper Chase, which chronicled the life of a young law student. As an attorney steeped in legal professionalism, Dick posited that financial planners needed to break from the sales realm and become true professionals, a pursuit which demanded “principles over apparent self-interest.” For financial planners to be genuine professionals who could be called upon to guide people in their personal finances, they must see the interest of their clients over their own. That is the true definition of a fiduciary.

I’ve used the word fiduciary now a number of times, but I haven’t explained why it is so central to this discussion. There are three different legal standards to which those in the financial realm are held, the highest of which is fiduciary. As mentioned, a fiduciary is legally bound to act in the client’s best interest. The next tier down is suitability. Suitability is the standard required of those who take commissions on investment products—stocks, bonds, options, mutual funds, and variable annuities, among others. The suitability standard requires that the salesperson sell a product generally considered to be suitable for the individual at that time. It does not create an advisory relationship and only has reign over a transaction at a moment in time. So, as long as the product sold at the time was suitable, the selling agent or broker’s responsibility has ended. Finally, we have caveat emptor—buyer beware—which reigns over most insurance product sales, with the exception of those that have a variable investment component. Insurance is regulated on a state-by-state basis, and as long as a product has been approved by the state’s insurance commissioner, the selling agent has very few restrictions on to whom the product can be sold . . . kind of like shopping at the five-and-dime.

How then, can you determine how to find a truly professional advisor, or if you already have an advisor, how do you know that he or she is a professional? Here are six criteria to which a truly professional advisor should be held. Your advisor should be:

• Educated
  • Minimum of a Bachelor’s Degree; preference for advanced degree—Master of Business Administration (MBA), Master of Science in Finance, or Master of Financial Planning (very few exist but their number is growing)—and/or financial planning specific certificate(s)
• Credentialed
  • CFP®, Certified Financial Planner™, is the financial planning credential
  • CPA, Certified Public Accountant, is the accounting credential, and an excellent addition to your financial planner’s resume
  • CFA, Chartered Financial Analyst, is a very demanding credential, specific to investment analysis
  • JD, Juris Doctorate, indicates you’re working with an attorney; a very demanding degree, often accompanying planners who specialize in estate planning
  • CIMA, Certified Investment Management Analyst, is awarded by the Institute for Certified Investment Management Consultants
  • AIFA® and AIF®, Accredited Investment Fiduciary Analyst and Accredited Investment Fiduciary are two newer credentials growing in reputation dealing specifically with investing as a fiduciary
  • ChFC, Chartered Financial Consultant, is good but should be in addition to CFP® credential and probably indicates insurance sales background
  • CLU, Chartered Life Underwriter, almost always indicates insurance sales background and should be combined with CFP® for credibility

    There is a veritable alphabet soup of letters that people put behind their names, but any of them that are not preceded by CFP®, CPA, CFA, or JD are either less than central to the practice of financial planning or masking a lack of appropriate credentials.

• Experienced
  • Minimum of five years experience and working in conjunction with senior planner, or minimum of 10 years, and still ideally partnering with a more seasoned planner
  • You can optimally ensure more experience by working with a firm employing a team approach versus a sole practitioner or a silo-style practice in which there are many advisors, but each one working for him or herself
• Independent
  • Should not be working for one of the Big Three, but also be wary of “Independent Broker Dealers” which carry the word independent, but often reflect the sales practices of the Big Three
  • Purely independent financial planning and Registered Investment Advisory (RIA) firm optimal
• Fee-only
  • Steer clear of conflict of interest by steering clear of commissions
• 100 percent fiduciary
  • Contrasted with part-time fiduciaries in the fee-based model or no-time fiduciaries in commission-only realm

There is no panacea or bias-free utopia in financial planning. I am part of the National Association of Personal Financial Advisors (NAPFA) as well as the larger Financial Planning Association and several subassociations, groups, and think tanks, and the discussion of how we can improve compensation models is endless, and will be, because we’ll never find something that will be optimal for every single client and advisor. The best advisor decision starts with you. Review the different variants listed above and determine what is best for you. An excellent online resource is available for you at www.focusonfiduciary.org. This is a web site designed by NAPFA to help consumers differentiate between advisors and salespeople. Also keep your eye out for a coalition that has been formed with the CFP® Board, the FPA, and NAPFA to ensure that the fiduciary standard becomes the minimum standard for financial advisors in the wake of the financial crisis.

I know some of my fee-only brethren will cringe when I say this, but a traditional stockbroker may very well be the best option for some people. They like the whole “hot tip” mentality and like having someone to call to say, “Hey, what do you think of this one?” And for someone who has become a do-it-yourself financial expert, going directly to an insurance agent to buy insurance makes perfect sense. There is absolutely nothing wrong with being a stockbroker or insurance agent. What is wrong is putting on the façade of a fiduciary when sales is the primary objective.

I warn you in advance that most companies in the financial realm will not allow their employees to sign the fiduciary pledge because they’re not willing to take on the liability risk. It is a shame, because I know that there are many good advisors who would prefer to act as a fiduciary. But from your perspective, it should be a no-brainer. Envision for a moment the perfect financial advisor for you has been duplicated. One of the two advisors works for an independent company that conducts all business as a fiduciary; the other works for a firm unwilling to allow the perfect advisor to commit to working only in your best interest. Which one do you choose?

Finally, I encourage you to look for more than a compensation structure in your ideal partner in personal finance. I asked Dick Wagner, the industry thought leader I mentioned, “What is the point of having a financial planner?” He said, “The point is to help people relate to the force of money in their lives.” There are brilliant technical financial planners who could strategize until your eyes glaze over but couldn’t identify with you enough to actually improve your life. And that is the point—for your life to be in some way unburdened or improved. That is going to require more than having the right investment allocation or retirement projection; it requires a relational connection and a deeper understanding that numbers aren’t the end, but the means. I encourage you to interview planners until you find one that is willing to learn about you and your personal principles and goals as part of his or her advisory process.

1. This quote came from an article in Investment Advisor in 2005, and was written by Kathleen McBride.

2. Charles Geisst, Wall Street: A History (New York: Oxford University Press, 1997).