Are Financial Advisors Losing Your Money?

By Tim Parker | April 24, 2012 AAA
Are Financial Advisors Losing Your Money?

So, you've been having a little bit of pain in your stomach. After convincing yourself that the end is near, you make an appointment with your doctor. You describe your symptoms and she tells you that it's nothing that a little bit of Tums won't fix. Much to your surprise it turned out to be minor, but what if your doctor gave you a different answer? An answer designed more for her benefit than for yours?
What if you went in and after hearing you say that you thought it was something serious, your doctor ordered an expensive series of tests that she knew you didn't need but was going to make her more money? Not only is that unethical, but if other doctors join in, our confidence in the medical industry will severely diminish.

Objective Advice
A recent study found that a large number of financial advisors did something similar to the fictitious doctor. In a study unveiled by the National Bureau of Economic Research, most financial advisors failed to give objective advice to their clients. The study's authors hired actors who made 300 visits to financial advisors in the Boston area. Each actor was given one of four investment profiles. Some had an all cash portfolio while others had a balanced portfolio of stocks and bonds. Others acted like the average retail day trader who chased stock performance while the fourth was heavily invested in company stock.

For three out of four of these portfolios, the financial advisors in the study switched them to higher fee actively managed funds or encouraged frequent trading in a majority of circumstances. Only the cash portfolio was met with more conservative advice. The study concluded that the majority of financial advisors will steer clients towards products and services that increase an advisor's income instead of doing what's best for the client.

Ethics
If this makes you even more wary of using a financial advisor, that's understandable, but remember that there are plenty of ethical advisors ready to help you. Advisors fall under two standards. The suitability standard is the most common and only requires a financial advisor to recommend products that are suitable for you. They don't have to disclose any conflicts of interest or put together the most fee-efficient portfolio.

Only Registered Investment Advisors fall under the fiduciary standard. They are required to put your interests above theirs and reveal any conflicts of interest. The fiduciary standard would require that they recommend lower-fee over higher-fee products assuming that the lower-fee product is of equal quality.

What Should You Expect from Your Advisor?
A study released by Fidelity Investments found that investors who didn't change their allocation away from stocks in 2008 and 2009 have performed better than those who took their money partly or completely out of equities. In fact, those who stayed the course performed twice as well as those who made changes.

Quality advisors know that a long-term buy and hold allocation is the best performing strategy over time. They know that attempting to time the market to save you from short term losses isn't a sound strategy. Don't expect your advisor to beat the market. If he tells you that he can beat the market, consider that a big red flag when picking an advisor. If the overall market is going down, your portfolio will as well. Don't expect your advisor to avoid short-term market corrections.

What you should expect is for him or her to construct a portfolio that is based on your personal profile and is low in fees. Expect that they will have semi-annual meetings with you to discuss your goals and adjust your portfolio if needed and finally, and expect them to communicate with you during extraordinary market events.

How to Pick the Right Advisor
According to experts, consumers don't understand how financial advisors work, which causes them to hire the wrong type of advisor. Think about these simple guidelines:

Registered Investment Advisor
This type of advisor is perfect for managing your investment portfolio. Although this advisor can give basic retirement planning advice, that isn't his or her primary area of expertise. In general, fee-only advisors have the fewest conflicts of interest.

Financial Planner
This is a much-abused title because anyone can call him or herself a financial planner. Look for a Certified Financial Planner instead. CFPs will help you put together a plan focused on retirement as well as other large events like college planning. Make sure to ask how he or she is paid. Ideally, pay by the hour if you need very little assistance and guidance in making a plan. Other fee structures may produce conflicts of interest. Most financial planners don't have a fiduciary responsibility.

The Bottom Line
Although some financial advisors failed the ethics test, that doesn't mean that there aren't advisors who will do the right thing with your money. Make sure to talk to at least three before you pick somebody and always rely on word of mouth instead of fancy advertising.

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