The Importance of Independent Advice
Investors are better off when they receive independent advice. But, the concepts of independent advice and independent advisors are very confusing to them. For example, most investors don't know the importance of independence or how to measure the objectivity of the advice or sales recommendations that they receive from their advisors.
Independence is further obscured by companies and advisors who have something to hide. They don't want investors to know their advice is tainted by self interests that increase company profits and advisor incomes. It's safe to say they are very skilled at hiding information they don't want investors to have.
What is Independent Advice?
Independence is a critical characteristic that impacts the quality of advice that investors receive from financial professionals. Independent advice has four primary characteristics:
- Advice is always in the investors' best interests
- Advice is free of any potential conflicts of interest that damage investors
- Advisors who provide independent advice also practice full disclosure
- Advisors are compensated with fees for their knowledge and services
Investors' Best Interests
Companies, executives, and advisors want to control investor assets so they can achieve their goals for revenues, profits, and incomes. Investors are dependent on the same assets to achieve their goals for comfortable retirements and financial security late in life. The critical question is who's financial interests come first?
- The shareholders who own the companies?
- They want profits that drive share prices
- The executives who run the companies?
- They want profits that drive bonuses and stock options
- The advisors who market the companies' products and services?
- They want income to pay for their lifestyles
- Or, the investors who own the assets?
- They want to achieve their financial goals
The answer to this question will vary by company and advisor and it will be based on their ethics and willingness to tell investors the truth.
Independent Advice: The willingness to put investor interests first eliminates most potential conflicts of interest.
Conflicts of Interest
Let's assume a fictitious company we'll call Acme Financial produces products that make the company a lot of money - for example mutual funds, annuities, and life insurance. The products deliver below average returns for above average expenses. Acme sales representatives are required to market the products even though investors would be better off with unrestricted choices. This major conflict of interest impacts hundreds of brand name financial services companies that produce their own products and services.
Other conflicts of interest are more subtle, but all of them damage the financial interests of investors. For example, advisors who are new to the industry describe themselves as investment experts because it helps them sell products. They fail to disclose they are new because investors might not buy what they are selling. They put their need to sell products ahead of the investors' need to buy from professionals who have knowledge that will help them achieve their financial goals.
Independent Advice: Investors should only select advisors who are willing to document they have no potential conflicts of interest.
Full Disclosure
Advisors who provide independent advice are willing to practice full disclosure because they have nothing to hide. They realize consumers need objective information when they select advisors. They also know written information is more reliable than information that is communicated verbally in advisor sales pitches. Investors benefit because they can use the information to screen-out weak, conflicted advisors and select competent, ethical, independent professionals. These advisors provide documentation that includes:
- A rating by an independent third party that compares their quality to other financial advisors.
- A professional profile that documents their credentials, ethics, business practices, and services
- A disclosure statement that describes potential conflicts of interest
- A Code of Ethics that describes their principled treatment of investors
Independent Advice: Only high quality, independent advisors can afford to be rated and practice full disclosure. Lower quality advisors don't want to disclose their weaknesses and conflicts of interest.
Advisor Compensation
Commission compensation creates additional conflicts of interests that may damage the independence of the advice that investors receive from their advisors. Some of the conflicts that surround this method of compensation include:
- The sources of commission payments and their interests
- Third parties pay commissions to advisors who sell their investment and insurance products (mutual fund, annuity, and life insurance companies)
- Broker/dealers pay commissions when investors buy or sell securities
- Advisors are paid commissions to sell products
- Advisors aren't compensated to provide ongoing advice or services.
- Advisor licensing permits them to sell products and receive commissions, but it does not permit them give advice.
- Advisor compensation is not impacted by the achievement of investor goals.
Even though third parties pay commissions to advisors for selling their products, this form of compensation is ultimately paid by investors. That's because companies raise the fees they charge investors or they create additional fees to cover their commission costs. For example, mutual funds charge 12b-1 fees to investors to offset their marketing expenses.
Independent Advice: Independent professionals are paid directly by investors because they charge fees for their knowledge and services. Investors know what they are paying and what they receive for those payments. There are no third parties interests when investors pay directly.
The Independent Advisor
There are several characteristics that describe high quality professionals who provide independent advice:
- They are Registered Investment Advisors (RIAs) or Investment Advisor Representatives (IARs)
- When they have securities licenses, the licenses are held by independent broker/dealers that do not manufacture investment or insurance products.
- They are acknowledged fiduciaries which means they are held to the highest ethical standards in the financial services industry
- They practice full written disclosure for information that impacts the achievement of investor goals
- They are compensated with fees like other professionals (CPAs, attorneys)
- They provide sophisticated wealth accumulation and preservation services that deliver results in complex financial markets
Authored by Jack Waymire
- Co-founder of www.PaladinRegistry.com
- 32 Years of financial service industry experience
- CEO and Chief Investment Officer for 21 years
- Author of the best-selling book, "Who's Watching Your Money?"
This editorial is for information purposes only and is not intended to be financial, tax, or legal advice. We strongly recommend you use the services of a qualified professional for these types of advice and services.
