Your new financial advisor has a well-decorated office, a firm handshake, and a bright smile. After an hourlong meeting, you leave with what you think is a state-of-the-art investment portfolio. You feel financially secure, taken care of.
It’s also possible you’ve made a huge mistake.
The White House under President Obama estimated that Americans lose $17 billion a year to conflicts of interest among financial advisors.
Wall Street lobbying groups dispute that math—and they are right to do so.
The actual dollar amount is probably much higher.
A wave of research over the past few years has documented serious problems with how Americans get financial advice.
Susan Shaffer, a 70-year-old retiree in Narberth, Pennsylvania, learned this the hard way as she hired and fired multiple advisors over two decades.
One chose inappropriate investments, including small-cap stocks. Another put her into funds with huge, back-loaded fees. The third promised to charge just $500 a year, then stuck her with thousands of dollars in commission costs.
Each time, Shaffer did her own research. She took classes, pored over dense account statements, and generally did the work she was paying her advisor for.
“You have to keep watching everything. You’re very vulnerable,” said Shaffer, who retired three years ago after a career in the pharmaceutical industry. “Nobody really had my interests at heart.”
Consumers like her say that’s the real problem: Many financial advisors just don’t care what’s best for you. But with an industry awash in misconduct, the bigger issue may be that they aren’t required to care.
You’d be forgiven for assuming your relationship with a financial advisor carries the same sort of solemnity as, say, attorney and client or doctor and patient.
An attorney is bound to zealously represent you; a doctor pledges to do no harm. So why aren’t financial advisors subject to the same duty?
Well, the economics of the industry—fees, commissions, quotas—can end up standing in the way.
The Fiduciary Rule, finalized under Obama and originally set to take effect earlier this year, seeks to cure this disconnect. All advisors were to be required to put clients first when handling retirement accounts, where the bulk of everyday Americans’ savings reside. But then Trump won the election, and on his 15th day in office, the Republican president ordered the Department of Labor to reconsider the rule.
His advisors echoed Wall Street arguments that tying the hands of advisors would limit investor choices, raise the cost of financial advice, and trigger a wave of litigation.
This Friday, the rule will take partial effect. Its future, though, remains deep in doubt.
Many Republicans in Congress oppose it, and Labor Secretary Alexander Acosta has suggested that at the very least it be revised.
Then last week, Trump’s newly appointed chairman of the Securities and Exchange Commission, Wall Street lawyer Jay Clayton, announced his agency would also seek comment on the topic, a process that could further threaten the rule’s survival.
While Washington wrestles with the fate of the Fiduciary Rule, the financial advice landscape remains supremely dangerous.
Three professors recently analyzed a decade of disciplinary data on 1.2 million financial advisors.
At the average firm, 8% of advisors have a record of serious misconduct.
Nearly half of those 8% held on to their jobs after being caught. About half of the rest got jobs at other financial firms. In other words, a year after serious misconduct, about three-quarters of advisors found to have wronged clients are still working.
It gets worse: Some 38 percent of those misbehaving advisors later go on to hurt even more clients.
You might think bigger firms would be more diligent, but you’d be wrong. At some large firms, more than 15% of advisors have records of serious misconduct. The highest was Oppenheimer & Co., where 20% had such black marks. Oppenheimer responded to the study, first published a year ago, by saying it replaced managers and made changes to hiring, technology, and compliance procedures.
Predators typically seek out the weak, and financial advisors are no different: The study shows that those with misconduct records are concentrated in counties with fewer college graduates and more retirees.
The unique nature of the investing business makes it easier to exploit client ignorance.
Investing is complicated, with sometimes-intentionally impenetrable jargon, and customers must trust their advisors in the same way they trust their doctors: If an expert makes a recommendation, you tend to follow it, whether that means getting heart surgery or a variable annuity.
“Some firms ‘specialize’ in misconduct and attract unsophisticated customers,” the researchers write.
More astute investors aren’t entirely at the mercy of advisors.
Certain products are so expensive and so typically underperform that their mere presence in your portfolio can suggest you’re getting bad advice. Variable annuities, high-fee mutual funds, and non-traded real estate investment trusts, or REITs, are good examples. Non-traded REITs charge, on average, upfront fees of 13.2 percent, while delivering returns about half those of traded REITs, which are also much easier to buy and sell.
Another example is the “reverse-convertible,” a complicated product in which a bond payment is linked to the performance of a stock. Banks will create two or more versions of the same reverse-convertible. The only difference is one offers a higher payout—yet investors usually end up choosing the inferior product.
University of Minnesota’s Mark Egan calculated that customers bought over 10 times more of a reverse-convertible with a 9 percent yield than an otherwise identical convertible with an 11.25% yield.
Why? Because that’s what their advisors told them to do. The more lucrative version paid advisors a commission of 2.15 percent, while the inferior one paid 3.09 percent. In other words, advisors could boost their pay by half if they steered clients to an obviously worse investment.
Commissions like these are the traditional way advisors hide costs from investors: Instead of clients paying them directly, companies pay advisers commissions to push their clients toward particular products.
“There’s an ever-present incentive to betray your client’s interest,” said Benjamin Edwards, a law professor at the University of Nevada, Las Vegas. These conflicts don’t just cost investors more money. They also skew the U.S. economy by pouring capital into less productive investments merely because they offer a better “kickback” to advisors, he said.
A perfect illustration of this phenomenon occurred just before the financial collapse of 2008. Researchers conducting a study sent “mystery shoppers” into 284 Boston-area financial advisors.
When clients walked in with the kind of low-cost, diversified portfolio independent experts recommend, only 2.4% of advisors approved of it and some 85% recommended making a change. Financial advisors were eight times more supportive if clients had a less-than-ideal strategy of chasing returns—one that was more likely to generate commissions.