SEEKING FINANCIAL ADVICE? LEARN THIS WORD FIRST

Harold’s friend Karen once boasted to him that she didn’t pay any fees to her financial advisor.

KAREN: The funds where he invests my money take care of all that.

HAROLD: Oh, what funds are those?

KAREN: I’m not exactly sure. There are so many. He moves my money between them when he feels some sector isn’t doing well. He outperforms the market by 2 to 3 percentage points, and the funds pay his fees.

Must we tell you that Karen’s investments carry high fees? And that her broker likely gets paid every time he moves her in or out of an investment?

Almost all of us believe that when we sit down to receive financial advice, the person we meet with—no matter who this person is—is duty-bound to act in our best interests:

Luckily, there’s a simple word that can help you find good financial advice. This word is so powerful that the vast majority of the financial services industry would rather you not know it. This word lets you know if the people or companies you sought out for financial advice have a duty to put your best interests first, or if, alternately, they can prioritize their own bottom line at the expense of your own.

This word is “fiduciary.”

THE FIDUCIARY STANDARD VERSUS THE SUITABILITY STANDARD

A fiduciary is a financial advisor who has a legal and regulatory duty to put your interests ahead of his or her own.

A financial advisor working to the fiduciary standard

1. has a legal duty to act in your best interests; and

2. is not getting paid to steer you into buying overpriced investment products you don’t want or need.

A majority of men and women offering financial advice don’t work to the fiduciary standard. Instead, they work to something called the suitability standard. The best way to describe this standard is to say that it’s the “it’s okay if it’s basically okay” standard for care.

How does this work in practice? Well, let’s pretend you are shopping for a dress to wear to a friend’s wedding. If you went to a store where the saleswoman was working to the fiduciary standard, she would have to ask you where you planned to wear the outfit. She’d inquire about your budget. As for the actual outfit itself? It would need to be flattering, the right color and fit for you. If it needed alterations, a nearby tailor could perform them inexpensively.

Now let’s say you go to the store where the salespeople need to meet the suitability standard. The saleswoman is under no obligation to find you the best deal. The dress she finds might be a little too big. She might recommend a dress that needs significant and expensive alterations. She could recommend one item over another because she receives a larger commission and not tell you. She’s probably not an evil person. She wants you to look good. But her advice is influenced by her own bottom line.

This is all legal. She provided adequate or suitable service.

Yes, we know we all shop for clothes that way. But, well, that’s clothing. Make a mistake, and you are out maybe $50. Financial advice, on the other hand, is all-important. Make a mistake, and you could be living with the consequences for the rest of your life. And the worst part of that? You might not even know you could have done better.

You are unlikely to ever find out that the person you believe is giving you the best, most objective financial advice on how to handle your life savings is actually steering you toward investments that are more likely to boost his bottom line than your own. Why? He doesn’t need to tell you. There is no requirement that someone working to the suitability standard inform you that there is a higher standard out there or that he is receiving a significant sales bonus for steering clients toward one investment over another that would cost the customer less.

THE ONLY CREDENTIAL THAT MATTERS: FIDUCIARY

At last count, there were more than two hundred titles would-be financial consiglieri can use to convey knowledge, integrity, and expertise to their customers. There are “chartered college planning specialists” and “retirement management analysts.” Merrill Lynch now has “trusted financial advisors,” a title presumably meant to distinguish them from all those less-than-trustworthy financial advisors at the brokerage. And according to the Consumer Financial Protection Bureau, there are more than fifty designations designed to indicate expertise in the financial matters of senior citizens alone.

Many of these terms are about as official as “designated driver,” designed mainly to make someone sound important and increase their sales of everything from annuities to estate-planning tools. There are “senior experts” and “registered senior investment advisors.” Something called an accredited retirement advisor requires zero in the way of course work and has no accreditation status whatsoever.

As for the popular and common term “financial advisor,” it means precisely nothing. Whether “advisor” is spelled with an e or an o, it still doesn’t matter.

None of these designations contain the word “salesperson” or “broker,” but that is, in fact, exactly what many of these people are.

They make a living by selling you financial goods and services while acting as a disinterested giver of advice. All too often, they drown out the advisors who are working in their clients’ best interests.

THERE IS NO SUCH THING AS A FREE LUNCH—OR DINNER

Unfortunately, it’s not that easy to meet an advisor working to the fiduciary standard. Why? They are often not the ones glad-handing, looking to meet clients.

Take the popular financial information lunches and dinners sponsored by those seeking to sell their financial 411. If you are over the age of fifty-five, you most certainly are familiar with this game. For the remaining youngsters, let us explain. All too often, those approaching retirement age receive solicitations inviting them to a complimentary meal at a local and well-regarded restaurant.

These events are ridiculously common—so much so that a few years ago AARP determined that if you were over the age of fifty-five, you had a one-in-ten chance of having attended one such event within the past three years. Just how bad are these seminars? Another study found that more than half the sales pitches reviewed by the surveyors contained exaggerations, false information, or other misleading statements. That doesn’t count the 13 percent that could be described succinctly by the word “fraud.”

The people who sell these products are good at what they do. Their primary job is to sell their financial wares. They promise to solve our very real problems, and to address our entirely legitimate fears. Often, the first item in the playbook is to prey upon our mistrust of the government. Since writing and doing the reporting for Pound Foolish, Helaine has sat through many such meals over the years and has been repeatedly told that Social Security and Medicare are doomed—or at least bound to be drastically cut. Taxes are going to rise. She’s in immediate danger of not being able to pay for her children’s college. She will outlive her retirement savings. The solution? Whatever financial vehicle the broker making the presentation is pitching.

It’s easy to assume that you would resist the hard sell. But it’s possible you wouldn’t. Under no condition should you attend these events. Helaine and Harold know no one who has been invited to a meal where simple budgeting strategies or low-cost index funds were discussed. Instead, the supposedly expert financial whiz leading the seminar is always selling a high-cost and often subpar-return product. Remember Harold’s favorite phrase: “If it’s free, you are the product.” You might also consider his second-favorite saying: “If you sit down for cards, and you don’t know who the sucker is—you do.”

YOUR FINANCIAL ADVISOR IS NOT YOUR FRIEND

You’ve seen the ads. You’ve heard the promos. Merrill Lynch promises “trusted advice and innovative solutions for affluent individual investors.” Banks like JPMorgan Chase say they establish strong personal relationships with their clients.

Well, yes, but . . .

The fact is many brokers are smart and nice. They’ll commiserate with you about getting your ten-year-old to do his homework so you can worry about paying for Harvard. They understand that for many of us money is an intimate matter and that we hunger for sympathy and advice.

It doesn’t matter. Your friendly neighborhood brokerage or bank is not a place to go for nonconflicted, fiduciary financial advice, any more than an appliance store is the best place to ask whether you really need a 3-D TV. A recent survey published by the New York Times proves the point. When Morningstar, the prominent investment research firm, reviewed the mutual funds offered by Goldman Sachs, Morgan Stanley, JPMorgan Chase, and Wells Fargo, it discovered a majority had underperformed their benchmarks for a decade.

Why do we fall for it? In many cases, you’ve been hearing the names of these brokerages and banks your entire life, and you consider them reliable and safe. But that’s not the track record. For all too many of them, their customers are a lucrative revenue stream. Whether on salary or commission, frontline people and brokers are under intense pressure to meet sales quotas for various financial products. From “alternative investments” to “structured products” and simple mutual funds, most of what they have to offer will cost more, might well come with more risk than you realize, and will underperform a simple index fund.

Remember: Stock picking doesn’t work. But your friendly neighborhood banker and broker have no obligation to share that information with you. Their business model (and often their self-image) rely on the belief that they are your friends and they can guide you through the financial maze, allowing you to triumph over—and often do better than—the markets.

It’s a pretty good business model.

This is where Helaine likes to cite one of her favorite academic studies ever.

A group of professors hired a group of actors to play the role of consumers seeking financial advice. They gave the actors specially designed faux portfolios and sent them to a selection of leading brokerage houses and banks. The result? Over and over again, would-be clients with perfect portfolios in well-diversified index funds were told to invest in high-fee investments, including managed mutual funds. People with imperfect portfolios were given imperfect advice; less than 10 percent of the brokers tested without their knowledge told their would-be clients to put their money in low-cost index funds. And just for an added kick, women were treated resoundingly worse than men and were more likely to receive financial advice from someone who didn’t even bother to ask about their overall financial profile.

As if all this weren’t depressing enough, almost none of the guinea pig clients had a clue about what had just happened. When the researchers asked them what they personally thought of the broker they had met with, 70 percent—yes, 70 percent!—said they were so impressed that they would consider returning with their own real-life investment portfolio in hand.

Lest you think this is only an American problem, a 2014 study examined the experience of Canadian consumers with financial advisors. On average, the advisors encouraged their customers to own more stock and earn about 1.7 percent higher annual returns. Unfortunately, the advisors charged a whopping 2.7 percent annual fee. This wiped out the advantages associated with stock ownership while leaving clients exposed to greater risk.

Take it from Melissa. She’d wisely put her funds in a low-cost group of index funds. But when her grandmother died and she received a small inheritance, she planned to move the money over to her main account. That is, until she spoke with her mom’s financial advisor. He was friendly and sympathetic and promised to take care of everything. So she left him in charge of the newly acquired money.

Two years later, Melissa read an article about how fees can eat away at investments. Curious, she took a look at her own portfolios. Her original one was doing fine—low-cost index funds. But the one managed by the supposedly friendly broker? It had experienced significantly slower growth. When Melissa investigated, she discovered the fees were more than double those in her original portfolio. “I felt like such an idiot,” she said. “I was taken in by a charismatic salesman.”

IF YOU WANT GOOD ADVICE, PAY FOR IT

Do you work for free? Neither do financial advisors.

If you want unconflicted financial advice, you almost certainly have to pay for it.

Very few of us have any idea of how much we are paying for financial advice. According to a 2011 survey by Cerulli Associates, a market research firm, one-third of us thought we were receiving a free service when we turned to a broker for financial advice. Another third admitted to absolute befuddlement about how someone would be compensated for investment strategies.

This isn’t because we are uniquely stupid. It’s because it is not in the interests of almost anyone doling out financial advice for you to realize how much his counsel is going to cost—or that it is going to cost you anything at all.

Financial pitches are littered with promises of “free consultations” and “no charge for meeting.” The financial advisors using them can get away with making these claims because they will indeed not get paid until they make a sale. Then all too many will receive a commission for pushing one financial product over another.

Helaine calls this the culture of commission. It can work a number of different ways. In one case, the financial advisor takes money right off the top. This is called a load, or a front-end fee. So let’s say you are seeking to invest $100,000 in a fund with a (whopping but not atypical) 5 percent load. You’ll pay $5,000 off the top for that investment.

There are also back-end loads. All of your money goes into the mutual fund or annuity, and the financial services company pays the broker his or her fee. Sounds like a bargain, right? Not exactly. In exchange, you agree to not move your money for several years or pay a substantial penalty for the privilege of doing so should the investment not work out or you change your mind.

Then there are trailing fees. That means the advisor selling the financial investment receives a commission for the sale for as long as you hold the investment. This is often around 0.5 percent, and it comes out of your investment year in and year out, regardless of whether it performs well or falls in value. If you stop to think about this, it obviously adds up.

Altogether, the Obama administration estimates that what it calls “backdoor payments and hidden fees” in the retirement savings industry are costing Americans up to $17 billion annually. And that’s just for individual retirement accounts. Even the best, most well-intentioned broker is going to have a tremendous incentive to give you financial advice that will boost his own bottom line.

There are some fiduciaries who work on a commission basis. But that arrangement is uncommon. If someone is truly working to advance your financial best interests, why create an additional incentive to mess with your investments?

BEWARE THE FEE-BASED ADVISOR

Beware of the term “fee based.” This is another one of the junk terms littering the financial advice industry. It means the advisor in question can charge a flat rate, but he or she might also work to commission. Some non-fiduciary brokers will also charge their clients for their advice, leaving the impression their advice is unbiased and meets the highest standards of care.

One way this works: The advisors charge a fee of up to several thousand dollars for sitting down with you and creating a formal financial plan. They then get to double dip, receiving commissions for the mutual funds, insurance, and other financial products they recommend you purchase as part of their plan. Unless you ask hard questions up front, you are unlikely to realize what’s going on until you receive the formal advice—if at all.

Unfortunately, this is perfectly legal. There is only one way to avoid falling victim to a fee-based advisor. Never assume someone is a fiduciary. Never assume he doesn’t ever work for commissions. Always ask.

You want to seek out an advisor who works on a fee-only basis. This means the advisor is paid by you—and only by you. That payment can take a number of forms:

Percentage of assets under management: This is an annual fee based on the amount of assets you are seeking advice on. The percent can range from as little as 0.15 percent for some of the online advisory services to 2 percent. (By the way, we think 2 percent is way too high a price to pay for financial advice.) Many advisors charge a sliding scale, with the percentage charged falling as the amount gets greater—for example, 1 percent charged for the first $500,000 and then 0.5 percent on the rest of the sum.

Flat fee: This is the financial advisor equivalent of a prix fixe meal. The financial advisor agrees to charge you one rate for a package of agreed-upon services. Perhaps that includes a budget review and overall financial plan. Or maybe it’s a get-out-of-debt package.

Hourly rate: You sit down with a financial advisor. He starts a clock. You pay by the hour for the advice. This can cost as little as $50 an hour for a financial coach, the sort of person who doesn’t make investment recommendations but can help you devise a budget and get-out-of-debt plan, to $250 to $500 an hour for someone with a certified financial planner credential.

If you’re used to getting a service “for free,” it’s hard to pay real money for it. We understand that. But it was never free advice. You only thought it was a complimentary service. Not only didn’t you know you were being charged, but you didn’t know how much of a bill you were paying.

HOW DO YOU FIND A FIDUCIARY?

So what is a fiduciary?

These are credentials that indicate someone is almost certainly working to the fiduciary standard:

And how can you find one of these people? One way, of course, is to ask. Another is to call or e-mail some of the organizations that represent them. They include both accreditation organizations and certain financial planner networks that will only work to the fiduciary standard. They include the following:

And how do you make certain someone is a fiduciary? You need to ask and ask quite specifically: Do you work to the fiduciary standard at all times? This last part, “at all times,” is important. As the fine print on brokerage forms indicates, the fact that an advisor commits to a fiduciary standard for some of her dealings with you does not hold her to this standard in others, even if she is providing detailed information and guidance. For example, even though CFPs are supposed to adhere to the fiduciary standard, there is a little loophole whereby they don’t need to act as fiduciaries if they are simply selling financial products and not offering planning services.

There is, unfortunately, no way around this question. If you ask someone if he is committed to offering advice in your best interests, a less-than-ethical financial salesperson could respond, “Would I ever not do that for you?” And you would be none the wiser.

Can these questions feel awkward? Sure. But again, if a financial advisor attempts to make you feel uncomfortable for asking, you should not be working with him or her.

Tara Siegel Bernard, a personal financial writer for the New York Times, recommends taking this even a step further. Never mind asking about the fiduciary standard. “Ask them to sign an oath stating they will act as fiduciaries,” she writes. She suggests one put together by the advocacy group the Committee for the Fiduciary Standard.

Putting Your Interests First

I believe in placing your best interests first. Therefore, I am proud to commit to the following five fiduciary principles:

I will always put your best interests first.

I will act with prudence; that is, with the skill, care, diligence, and good judgment of a professional.

I will not mislead you, and I will provide conspicuous, full and fair disclosure of all important facts.

I will avoid conflicts of interest.

I will fully disclose and fairly manage, in your favor, any unavoidable conflicts.

ADVISOR FIRM AFFILIATION DATE

Someone who is legally obliged to act in your best interests is almost certainly going to be happy to share that information with you. She’ll likely welcome the question. It will make her look better to tell you that she is legally bound to put your interests ahead of her own. You and your family are trusting your advisor with a lot of money, maybe your life savings. You’re entitled to ask her about her obligations to you.

CONSIDER USING ROBO-ADVISORS

Robo-advisors are the newest advisors on the block. Less than ten years old, these companies use computers in place of the human touch. Instead of sitting down with an advisor, would-be investors answer a series of questions about their financial history, goals, obligations, and risk tolerance. The algorithms then suggest a series of investments.

The fees for these companies vary, but they are significantly lower than those for traditional advisors. Robo-advisors have proven so popular that some mutual fund families and discount brokerages are starting their own. And no wonder. The advantage of the business model is obvious. Robo-advisors bring down the price of advice to something almost anyone can afford.

Not all online investment schemes are created equal, however. Some companies specialize in helping you select the right mix of low-cost index and exchange-traded funds, but other robo-advisors encourage you to trade individual stocks, options, and other stuff that should have no role in your life. Still others claim to offer the service for free but are making money in hidden fees.

No matter how good it sounds, you still need to ask if a robo-advisor is a fiduciary.

FIDUCIARY OR SUITABILITY, YOU STILL NEED TO DO DUE DILIGENCE

Finally, we need to add a disclaimer. Seeing a fiduciary and paying for your own financial advice are no guarantees. You will still need to do due diligence. But you are more likely to be on firmer ground.

There are numerous places to look up your financial advisors’ records, and, unfortunately, you might well need to check in more than one place. Check most brokers at the Financial Industry Regulatory Authority. If you are thinking of working with a certified financial planner, the CFP Board maintains disciplinary records on its members. State regulatory authorities also maintain databases. Our advice: Check them all.

You work hard for your money. Sometimes you will want advice on how to best handle it. Many of us can benefit from an objective, outside eye. The good news is—tough economic realities or not—you can still boost your own bottom line when you get aid. Just use the word “fiduciary.” It just might change your financial life.