It’s funny. All you have to do is say something nobody understands, and they’ll do practically anything you want them to.
—J. D. SALINGER, THE CATCHER IN THE RYE
If you’re reading this book as a financial advisor, grappling with the labyrinth of the financial services realm, you are likely familiar with the sentiment we are about to explore. Daren’s transition from a career in organizational development to the world of financial planning exemplifies this journey. Joining a prestigious brokerage, he was a beacon of enthusiasm, believing wholeheartedly that his mission was to secure his clients’ futures, one portfolio at a time. Daren embarked on his professional journey with unwavering dedication and immersed himself in learning every facet of the business—financial planning intricacies, client relationships, and the cultivation of his clientele. His resolve to absorb copious knowledge and excel in his profession was unwavering. He thrived on the challenge and the ever-evolving landscape of the financial services sector.
Yet, at the heart of Daren’s endeavors was an unwavering commitment to serving and advocating for his clients’ best interests. However, as his understanding deepened, the stark realities of operating within the brokerage world grew increasingly difficult to reconcile. Beneath his optimism lay a far more complex and challenging reality, filled with ethical dilemmas that tested his resolve.
The early years were a whirlwind, concealing the inherent conflicts of interest beneath the sheen of clients’ initial enthusiasm. I was admittedly blind to the conflicts lurking beneath the surface, overshadowed by the euphoria of new beginnings. In a landscape starved of reliable information, exploring alternative financial advising methodologies was akin to navigating a dense fog.
The industry was fraught with pitfalls, with brokerages and insurance agents vying for dominance, each peddling their wares with little regard for the consequences. It took years of piecing together fragmented insights from disparate sources, sporadic conversations, and the occasional trade publication to fully grasp the industry’s true nature.
As I delved deeper, I became a self-taught expert in deciphering the intricate web of nuanced business models—from insurance agents to broker-dealers, RIAs, and the hybrid monstrosities that straddled the line between independence and servitude, each with their own self-serving agenda.
Brokerage firms emerged as the epitome of Wall Street’s profit-driven machinery, prioritizing the sale of financial products over genuine client welfare. Meanwhile, insurance agents peddled insurance as a panacea for all financial woes.
Despite the facade of independence touted by modern brokerages, dually registered independent firms merely echoed the structures of their Wall Street counterparts, blending financial manufacturing with a semblance of autonomy. The emergence of broker hybrids further muddied the waters, blurring the lines between fiduciary duty and profit-driven brokerage.
While at the firm, I encountered a deliberate lack of education on alternate business models, but who am I kidding? Brokers, driven by profit motives, prioritize their interests over client welfare. This calculated ignorance extends beyond my firm; it’s an industry-wide phenomenon. Companies intentionally keep their employees uninformed to maintain control, preventing them from exploring better alternatives.
I realized the extent of their manipulation when my firm restricted interactions with advisors from other companies. This isolation mirrors the tactics of authoritarian regimes, perpetuating a distorted superiority while withholding contrasting information.
Despite the allure of lucrative incentives, I eventually realized the compromise wasn’t worth it. I chose to break free from the shackles of the brokerage world, driven by a desire for ethical alignment rather than financial gain.
Change begins with questioning the status quo, even when the answers are uncomfortable. Ignorance may offer temporary comfort, but it stagnates progress. This book aims to illuminate the shadows of ignorance within our profession. While employers may prefer us to remain uninformed, knowledge empowers us to make informed decisions. Let’s unravel the complexities within these pages together.
This actuality is not negligent on the part of the companies. The deliberate concealment of information within corporate entities is mere oversight—a calculated strategy to keep employees in the dark. Companies meticulously orchestrate a state of ignorance among their workforce, shielding them from alternative arrangements that might challenge the superiority of their own models. My own experiences underscored this reality vividly.
During my tenure, my firm whisked me across the country to meet with fund families and acquaint myself with their products. Yet, they barred me from engaging with advisors at competing firms. It was a systematic effort to perpetuate our ignorance about potentially better alternatives in the industry. This isolation was akin to working for an automotive giant like Ford and being barred from interacting with counterparts at Toyota or General Motors for fear that you would discover that competitors had better processes, pay scales, or customer service models. It sounds a little insane on its face, and in the apparent sense, it was. Yet, it’s oddly accepted.
I now comprehend the motives driving this orchestrated ignorance—and why the big firms went to such great lengths to perpetuate it—an insatiable desire to instill blind faith in the superiority of their business model. They wanted us to drink only their Kool-Aid concerning the superiority of their model, approach, culture, investments, and so on. It was akin to living in a communist state where citizens are brainwashed on the virtues of an idea by a robust propaganda system and denied access to contrary information.
However, our propaganda tools served the ultimate in capitalism—we were incentivized to make boatloads of money for them, and, in turn, we made boatloads of money for ourselves. Eventually, the money became too good to rock the boat. Yet, despite the allure of substantial financial gain, the compromise proved untenable. Despite making tons of money by the time I chose to leave the brokerage world, I knew deep down the compromise was not worth the paycheck, so I made a change.
You may be wondering, if we lived in these insular worlds enforced by the paranoid politburo in corporate headquarters, how did we learn about the alternatives?
Carmine’s story embodies this profound awakening. His pursuit of knowledge, ignited by his collaboration with a business coach in 2008 and interactions with a network of independent advisors, shattered the veil of ignorance that once clouded his vision. Seeking external perspectives and witnessing advisors genuinely advocating for their clients’ best interests sparked a seismic shift in Carmine’s worldview.
This pivotal experience pried Carmine’s eyes open, aligning with his growing unease regarding the delicate balance between serving his clients and tending to his family’s needs. He gradually realized that his professional pursuits were shackled to a system where preserving his financial rewards and affiliations necessitated compromising his integrity. It dawned on him that maintaining quotas and pleasing the company often required him to prioritize sales over the genuine well-being of his clients, forcing Carmine to work with clients that were not ideal to his practice in order to sell them insurance products.
When you start asking questions and find that the answers leave you unsettled, it sets in motion a chain reaction of transformation. Far too often, we cocoon ourselves in a false sense of security, opting to disregard the uncomfortable truths that confront us. Change is a formidable force, demanding courage and resilience to break free from the clutches of ignorance. When answers no longer suffice, change becomes inevitable. Let’s not consign ourselves to the darkness of ignorance—let this book be our beacon of enlightenment.
We, however, don’t want anyone else to live in a dark hole of ignorance about our profession. While your employer may prefer to keep you in the dark, this book stands as a beacon of knowledge, guiding us to unravel the complexities of our field right here, right now. Together, let us decipher the mysteries and emerge stronger, armed with understanding and clarity.
Let’s explore the intricacies often overlooked by many financial professionals: the distinctions between nonfiduciary, fee-based, and fee-only models.
In the realm of financial services, the modus operandi for insurance agents and registered representatives revolves around the concept of “suitability.” They recommend financial products they deem “suitable” for their clients, earning commissions (and often bonuses) through transactions. Yet, herein lies the disconnect: these agents benefit from buying and selling specific instruments, sometimes proprietary, regardless of whether they truly serve the client’s best interests.
The commissions involved are often invisible or opaque to the client, buried within convoluted statements that fail to highlight the full extent of fees.
Instead, statements disclose certain fees while frequently burying additional (and often substantial) fees within the dense, convoluted fine print. These transactions might not always align with the client’s best interests; in fact, we know that transactional costs can have detrimental effects on client portfolios. Therefore, the more activity within the client’s account, the more likely the client’s financial well-being will suffer.
Furthermore, these insurance and brokerage commissioned agents are enticed with lucrative bonuses and extravagant incentives for peddling high-profit instruments, fostering a culture where transactional gains supersede genuine client welfare. This ethos, or lack thereof, undermines the mere essence of morality, as the emphasis shifts from building lasting client relationships to driving sales figures. The incentives are purely transactional and sales-based, while the rhetoric is about relationships. This fundamental disconnect is questionable at best, of course. Still, it can get lost in the fog of battle—the battle to earn that delicious-looking vacation to Tahiti that the company dangles before its sales force.
It’s essential to tread carefully here. While acknowledging the well-intentioned individuals within Wall Street giants, we must confront a system engineered to line the pockets of financial institutions operating under the cloak of “suitability.” After all, once upon a time, when the Department of Labor planned to force all the advisors to act in the “best interest” of their clients when handling retirement money, annuity sales were slashed overnight.
Clients often find solace in these arrangements, shielded from the true extent of their advisor’s earnings and unaware of potentially superior investment options. As we often assert, if clients are unaware of their fees, they likely surpass their expectations. The commission-based structure often leaves clients unknowingly forfeiting substantial sums, as the system intentionally obscures these realities.
A survey by the Financial Industry Regulatory Authority’s (FINRA) Investor Education Foundation sheds light on the pervasive lack of transparency, revealing that a significant portion of investors (31 percent) remain oblivious to their investment fees.2 Many (60 percent) fail to grasp the costs associated with financial professionals’ advice, highlighting a concerning trend of uninformed decision-making within the financial realm.3
These percentages don’t add up, as someone might fall into two of the three categories. Still, it is evident that most investors consulting a financial professional are entirely unaware of what it costs them—if they are even aware that they are paying.
When starting my career, a friend steered me toward a prominent insurance company where the local manager oversaw a sizable team of over thirty agents. It quickly became apparent that my aspirations to become a CERTIFIED FINANCIAL PLANNER™, prioritizing a meticulous planning process and adhering to stringent ethical standards, were at odds with the company’s ethos. My manager incessantly questioned my desire to pursue the CFP® designation, asserting that true client service was synonymous with selling the company’s purportedly superior products.
And to sweeten the deal, the company dangled extravagant, all-expenses-paid vacations as rewards for peddling these products, which conveniently lined the company’s coffers with hefty profits. While some of these products often did benefit the customer, that was merely a serendipitous side effect. (OK, truthfully, I didn’t use the term “serendipitous side effect” myself. Daren gave me that line and spelled it for me. I’m pretty sure we don’t have serendipity in New Jersey. Sometimes we’re lucky, though.)
The primary function of these products was to boost the company’s stock performance by a fraction of a cent. When I reached my breaking point, exacerbated by the company quadrupling its product sales quotas, I decided to bid farewell to the behemoth insurance outfit. My manager’s dismissive response, suggesting I explore unscrupulous tactics, like selling off clients’ bond holdings to fund whole-life policies (what the company deemed “bond alternatives”), was the final straw.
The company’s fixation on life insurance as a panacea for every financial woe was absurd—akin to the proverbial hammer and nail scenario where every problem was treated as if it were a nail. We used to joke that if your knee hurt, you could rub some whole life insurance on it, and you’d feel better. The pervasive cloud of cognitive dissonance (thanks for that psychological construct, Daren!) that enveloped my colleagues failed to sway my conscience; I refused to succumb to the allure of easy profits at the expense of ethical integrity.
At that point, my resignation was a done deal (or what Daren would call a fait accompli). The depressing climate in which we operated convinced all my colleagues that this was a reasonable way to go through life. I’m happy to say that my conscience was not so easily bamboozled.
Fee-only advisors represent a departure from the traditional commission-based model embraced by agents. Their fees are explicitly disclosed at the outset, typically as a percentage of total assets under management—and are deducted directly from the client’s portfolio. While alternative structures such as fee-for-service, subscriptions, hourly, or flat fees have gained traction in recent years, we’ll simplify by grouping them together at one end of the spectrum. The debate over which approach best serves clients is an ongoing one.
This model offers several distinct advantages. It is a vastly superior arrangement for several reasons. First and most prominent is the transparency it affords. Clients are fully aware of their financial advisor’s fees, enabling them to gauge whether the value justifies the cost. The usual fee amounts to 1 percent of a client’s assets under management. Thus, for a family with a portfolio worth a million dollars, the annual fee would be $10,000. While this may seem substantial, contributing 1 percent of added value to a portfolio of such magnitude is relatively straightforward for a competent financial advisor. Indeed, there are instances where, in just a single day, I have assisted a client in earning an additional 1 percent or prevented them from making a mistake that could have resulted in a 1 percent loss.
It’s important to recognize that the $10,000 we charge is only a small fraction of what a large insurance company or brokerage extracts from a million-dollar portfolio annually; it’s simply concealed within spreads, margins, and kickbacks. By engaging an independent fee-based advisor, you avoid paying for extravagant office towers, relentless television advertising campaigns, or the hefty CEO salaries typical of big insurance companies or brokerages. A closer look at company payouts to advisors, which we’ll explore more later, reveals significant disparities between major national companies and independent brokerages.
The second reason investors should choose to work with an advisor who charges a fee, not commissions, is the dovetailing of interests. Under this arrangement, the financial advisor increases their income when the client’s assets grow and earns less when their value declines. Their fortunes rise and fall in tandem; thus, clients can trust that their advisor is financially incentivized to act in their best interest. Moreover, the financial advisor has no vested interest in generating transactions or selling proprietary products that don’t enhance the portfolio’s value. With interests aligned, the fee-based financial advisor always serves the client’s best interest.
A message to the fee-only crew. We’re not trying to dismiss your argument that “fee-only” is cleaner. We also have a perspective that suggests “fee-only” and “fee-based” offer trade-offs. Neither is superior; let’s first work to end the commission-based “suitability” issue, and then we can fight over fee-only versus fee-based. We can be allies for the time being.
You may have noticed that we muddied the waters by talking about fee-only advisors at the start and fee-based advisors at the end. We did this because the Certified Financial Planning Board stipulates that anyone who sells insurance, has an insurance license, or works in the same company as someone with an insurance license cannot call themselves fee-only. Insurance products spin off commissions. Why is that an issue?
Insurance commissions are an issue because they create an inherent conflict of interest. We do believe asset protection is critical to any financial plan. Fortunately, insurance products are becoming more transparent, and fee-based options are becoming available. However, these fee-based options do present their own issues. When appropriately employed, insurance can be a valuable tool in a financial plan. (We also rarely sell annuities, which we are generally allergic to, but occasionally feel that they may be valuable to a client in a narrow set of circumstances, particularly one requiring a guaranteed payout in retirement. When we do use them, we use a fee-based option.)
The bottom line is that anyone who could experience an adverse event and could go bankrupt should have insurance to protect their assets. Homeowners insurance, life insurance, long-term care insurance, and other products all have a place in most financial plans, including ours. We’re both breadwinners and fathers who want their wives and children protected if something happens to us. A financial advisor not considering insurance as part of a client portfolio is probably only partially doing their job.
The problem with insurance is that it is often sold and classified as a financial instrument rather than one providing asset protection. These sorts of products pop up periodically, such as whenever the CEO of a big insurance company has a payment coming due on their yacht. The products are designed to enhance the corporate bottom line and provide agents in the field with something new to sell to clients, emphasizing all the fancy bells and whistles attached without mentioning the hefty fees they will yield. Thus, the financial regulators exempted insurance from the fee-only claim.
Fee-based advisors represent a departure from the traditional commission-based model embraced by insurance agents. However, they can also sell insurance products as long as they are not variable products for which they receive commissions. Again, eliminating these options from the menu of services we can offer our clients strikes us as contrary to their best interests. If we find a financial instrument that is in our client’s best interest we will advise the client to purchase irrespective of whether it delivers a commission to us; this represents a minuscule percentage of our income. The difference is a fee-based advisor has to “act in the best interest” at all times instead of abiding by the “suitability” standard. There can be no holidays in this standard.
Some advisors want to keep their hands pristine and be able to maintain the claim that they are fee-only. We understand that position and certainly are much more simpatico with them than with commission brokers. We feel that they are punting on a critical element of their client’s financial plans and not offering expertise that would benefit their clients. We build our books of business on deep personal relationships, and our clients know we would never steer them wrong on insurance.
Even if it were merely a matter of enlightened self-interest rather than our genuine concern for our client’s well-being, it hardly makes sense for us to jeopardize our relationship on a tiny commission when nearly every penny we earn is fee-based. As a fee-based advisor, you don’t get to take a holiday from acting in the client’s best interests when discussing insurance. We also know many fee-only advisors who partner with an insurance professional to address their client’s protection needs. This model works very well because agents who only sell insurance tend to be specialists and know a lot about the ever-changing product options.
Both of us are fee-based, not fee-only. We recognize the critical role insurance plays in a well-balanced portfolio and will advise our clients about the best products for their needs. It is not exactly rocket surgery. After all, we figured it out—that any sound financial plan rests on five pillars:
Five Pillars of Financial Planning
1. Investments and savings
2. Retirement
3. Risk management
4. Estate planning
5. Tax planning
For each client, we do a deep dive into each pillar and ensure they’re firing on all cylinders. That discovery process includes insurance—most fee-only advisors ignore it; some will analyze their client insurance and refer out to get policies as needed.
We’ve taken a tangent in our discourse on the difference between a commissioned agent and a fee-based (or fee-only) advisor, but there is one more important reason to prefer the fee arrangement.
There, you have the three broad categories of financial professionals. Within that, a few distinctions are worth understanding regarding the types of financial companies an advisor might affiliate with.
Typically, insurance agents work under an insurance company, but you can also be a financial advisor and offer advisory services, just like Carmine did. They get excellent training in their products but no others. They face voluminous product sales requirements to maintain their contracts and benefits, and because they work for large bureaucracies, there are extreme limitations on the agility of their technology.
Insurance companies are financial services companies that trade in various financial products, such as annuities, mutual funds, and other securities. Agents are salespeople first. They are also not fiduciaries; they work on commissions. Advisors at insurance companies are fiduciaries to their clients but only on advisory services, not with insurance sales. In fact, the company Carmine was affiliated with allowed you to become an advisor (work in your client’s best interest) only if you sold enough of their insurance products.
These are full-service brokerages that provide a comprehensive range of services, such as investment banking, trading, and wealth management. Clients’ assets are custodied at the wirehouse, and advisors are typically considered employees of the wirehouse or bank. The company disseminates research and financial information and provides a chassis on which all advisors can add customized products for clients. These companies offer proprietary products in addition to cross-selling various other financial instruments. The advantage for the consumer is that they can purchase multiple financial products through one broker. Yet, they must come from the wirehouse’s menu of services even if a product outside that menu best serves the client.
From the employee’s standpoint, wirehouses offer security and a solid foundation from which to work. But brokers pay for that security, capturing, on average, 40 percent of their revenue.4
These asset managers usually have their Series 7 licenses, allowing them to sell commissionable products like annuities and mutual funds and still offer advisory services. To do so, they must affiliate with a broker-dealer. This affiliation is comparable to a franchise arrangement or a real estate broker situation, where the financial advisor is independent but has the power of the broker-dealer/RIA behind them. We will get into this more in chapter 3, but this hybrid model is a good alternative for those who want to work independently but prefer the security of the mothership. In this environment, your regulatory requirements must check the box for FINRA and the Securities and Exchange Commission (SEC).
RIAs must, by law, act in a fiduciary capacity and thus are held accountable for working unconditionally for the client’s best interests, even at the short-term expense of their own financial interests. RIAs must register with the SEC or their state securities regulator and disclose any possible conflicts of interest to their clients. RIAs have more autonomy than everyone. These financial advisors are true fee-based/fee-only client advocates who must obtain Series 65 or 66 licenses to practice their trade. There is no broker-dealer relationship and no commissions paid for investment vehicles.
A couple, ages forty-five and forty-three, comes to us with minimal assets but three kids to put through college. They want to know how to save enough to pay for school and still retire. This question is ridiculous in one sense—think about the pathology in an educational system where college costs six figures—but an important one, especially if you want your children to have opportunities in our knowledge-based economy. Furthermore, given the state of Social Security and the size of our nation’s debt load, saving robustly for retirement is more imperative than ever.
The first thing we do is collect data because no matter what customer-focused business you’re in—therapy, real estate, website design, car sales, whatever—the first and most crucial step is to listen to the client and understand their needs and desires. We do a top-to-bottom assessment of their financial statement, giving them a clear and unadulterated State of the Union address. After the evaluation, everyone is on the same page about where they stand. This first step is undoubtedly necessary because if your GPS doesn’t know where you are, it can’t give you directions to where you’re going.
The next step is to determine the destination. What does the client want to achieve? What is critical, and what would merely be nice to have? How much are they willing to sacrifice or risk to get there? Again, this is important because if you don’t know where you are going, any road will get you there.
Once we have a precise picture of the destination, we can reverse engineer the savings and investments most likely to help them reach those goals. The client may not love what we find—many people who have not yet begun planning their financial lives find themselves with substantial work to do to reach their goals. But at least we clarify how far behind they are and what will be required to get there.
We have a proprietary tool that automates some of this process that we call RISE—Right fit, right vision (to ascertain up front whether we’re the right advisors for them), Initial analysis, Strategy, and Execution. We run Monte Carlo simulations to determine the probability in percentage terms that they will succeed in reaching their goals. By enunciating for our clients the roadblocks they will face, guiding them to wise decision-making as conditions change, and offering our expertise about the best mix of savings, investments, and protection to suit their needs, we achieve great fulfillment when their starting point of 0 percent chance of success turns into a high probability thanks to our established plan.
We do not tell our clients what to do with their money. Our job is to show them the full array of options, help them understand the impact of their decisions, offer guidance when they request it, and execute their decisions in the most efficient manner possible. Of course, our job is never-ending because the only constant in life is change.
In the case of the couple above, they were like many new clients who entered with a 0 percent chance of success, given what they had been doing to plan their financial future, which was mostly nothing. Starting at that age, with children already in middle and high school, presents daunting challenges and almost guarantees that the children will not be going to out-of-state or private universities absent substantial scholarships. But as things currently stand, if they follow our plan, which they seem inclined to do, they have a better than 80 percent chance of success.
No one is ever at 100 percent because family tragedy can interfere, Social Security could disappear, taxes could double, the dollar’s value could collapse, and a whole host of even harder-to-envision circumstances could divert their plan from success. But notwithstanding some black swan events, they are in good shape.
Now that my colleagues and I have developed a relationship with the couple, connected on LinkedIn, seen photos of their kids, and followed their achievements now that we consider them friends and clients, the fees we will earn from their business will pay the bills. Still, the gratitude we feel knowing that we have the expertise to help them achieve their personal goals fills our souls. We were earning the fees the old way but losing our souls. This approach feels so much better.
There’s more than one way to find a better life after being hired by a big firm. Determining the best way for you will take an honest look at what’s out there and what you’ll be happier doing. We’ll break it all down in the next chapter.